Midterm Period

Module 2 part 2
GOOD GOVERNANCE ANS SOCIAL RESPONSIBILITY

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GOOD GOVERNANCE AND ETHICS:

“Corporate governance is concerned with holding the balance between economic goals and between individual and
communal goals. The governance framework is there to encourage the efficient use of resources and equally to
require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of
individuals, corporations and society.”
As many companies become bigger and powerful corporate governance remains important. Shareholders need to be
protected from crooked or merely indolent boards pf directors and executives. Same way, the public interest is in
danger when huge companies are misgoverned. Poor corporate governance practices have demoralizing effects on
shareholders and bigger public.
Technically speaking, corporate governance is a system of processes, policies and rules that direct and control an
organization’s conduct for the good management of companies. To create an effective good governance, a system is
required in order to create and sustain good relationship among these people to avoid anyone be cheated or
exploited.
Corporate governance consists of the relationship between the numerous stakeholders involved and the goals for
which the corporation is directed. In modern business corporations, the chief external stakeholder groups are
shareholders, debt holders, trade creditors, suppliers and communities affected by the corporation’s activities.
Internal stakeholders include the board of directors, executives and other employees.
Corporate governance is also a process that aims to apportion corporate resources in a way that enhances value for
all stakeholders such as the shareholders, investors, employees, customers, suppliers, environment and the
community in general. It also holds those at the controls to account by evaluating their decisions on transparency,
inclusivity, equity and responsibility. The World Bank defines governance as the exercise of political authority and
the use of institutional resources to manage society’s problems and affairs. Its main objective is to put an end to the
abusive and somehow unlawful and improper activities of some entrepreneurs and business owners.

Identifiable strategic aims of corporate governance:

1. Ensuring a higher degree of transparency in an organization by encouraging full disclosure of transactions in the
company accounts.
2. Encourages accountability of the management to the company directors and the accountability of the directors to
the stakeholders.
3. Ensures equitable treatment of all stakeholders of the company.
4. Allows firms to evaluate their behavior before they are scrutinized by the regulatory bodies.
5. Its main objective is protect the long-term interests of the stakeholders.

ELEMENTS OF GOOD GOVERNANCE

Corporate governance requires companies to develop and closely monitor comprehensive and robust
programs and mitigate any number of possible risk factors. There are several form of corporate governance
but they generally involve emphasis on creating and maintaining company direction and promoting goodwill with
shareholders and other stakeholders. The key principles of good governance differ depending on the
country, industry, regulator and stock exchange.

Common major characteristics of codes of governance

1. Direction – Providing overall direction for the business, its leaders and employees is a major part of corporate
governance. Making strategic decisions and discussing current and future concerns of the company are
tactics of this element.
2. Oversight – It provides some level of leadership oversight in companies. This ensures that leaders act in the best
interest of shareholders and other stakeholders.
3. Stakeholder relations – Corporate governance encompasses a business’s accountability to each stakeholder
groups. Traditionally, this role has largely centered on investor relations and communication of company
decisions. Investors can often find contact information for board members on company websites.
4. Corporate citizenship – Another major evolution in the early 21 st century that companies commonly include a
corporate citizenship statement on corporate governance or investor relationship web pages. Such
statements communicate the business’s intent to act with social and environmental responsibility. In general,
governance includes an awareness that companies should balance profit-generating activities with responsible
policies and practices.
5. Independence of directors – Independent judgement is almost always in the best interest of the company.
Having a majority of non-executive independent directors will help avoid prejudice and
confl21`1icts of interest between the board and the management. In most cases, if the directors of
the company are also the owners and/or their family members, entrepreneurs appointed by
friends, or individuals who are involved in the daily management of the company, the board is
unlikely to be impartial.

6. Effective risk management – Companies cannot avoid risk, so it is vital to implement effective strategic risk
management.

7. Solid structure and organization – A solid structure and organization within the company is essential to fluidly
implementing and dispersing corporate governance objectives. Companies will need to be able to monitor
all their dealings, interactions, and transactions effectively.
8. Transparency – Transparency helps unify an organization. When employees understand management’s strategies
and are allowed to monitor the company’s financial performance, they understand their roles within the
company. Transparency is also important to the public, who tend not to trust secretive corporations.

