BUMA 20033 (Good Governance and CSR): Module 3

Topic: Corporate Governance and Ethical Considerations

References: Investopedia, Google, Scribd Files, Personal notes of the instructor from his
Bachelor and MBA degree

I. Learning Objective

1. Identify and Explain the different normative ethical theories commonly used
in business decision making.

II. Contents

1. Elements and Concepts of Corporate Governance

2. Corporate Governance and the Agency Theory
3. Corporate Governance and the Stewardship Theory
4. Corporate Governance and Stakeholder Theory
5. Individual and Situational Influences on Ethical Behavior
6. Potential Problems in Corporate Governance

III. Elements and Concepts of Corporate Governance

 Concept

o Corporate governance is the system of rules, practices, and processes

by which a firm is directed and controlled.

o Corporate governance essentially involves balancing the interests of a

company's many stakeholders, such as shareholders, senior
management executives, customers, suppliers, financiers, the
government, and the community.

o Since corporate governance also provides the framework for attaining

a company's objectives, it encompasses practically every sphere of
management, from action plans and internal controls to
performance measurement and corporate disclosure.

o Bad corporate governance can cast doubt on a company's operations

and its ultimate profitability.

o A company's board of directors is the primary force influencing

corporate governance.

 Elements – 6 Elements of Effective Corporate Governance According to

Aimee B. Forsythe, CFA, July 24, 2018.

1. Director independence and performance

 The most effective boards have a majority of independent directors

who are able to supervise company management and independent
committees for the benefit of shareholders.
2. Focus on diversity

 Studies have shown that companies with more diversified boards are
more risk averse, have less volatile stock returns, and are more likely
to pay dividends. So, it can be argued that diversity by gender, age, and
minority representation should be a key goal for the composition of
every company’s board and senior management ranks.

3. Regular compensation review and management

 Pay should be aligned with performance, with an emphasis on the long

term.

 Avoid “paying for failure,” by avoiding guaranteed compensation and

excessive severance packages.

 Create an independent compensation committee for effective oversight.

 Ensure transparent and comprehensive compensation disclosures.

 Manage payments made to nonexecutive directors. Overpaid

nonexecutive directors may not make independent judgments on
managers’ compensation and performance.

4. Auditor independence and transparency

 Auditors should be independent (with no financial interest in a

company) with the majority of their revenues derived from audit
activities, not consultation services.

5. Shareholders rights and takeover positions

 Investors should consider shareholder rights as a key element of good

governance as well.

 Do all shareholders hold equal voting rights or is one share class

advantaged over the other?

 Do shareholders have access to place proposals on proxy ballots or

nominate directors?

 What actions can a board take without shareholder approval, such as

amending company bylaws?

6. Proxy voting and shareholder influence

 Shareholders must have the ability to use their votes to send a message
to the board by withholding votes for the directors in cases where the
 company has delayed taking action on winning shareholder proposals,
failed to deal with a director’s poor performance, or did not improve
board accountability and oversight.

IV. Corporate Governance and the Agency Theory

 Agency Theory

Agency theory is used to understand the relationships between agents and

principals.

The agent represents the principal in a particular business transaction and is

expected to represent the best interests of the principal without regard for self-
interest.

The different interests of principals and agents may become a source of

conflict, as some agents may not perfectly act in the principal's best interests.

The resulting miscommunication and disagreement may result in various

problems and discord within companies. Incompatible desires may drive a
wedge between each stakeholder and cause inefficiencies and financial
losses. This leads to the principal-agent problem.

The principal-agent problem occurs when the interests of a principal and

agent come into conflict. Companies should seek to minimize these situations
through solid corporate policy. These conflicts present normally ethical
individuals with opportunities for moral hazard. Incentives may be used to
redirect the behavior of the agent to realign these interests with the principal's
concerns.

V. Corporate Governance and the Stewardship Theory

The steward theory states that a steward protects and maximizes shareholders
wealth through firm Performance.

Stewards are company executives and managers working for the shareholders,
protects and make profits for the shareholders.

The stewards are satisfied and motivated when organizational success is attained.
It stresses on the position of employees or executives to act more autonomously so
that the shareholders’ returns are maximized. The employees take ownership of
their jobs and work at them diligently.

VI. Corporate Governance and the Stakeholder Theory

Stakeholder theory incorporated the accountability of management to a broad

range of stakeholders.
 It states that managers in organizations have a network of relationships to serve –
this includes the suppliers, employees and business partners.

The theory focuses on managerial decision making and interests of all

stakeholders have intrinsic value, and no sets of interests is assumed to dominate
the others

VII. Individual and Situational Influences on Ethical Behavior

 Internal Factors

1. Knowledge
2. Values
3. Personal Goals
4. Morals
5. Personality

 External Factors

1. Environment
2. Peers, Friends, Family Members,
3. Colleagues
4. Leaders

VIII. Potential Problems in Corporate Governance (According to J.Muir &

Associates, A business law firm)

1. Conflict of Interest

 Avoiding conflicts of interest is vital. A conflict of interest within the

framework of corporate governance occurs when an officer or other
controlling member of a corporation has other financial interests that
directly conflict with the objectives of the corporation.

For example, a board member of a solar company who owns a

significant amount of stock in an oil company has a conflict of interest
because, while the board he or she serves on represents the
development of clean energy, they have a personal financial stake in
the success of the oil industry.

When conflicts of interest are present, they deteriorate the trust of

shareholders and the public while making the corporation vulnerable to
litigation.

2. Oversight issues

 Effective corporate governance requires the board of directors to have

substantial oversight of the company’s procedures and practices.
 Oversight is a broad term that encompasses the executive staff
reporting to the board and the board’s awareness of the daily
operations of the company and the way in which its objectives are
being achieved. The board protects the interests of the shareholders,
acting as a check and balance against the executive staff.

Without this oversight, corporate staff might violate state or federal

law, facing substantial fines from regulatory agencies, and suffering
reputational damage with the public.

3. Accountability issues

 Accountability is necessary for effective corporate governance. From

the top-level executives to lower-tier employees, each level and
division of the corporation should report and be accountable to another
as a system of checks and balances. Above all else, the actions of each
level of the corporation is accountable to the shareholders and the
public.
Without accountability, one division of the corporation might endanger
the success of the entire company or cause stockholders to lose the
desire to continue their investment.

4. Transparency

 To be transparent, a corporation must accurately report their profits

and losses and make those figures available to those who invest in their
company.

Overinflating profits or minimizing losses can seriously damage the

company’s relationship with stockholders in that they are enticed to
invest under false pretenses.

A lack of transparency can also expose the company to fines from

regulatory agencies.

5. Ethics violations

 Members of the executive board have an ethical duty to make

decisions based on the best interests of the stockholders.

Further, a corporation has an ethical duty to protect the social welfare

of others, including the greater community in which they operate.
Assessment:

Assume for the moment that you will be chosen to serve as the CEO of a prestigious
marketing firm in the Philippines. This indicates that both internal and external stakeholders
have confidence in your ability to lead the business. How will you, as CEO, protect the
interests of all stakeholders? Explain comprehensively.
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