The theory of corporate governance is based on the idea that self-interested managers may take actions that benefit themselves with the cost of these actions borne by shareholders and stakeholders.  This is called the "agency problem"(because managers are "agents" of the shareholders) and the costs resulting from this problem "agency costs."

Examples of agency costs include:

• Inflated compensation and/or excessive corporate perquisites
• Not putting in the time and effort to find investments that increase shareholder value
• Manipulating financial results to increase the size of a bonus or stock price
• Excessive risk taking to boost short-term results and bonuses
• Failure to groom successors so that managers become “indispensable” to the organization
• Pursuing uneconomic acquisitions for the sake of managing a larger enterprise
• Thwarting a hostile takeover attempt to protect a job

To lessen agency costs, a system of corporate governance is put in place.  At a minimum, a governance system includes a board of directors to oversee management and an external auditor to review financial statements.  In practice, governance systems are much broader and include the influence of all stakeholders in the company: shareholders, creditors, employees, customers, suppliers, investment analysts, the media, and regulators. 

In evaluating governance systems, stakeholders should keep in mind that:

• More is not always better.  Governance systems should be economically efficient, meaning they should cost less than the agency costs they are preventing.
• There are no universal "best practices."  Governance systems should be designed to meet the needs of the individual company, based on its industry, strategy, competitive positioning, culture, and local regulations.

Key Dates in U.S. Corporate Governance History

1933–1934
In the wake of the 1929 market crash and the Great Depression, Congress creates the Securities Act of 1933, which requires registration and disclosures about stocks and bonds being sold to investors, and prohibits deceit in the sale of securities. The Securities Exchange Act of 1934 creates the Securities and Exchange Commission as the nation’s securities industry regulator.

1968
The Williams Act imposes new rules on tender offers for companies by requiring bidders to pay the same price to all shareholders and disclose the source of cash. It also gives shareholders time to make up their minds.

1970s
States pass anti-takeover laws requiring more notice and giving state regulators power to delay takeovers. Many laws are later struck down by the U.S. Supreme Court.

Mid-1980s
Institutional Shareholder Services and the Corporate Library are formed to create corporate governance ratings and analysis of publicly traded companies.

1993
Section 162(m) of the Internal Revenue Code forbids corporations from deducting from their taxes compensation over $1 million for the CEO and top four executives unless that compensation is performance based.

2002
After Enron and WorldCom implode, the Sarbanes-Oxley Act imposes new rules on boards of directors, new disclosure and personal liabilities on CEOs and CFOs, and more recording and testing of corporate risk factors.

2006
The Securities and Exchange Commission considers broad new disclosures about executive pay, including details of severance and retirement plans and perquisites.
Sources: Websites of the Securities Industry Association, Institutional Shareholder Services, the Corporate Library, and the Securities and Exchange Commission.

2010
Dodd-Frank Wall Street Reform and Consumer Protection Act. An Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end "too big to fail", to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes (includes legislation on corporate governance features).