Governance and Responsibility

What is corporate governance?

Lisa Mary Thomson, ET Bureau Jan 18, 2009, 12.19am IST

Corporate governance refers to the set of systems, principles and processes by which a
company is governed. They provide the guidelines as to how the company can be directed or
controlled such that it can fulfil its goals and objectives in a manner that adds to the value of the
company and is also beneficial for all stakeholders in the long term. Stakeholders in this case
would include everyone ranging from the board of directors, management, shareholders to
customers, employees and society. The management of the company hence assumes the role of
a trustee for all the others.

From Wikipedia, the free encyclopedia

Corporate governance is most often viewed as both the structure and the relationships which
determine corporate direction and performance. The board of directors is typically central to
corporate governance. Its relationship to the other primary participants, typically shareholders
and management, is critical. Additional participants include employees, customers, suppliers,
and creditors. The corporate governance framework also depends on the legal, regulatory,
institutional and ethical environment of the community. Whereas the 20th century might be
viewed as the age of management, the early 21st century is predicted to be more focused on
governance. Both terms address control of corporations but governance has always required an
examination of underlying purpose and legitimacy. – – James McRitchie, 8/1999

Corporate governance is “accountability to providers of capital.” — Bruce Weber, dean of the

Lerner College of Business at the University of Delaware, at the inaugural meeting in November
of the newly reconstituted advisory board for the John L. Weinberg Center for Corporate
Governance.

Corporate governance is about “how investors get the managers to give them back their money”
(Shleifer & Vishny, “A Survey of Corporate Governance,” Journal of Finance 52(2) 1997: 738)

Corporate governance is gathering together a group of smart, accomplished people around a

board table to make good decisions on behalf of the company and its stakeholders. — As We
Start Anew, Jim Kristie, editor and associate publisher of Directors & Boards.

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Generally, corporate governance refers to the host of legal and non-legal principles and practices
affecting control of publicly held business corporations. Most broadly, corporate governance
affects not only who controls publicly traded corporations and for what purpose but also the
allocation of risks and returns from the firm’s activities among the various participants in the
firm, including stockholders and managers as well as creditors, employees, customers, and even
communities. However, American corporate governance doctrine primarily describes the control
rights and related responsibilities of three principal groups:

1. the firm’s shareholders, who provide capital and must approve major firm transactions,
2. the firm’s board of directors, who are elected by shareholders to oversee the management
of the corporation, and
3. the firm’s senior executives who are responsible for the day today operations of the
corporation.

In broad terms, corporate governance refers to the way in which a corporations is directed,
administered, and controlled. Corporate governance also concerns the relationships among the
various internal and external stakeholders involved as well as the governance processes
designed to help a corporation achieve its goals. Of prime importance are those mechanisms and
controls that are designed to reduce or eliminate the principal-agent problem. (H. Kent Baker
and Ronald Anderson, Corporate Governance: A Synthesis of Theory, Research, and Practice ,
2010)

The system by which companies are directed and controlled. (Sir Adrian Cadbury, The
Committee on the Financial Aspects of Corporate Governance)

“Corporate Governance is concerned with holding the balance between economic and social
goals and between individual and communal goals. The corporate 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” (Sir Adrian Cadbury in ‘Global Corporate Governance
Forum’, World Bank, 2000)

The process by which corporations are made responsive to the rights and wishes of stakeholders.
(Demb and Neubauer, The Corporate Board: Confronting the Paradoxes )

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Corporate governance describes all the influences affecting the institutional processes, including
those for appointing the controllers and/or regulators, involved in organizing the production and
sale of goods and services. Described in this way, corporate governance includes all types of
firms whether or not they are incorporated under civil law. – Shann Turnbull

Corporate governance is about “the whole set of legal, cultural, and institutional arrangements
that determine what public corporations can do, who controls them, how that control is
exercised, and how the risks and return from the activities they undertake are allocated.” –
Margaret Blair, Ownership and Control: Rethinking Corporate Governance for the Twenty-First
Century, 1995.