9. Self-Evaluation – Mistakes will be made, no matter how well you manage your company. The key is to perform
regular self-evaluations to identify and mitigate brewing problems. Hiring outside consultants to analyze the
operations also can help identify ways to improve a company’s efficiency and performance.

TWO DISTICT APPROACHES TO CORPORATE GOVERNANCE

Corporate governance is all about monitoring and controlling management decisions and strategies all to the best of
the company’s stakeholders.

1. Rules-Based Approach – in a rules-based, all provisions are legal rules, supported by law which attracts
punishment from the law, if there is failure to comply.

Usual characteristic of a rules-based approach:

1. approved set of requirements
2. fast approach of ensuring conformity
3. implements a checklist method
4. clear difference between conformity and non-conformity
5. easy to observe that entity is conforming
6. lessening of flexibility on the part of management and auditors
7. challenging to set rules entirely for all situations
8. likely to misunderstand rules
9. similar rules apply to all, whatsoever their sizes are

Advantages:
1. Companies do not have the choice of ignoring the rules
2. All companies are required to meet the same minimum standards of corporate governance
3. Investor confidence in the stock market might be improved if all the stock market companies are
required to comply with recognized corporate governance rules.

Disadvantages:
1. The same rules might not be suitable for every company, because the circumstances of each company are

different. A system of corporate governance is too rigid if the same rules are applied to all companies.
2. There are some aspects of corporate governance that cannot be regulated easily, such as negotiating the

remuneration of directors, deciding the most suitable range of skills and experience for the board of
directors,
and assessing the performance of the board and its directors.

2. Principles-based Approach – is grounded on the outlook that a distinct set of rules is unfitting for every
company. Circumstances and situations vary from companies to companies. The circumstances of a
company can change every now and then.
In a principles-based jurisdiction, legal force applies to the provisions of company laws but additional
listing rules are enforced on a “comply or explain” basis. If there is a reason of non-compliance, there should
be an explanation for the shareholders.

Common characteristics of a principle-based approach:

1. activities of entities must address major principles set out in codes of best practice
2. not merely a box-ticking application
3. more demanding to avoid than a rules-based approach
4. easy to observe that entity is complying
 5. directors are necessary to work in the entity’s best interest
6. more stretchy, and therefore better able to cope with different situations
7. easier defense for obvious breach of principles
8. but principles maybe construed in different ways

THE AGENCY THEORY

The relationship between the agents and principals in the business is being examined in an agency theory. The agent
represents the principal in a particular business transaction and takes decisions on behalf of the principal in an
agency relationship. Any agent is expected to disregard his self-interest in order to represent the best interest of the
principal.

Due to differing risk viewpoints and business goals, issues may arise around the relationship between the agent and
the principal. Often times, the opposing interests of principals and agents could turn into a cause of conflict because
some agents do not sincerely for the principal’s best interests.

In a corporate set-up, the top executives are usually elected by shareholders. The shareholders are true owners of the
company. An agency relationship exists between the shareholders and the top executives who should act for the best
interests of these owners. Any congruity among the desires of these two parties may causes inefficiencies and
financial losses leading to principal-agent problem. Conflicts arising from agent and the principal relationship
usually pose opportunities for moral threat in order to readdress the behavior of the agent to readjust his interests
with that of the principal’s incentives could be offered to the former. Simply, incentives would encourage agents to
act in agreement with the principal’s interests.

Using agency theory incentives could be designed appropriately by identifying what best motivates agent to act. On
the other hand, incentives that boost wrong behavior should be deleted. Only those incentives and rules that
discourage moral threat should be maintained.

A good example of agency theory is the manner in which a government works. People elect their political
representatives to manage the country in a manner that take advantage of their interests. Normally, representatives
from various political groups make promise of changes to voters. However, most of the times upon assumption of
office the masses find themselves cheated by their elected candidates who would turn out to be corrupt officials. In
this case, the voters stand as principals who elect the government officials to perform as agents. The employees and
employers of an organization also display a common example of agency theory.

