Not so long ago a successful company was simply one that was profitable. How that company was managed, the ethics of its owners and management were simply of no interest or consequence to the public at large.
Things have changed in the last couple of decades. It is no longer enough for a company to merely be profitable; it also needs to show good corporate citizenship through a whole host of practices and policies like environmental awareness, ethical behavior and sound corporate governance practices.
Interest in the corporate governance practices of modern corporations, particularly in relation to accountability, increased dramatically following the high-profile collapses of a number of large corporations during the early 2000s, most of which involved accounting fraud; and then again after the recent financial crisis in 2008.
Continuing corporate scandals in various forms have sustained both public and political interest in the regulation of corporate governance.
In the U.S., the major scandals include Enron and MCI Inc. (formerly WorldCom). Their demise was the driver for the U.S. federal government passing the Sarbanes-Oxley Act (SOX) in 2002. This piece of legislation was intended to restore the public’s confidence in corporate governance.
Similar corporate governance failures in other countries such as Parmalat in Italy and Siemens in Germany stimulated increased regulatory and legal interest.
This article is a brief introduction to Corporate Governance. In it we are going to look at its definition, its foundations and its core principles.
Corporate governance in a broad sense is the mechanisms, processes and relations through which corporations, businesses, organizations, company’s or firms are controlled and directed. To make life simpler I will refer to all of these different organizations as ‘corporations’.
Corporate governance can be defined simply as “a system of rules, practices and processes by which a corporation is directed and controlled”.
In essence corporate governance involves balancing the interests of the many stakeholders in a corporation. These stakeholders include its shareholders, management, customers, suppliers, financiers, government and the wider community.
We can take this definition and expand it, taking it to the next level to provide greater granularity. Doing this our original definition of corporate governance can be expanded as follows;
“A system of rules, practices and processes by which a corporation is directed and controlled,
- with the focus on internal and external corporate structures with the intention of,
- monitoring the actions of management and directors and thereby,
- managing agency risks which may arise from the misdeeds of corporate officers”.
Governance structures identify the distribution of rights and responsibilities among different participants in the corporation.
Who are these participants? Generally (but not exclusively), these include the board of directors, managers, shareholders, creditors, auditors, regulators, and other ‘interested’ parties (who are referred to as ‘stakeholders’). This also includes the rules and procedures for making decisions in corporate affairs.
Corporate governance processes through which corporations' objectives are set and pursued are in the context of the social, regulatory and the market environments.
Governance mechanisms include monitoring the actions, policies and decisions of corporations and their agents.
The agency risk mentioned in the expanded definition is the risk that the management of a corporation will use its authority to benefit itself rather than shareholders. An example is that of directors or managers who may elect to pay themselves higher salaries, which increases overhead, rather than to pay out extra profits as dividends. In a more sinister example, these directors or managers may actually steal the business' money.
Corporate governance practices are affected by attempts to match up the interests of all stakeholders.
Current deliberations on corporate governance tend to refer to various principles that have been set out in a number of documents that have been published since 1990. There are three core ‘source’ documents for Corporate Governance Principals.
These documents are;
- The United Kingdom’s Cadbury Report of 1992,
- The OECD Principles of Corporate Governance (1998 and 2004), and
- The United States Sarbanes-Oxley Act of 2002.
The Sarbanes-Oxley Act, is an attempt by the United States federal government to transpose several of the principles recommended in the Cadbury and OECD reports into Federal law.
There are five core principals in the area of corporate governance. We will briefly examine each of these five principles in greater detail.
Rights and equitable treatment of shareholders
Corporations should respect the rights of shareholders and assist shareholders to exercise those rights. Shareholders can be helped to exercise their rights by open and effective communicating of information and by encouraging them to participate in general meetings of the corporation.Interests of other stakeholders
Corporations should recognize that they have legal, contractual, social, and market driven obligations to non-shareholder stakeholders. Included in this category are employees, investors, creditors, suppliers, local communities, customers, and policy makers.Role and responsibilities of the board of directors
The board needs sufficient relevant skills and understanding to review and challenge management performance. The board also needs to be of adequate size and have the appropriate levels of independence and commitment.Integrity and ethical behavior
Integrity should be a fundamental requirement in choosing corporate officers and board members – there should be no exceptions to this rule. Corporations should develop, publish and explain a code of conduct for their directors and executives that promotes ethical and responsible decision making.Disclosure and transparency
Corporations should clarify and make publicly known the roles and responsibilities of board of directors and management to provide stakeholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the corporations should be timely and balanced to ensure that all investors have access to clear, factual information.In this article I have provided a brief introduction into Corporate Governance, what it is and the tools that are used to facilitate its execution as well as the five core corporate governance principles.