Corporate governance is the relationship among various participants [chief executive officer,
management, shareholders, employees] in determining the direction and performance of
corporations” – Monks and Minow, Corporate Governance , from 1995 version.

Corporate governance deals with the way suppliers of finance assure themselves of getting a
return on their investment. – Shleifer and Vishny, 1997.

The OECD Principles of Corporate Governance states:

"Corporate governance involves a set of relationships between a company’s management, its

board, its shareholders and other stakeholders. Corporate governance also provides the
structure through which the objectives of the company are set, and the means of attaining those
objectives and monitoring performance are determined."

While the conventional definition of corporate governance and acknowledges the existence and
importance of 'other stakeholders' they still focus on the traditional debate on the relationship
between disconnected owners (shareholders) and often self-serving managers. Indeed it has been
said, rather ponderously, that corporate governance consists of two elements:

1. The long term relationship which has to deal with checks and balances, incentives for
manager and communications between management and investors;
2. The transactional relationship which involves dealing with disclosure and authority.

This implies an adversarial relationship between management and investors, and an attitude of
mutual suspicion. This was the basis for much of the rationale of the Cadbury Report, and is one

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of the reasons why it prescribed in some detail the way in which the board should conduct itself:
consistency and transparency towards shareholders are its watchwords.

What are the principles underlying corporate governance?

Corporate governance is based on principles such as conducting the business with all integrity
and fairness, being transparent with regard to all transactions, making all the necessary
disclosures and decisions, complying with all the laws of the land, accountability and
responsibility towards the stakeholders and commitment to conducting business in an ethical
manner. Another point which is highlighted in the SEBI report on corporate governance is the
need for those in control to be able to distinguish between what are personal and corporate funds
while managing a company.

Why is it important?

Fundamentally, there is a level of confidence that is associated with a company that is known to
have good corporate governance. The presence of an active group of independent directors on
the board contributes a great deal towards ensuring confidence in the market. Corporate
governance is known to be one of the criteria that foreign institutional investors are increasingly
depending on when deciding on which companies to invest in. It is also known to have a positive
influence on the share price of the company. Having a clean image on the corporate governance
front could also make it easier for companies to source capital at more reasonable costs.
Unfortunately, corporate governance often becomes the centre of discussion only after the
exposure of a large scam.

Separation of Ownership and Control

The corporation, in contrast, for example, to a partnership, separates ownership from operational
control - this concept is, of course, fundamental to any definition of corporate governance and is
commonly referred to as the agency issue, or Agency Theory. It is this separation which creates
the need for systems of independent monitoring and control. Historically, it was the freedom that
this separation created to take much bigger risks in order to expand that prevented for so long the
permission of such organisations to exist, with the potential dangers it implied. And it is this
freedom which has required mechanisms to be constructed to try and prevent it being abused.

Summary

A number of comments can be made about the above definitions of corporate governance:

a) The management, awareness, evaluation and mitigation of risk are fundamental in all
definitions of good governance. This includes the operation of an adequate an adequate and
appropriate system of control.

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b) The notion that overall performance is enhanced by good supervision and management
within set best practice guidelines underpins most definitions.
c) Good governance provides a framework for an organization to pursue its strategy in an
ethical and effective way and offers safeguards against misuse of resources, human,
financial, physical or intellectual.
d) Good corporate governance is not just about externally established codes, it also requires a
willingness to apply the spirit as well as the letter of the law.
e) Good corporate governance can attract new investment into companies, particularly in
developing nations. It enhances shareholder trust.
f) Accountability is generally a major them in all governance frameworks, including
accountability not just to shareholders but also other stakeholders, and accountability not just
by directors but by auditors as well.
g) Corporate governance underpins capital market confidence in companies and in the
government/regulators/tax authorities that administer them. It helps protect the value of
shareholders’ investment.