Two vital situations which make efforts on resolving agency conflicts:

1. Different risk desire – Shareholders and managers differ in the level of risk they are eager to assume.
Shareholders do not participate in the daily operations of the company. Hence, they do not have full knowledge of
the reasons behind important business decisions. On the other hand, managers are more futuristic and willing
to assume greater risks because of their closeness to important information. They believe in the going-
concern concept of the business and decide for the long-term view of the company in mind. The shareholders
are intensely interested in increasing the present and future value of their investments, whereas the top executives
are highly concerned in the sustainable growth of the company. Therefore, these differences in their interests
and approaches form a sense of suspicion and disagreement.
2. Super self-centered executives – this situation is when the managers are just interested in providing short-term
performance to the owners to obtain their compensation hikes. Generally, this is more common yet very
risky condition.

THE STEWARDSHIP THEORY

A steward is defined as someone who protects and takes care of the needs of others. Under the stewardship
theory, company top executives protect the interests of the owners or shareholders and make decisions on
their behalf. Their sole objective is to create and maintain a successful organization so the shareholders prosper.
Officer(CEO) and Chairman responsibilities under one executive, with a board comprised mostly of in-
house members. This allows for intimate knowledge of organizational operation and a deep commitment to
success.

While profit energize any business, some companies may consider themselves part of something greater.
Stewardship theory holds that ownership does not actually own a company but simply hold it in trust. This
means that profit takes a second priority after meeting a company’s design of honoring a founder’s vision. Often
managers’ seek other ends besides financials which could be in the form of sense of worth, altruism, a good
reputation, a job well-done, a feeling of satisfaction and a sense of purpose.

In the stewardship theory, innately seek to do a good job, maximize company profits and bring good returns
to stockholders because they feel a strong duty to the company. They do this essentially for the interest of the
company and not for their own financial interest.

In corporate governance, during difficult situations faced by the business, it is the requisite that stewardship
governance takes a Chief Executive Officer (CEO) who is dependable and prepared to set his personal
interests only secondary for the interest of the company. Stewardship governance entails choosing the right
personality that would lead the boardroom of the company.

Several models of stewardship theory:

1. operating with as little negative impacts as possible against the environment or the Earth;
2. supporting human and animal rights;
3. abstaining from using products made in sweatshop (business employing workers at low wages, for long
hours, and under poor conditions);
4. renouncing product testing on living subjects; and
5. honoring the belief of several leadership
****Often these models are likely to be subjective, which give management a bit of headache in identifying the
borderline
concerning socially responsible and irresponsible behavior.

Significant applications of stewardship theory in corporate governance:

1. On Business – A company dedicated to a higher purpose will attract customers who believe in similar purpose.
On the other hand, customers continuously compare how the company truly operates against what it talks about
stewardship in its corporate governance. Any gap identified between action and talk will create a big
impact on the customers.
2. On Employees – Company’s stewardship can be clearly seen at an instant by employees on the way they are
treated. Employees may possibly higher expectations when a company operates with profitability as the motive.
Although employees with identical vision would prefer to stay with a company and perform excellently to
attain company’s goals though they may have higher pay in other companies. When employees sense that they ae
part of something greater, a strong and concrete practice of stewardship improves company drive and
determination.
3. On Customers – When customers sense that they are part of something greater, they may likely stay connected
with businesses that are stewardship-driven. Even if the prices for goods or services become higher, they would
remain loyal to these businesses.

STAKEHOLDER THEORY
Stakeholder theory states that the purpose of a business is to create value for wider group stakeholders other
than just shareholders. This theory considers the corporate environment as a network of interconnected
groups, all of which are required to be pleased to sustain the healthy and success of the company in the long-term.
A stakeholder refers to any individual or group of individuals who can affect or be affected by actions done
by a business. It consists of those who work in its stores, those who work and live close to its factories, those
who do business with it, and even of competitors, as the company may form the setting in its industry.
 The stakeholder theory was coined originally by Edward Freeman as he recognized such as an important
element of Corporate Social Responsibility (CSR). Corporate Social Responsibility is a concept that places bigger
responsibilities on companies in the form of economic, legal, ethical or even philanthropic. Freeman’s
theory advocates that a company’s genuine success comes from satisfying all its stakeholders, not only those who
might gain profit from its stock.