Corporate Governance Concepts

1. Fairness

Directors’ deliberations, systems and values that underlie the company must be balanced by
taking into account everyone who has legitimate interest in the company, and respecting their
rights and views. In many jurisdictions, corporate governance guidelines reinforce legal
protection for certain groups such as minority shareholders.

2. Transparency

Open and clear disclosure of relevant information to shareholders, also not concealing
information when it may affect decision making. It means open discussion and a default position
of information provision rather than concealment. Disclosures required by law or regulation and
also voluntary disclosure. Transparency helps resolve the agency problem – conflict of interest
between owners and managers. Other than effective disclosure rules, strong internal controls are
necessary to ensure that the disclosed information is reliable. Published information must be true
and fair, with supporting explanations.

Concealment may be justified to protect company strategy to maintain competitive advantage. In

as much as transparency must be achieved, confidentiality must also be observed.

3. Innovation

Innovation required since needs of businesses and stakeholders can change over time.

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4. Skepticism

ISA 200 definition: “an attitude that includes a questioning mind, being alert to conditions which
may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence.” In assessing management decisions and evidence, an open and enquiring mind must
always be employed.

5. Independence

Avoidance of being unduly influenced by vested interests and being free from any constraints
that would prevent a correct course of action being taken. It is an essential component of
professionalism and professional behavior.

• Independence of mind – providing an opinion without being affected by influences

compromising judgment.

• Independence of appearance – avoiding situations where an informed third party could

reasonably conclude that an individual’s judgment would have been compromised. Other than
being independent, you must also be seen to be independent.

Be free from conflicts of interest.

6. Probity/honesty

Telling the truth. Not misleading the shareholders and all other stakeholders. No taking bribes
and reporting information in a slated way that is meant to give an unfair impression.

7. Responsibility

Management must accept credit or blame for governance decisions. There must be clear
definition of roles and responsibilities of senior management. King report stresses the need for
systems to allow for corrective action and penalizing mismanagement. All board decisions must
be in the best interest of all stakeholders – Employees, customers, creditors, government,
shareholders, public etc.

8. Accountability

The organization must be answerable for all its actions. Directors must be answerable to
shareholders e.g through provision of information through financial statements on annual basis
and at annual general meetings. Investors really want to know that directors are acting to their
best interest. Hence, corporate governance codes have been developed following a number of
corporate scandals that have occurred in the past.

9. Reputation

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How other view a person or organization. It also includes reputation for competence, quality and
reliable goods, timely service, being managed in an orderly way.

Poor reputation has consequences such as:

• Suppliers and customs not willing to deal with the organization;

• Failure to attract and/or retain high-quality staff;

• Fall in demand due to consumer boycotts;

• Increased public relations costs;

• Loss of market value due to fall in investor confidence; etc.

10. Judgment

The board should make decisions that enhance the prosperity of the organization in order to
achieve the objective of profit maximization. Therefore, the board must have a thorough
understanding of the business and its environment to be able to provide meaningful direction to
it. Hence, care must be excised in recruitment and training of directors. Directors must bring
multiple conceptual skills to management to maximize long term returns. Risk management must
be employed in decision making.

11. Integrity

“….means straightforward dealing and completeness. What is required of financial reporting is

that it should be honest and that it should present a balanced picture of the state of the company’s
affairs. The integrity of reports depends on the integrity of those who prepare and present them.”
Cadbury report.

Integrity means someone of high moral character, who sticks to strict moral or ethical principles
no matter the pressure to act centrally. In working life, it means adhering to the highest standards
of professionalism and probity. Straightforwardness, fair dealing and honesty in relationships
with the different people and constituencies who you meet are particularly important.

Generally there is need for personal honesty and integrity of preparers of accounts. This goes
beyond adhering to accounting or ethical guidelines.

Integrity is an essential principle of the corporate governance relationship particularly in

relationship to representing shareholder interests and exercising agency.

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