The stakeholder theory in corporate governance centers on the effects of corporate activities on all
recognizable stakeholders of the company. This theory suggests that corporate officers and directors must
consider the interests of every stakeholders in its governance practice. It is highly essential that a company
must communicate its corporate governance to make sure that there is a strong relationship between the
community and the investor.

Six principles that must direct the connection between the stakeholders and the corporation according to
Freeman:

1. The principle of entry and exit – there must be a clear-cut and transparent rules and policies such as hiring
employees and terminating their employment.
2. The principle of governance – this principle considers the manner of modifying the rules about the relationship
between the stakeholders and the company.
3. The principle of externalities – this is about how a group that does not gain from the actions of the company has
to undergo some problems because of the said actions. Additionally, it suggests that anybody who has to
shoulder the costs of other stakeholders has the right to turn into a stakeholder too. Somebody who is
affected by a business develops into a stakeholder.
4. The principle of contract costs – each group to a contract should either endure identical amounts when it comes
to cost or the cost they endure should be proportionate to the benefits they have earned in the company. Not
all of these costs are purely financial, so they may be demanding to measure.
5. Agency principle – this principle reflects on the manager of a company as its agent and hence has responsibilities
to the stakeholders and also the shareholders.
6. The principle of limited immortality – this principle ensures the success of the company and its owners
similarly for a longer time period. Although it is impossible for a company to be immortal but it must and can
remain in existence for a length of time.

Categories of stakeholders inside the company:

1. Organizational stakeholders – are those people that are present inside the company. They have a direct interest
on how the company is doing. These stakeholders usually make certain that the company is robust and healthy
to seek advantages and benefits from it. The staff and employees as well as the managers are the main
stakeholders here.
2. Economic stakeholders – the customers in addition to bankers, creditors and suppliers, are the most important
stakeholders. These people function as the essential boundary between the company and the bigger societal
environment. Customers are regarded as very important because without their loyal customers a company
may not even exist.
3. Societal stakeholders – these stakeholders regulate the business setting under which the company function.
Government agencies, regulators, communities and the environment itself are the major players here.
Obviously, a company is required to follow the laws and respect certain issues the society is involved.

Certain general principles of stakeholder theory in business:

1. Rights and equitable treatment of shareholders- shareholders have certain rights which a company must
respect. They should be permitted to use these rights. A company can help shareholders apply their rights by
openly and effectively communicating information and by inspiring shareholders to actively partake in
general meetings.
2. Interest of other stakeholders – companies must know that they have legal, contractual, social and market-
driven responsibilities to non-shareholder stakeholders, such as the employees, investors, creditors, suppliers, local
communities, customers and policy makers.
3. Role and responsibilities of the board – the board requires adequate pertinent skills and understanding to
appraise and challenge management performance. It also needs acceptable size and suitable levels of objectivity and
commitment.
4. Integrity and ethical behavior – in selecting corporate officers and board members one of the fundamental
requirements is integrity. Companies have to fashion a code of conduct for their directors and executives
that encourages ethical and equitable decision making.
5. Disclosure and transparency – companies must explain and make transparent to the public the roles and
responsibilities of board and top management in order to offer stakeholders with a level of accountability.
They should also write and implement distinct procedures to freely authenticate and protect the truthfulness of
the company’s financial reports. There should be timely and balance release of substantial matters about the
company so that investors are sure to receive clear and factual information.

END OF LESSON
MODULE 2 PART 2

References:
Book:
Corporate Social Responsibility and Good Governance in the Millennial Age 2019 by Prof. Angelita Ong Camilar-Serrano, DBA

Online:

Why Your Small Business Needs Good Governance and Accountabilityby Lucy Elizabeth Moffat | Oct 13, 2017
https://growfactor.com/blog/why-your-small-business-needs-good-governance-and accountability/#:~:text=Good%20governance%20is%20when
%20a,including%20customers%2C%20shareholders%20and%20regulators.