Importance of Corporate

Governance

By
Resham Raj Regmi
Advocate
[email protected]
 What is inside?
• Contribution of CG in corporate level.
• Contribution of CG to different
stakeholders.
• Contribution of CG toward economic
development.
• International effects.
 For A Corporation
• Corporate Governance helps to;
– Enhance better relationship with different
stakeholders
– Ease the access to finance
– Better operational management
– Enhance reputation
– Enhance performance
 For Stakeholders
• Different stakeholders get returns
differently;
– Shareholders – more return in investment and
empowerment
– Creditor – timely return and empowerment
– Employee – return, encouragement and participation
– Government – increased tax, employment, economic
activities
– General public – responsible business and shared
benefit of natural and local resources
 For Nation
From national perspective contribution of CG may be as
follows:
• Better access to external finance by firms, which in turn
can lead to;
– Larger investments,
– Higher growth, and
– Greater employment creation.
• Lower costs of capital and higher firm valuation, which
make;
– Investments more attractive to investors and
– Lead to growth and more employment.
 ....continue
• Improved strategic decision making and operational
performance, through better allocation of resources and
more efficient management, which create wealth more
generally.
• Reduced risk of corporate crises and scandals, a
particularly important outcome given the potentially large
economic and social costs of financial crises.
• Better relationships with stakeholders, which improve
social and labour relationships, help address such issues
as environmental protection, and can help further reduce
poverty and inequality.
 Increase access to financing
• Financial and capital markets are better
developed in countries with strong protection of
property rights,
• In countries with better property rights, firms
thus have greater access to financing
• Better creditor rights have been shown to be
associated with deeper and more developed
banking and capital markets,
• A similar relationship exists between the quality
of shareholder protection and the development
of countries’ capital markets.
 Continued.
There is also evidence that under
conditions of poor corporate governance
(and underdeveloped financial and legal
systems and higher corruption), the growth
rate of the smallest firms is the most
adversely affected, and fewer new firms
start up—particularly small firms. (Beck,
Demirgüç-Kunt, and Maksimovic 2002;
Rajan and Zingales 1998).
 Higher firm valuation

• The quality of the CG framework affects

not only the access to and amount of
external financing, but also the cost of
capital and firm valuation.
• Outsiders are less willing to provide
financing and are more likely to charge
higher rates if they are less assured that
they will get an adequate rate of return.
 Continued.
• The cost of capital has been shown to be higher
and valuation lower in weaker property rights
countries (La Porta and others 2000).
• Investors also seem to apply a discount in their
valuation for firms and countries with relatively
worse corporate governance.
• in countries with weaker property rights,
controlling shareholders also obtain a fraction of
the value of the firm that exceeds their direct
ownership stake, at the expense of minority
shareholders.
 Better operational performance
• The way better corporate governance can add
value is by improving the performance of firms,
whether through more efficient management,
better asset allocation, better labor policies, and
similar efficiency improvements.
• Better corporate governance leads not only to
improved rates of return on equity and higher
valuation, but also to higher profits and sales
growth.
 Reduced risk of financial crises
• The quality of corporate governance can also
affect firms’ behavior in times of economic
shocks and actually contribute to the occurrence
of financial distress, with economy wide impacts.
• Corporate governance can play an important
role in determining individual firms’ behavior, in
particular the incentives of insiders to
expropriate minority shareholders during times
of distress.
• Firm-level evidence consistent with the view that
corporate governance helps explain firm
performance during a financial crisis.
 Better Relationships with all
Stakeholders
• Besides the principal owner and management,
public and private corporations must deal with
many other stakeholders, including banks,
bondholders, labor, and local and national
governments.
• Each of these monitor, discipline, motivate, and
affect the management and the firm in various
ways.
• Two forms of behavior can be distinguished in
CG issues related to other stakeholders:
stakeholder management and social issue
participation.
 Continued.
• For the first category, the firm has no choice but
to behave “responsibly” to stakeholders: they
are input factors without which the firm cannot
operate; and these stakeholders face alternative
opportunities if the firm does not treat them well.
• Whether participation in social issues is also
related to good firm performance is less clear.
Involvement in some social issues carries costs.
 How does CG Affect Growth and
Development
• CG increase access to external financing.
This in turn can lead to larger investment,
higher growth, and greater employment
creation.
• CG lowers the cost of capital and
associated higher firm valuation. This
makes more investments attractive to
investors, also leading to growth and more
employment.
 Continued.
• CG enhance better operational performance
through better allocation of resources and better
management. This creates wealth more
generally.
• CG can be associated with a reduced risk of
financial crises. This is particularly important, as
financial crises can have large economic and
social costs.
• Good CG means generally better relationships
with all stakeholders. This helps improve social
and labor relationships and aspects such as
environmental protection.
CG and Related Elements of
Growth
The research on the role of CG for
economic development and well-being is
best understood from the broader
perspective of other foundations for
development, notably:
– The importance of finance,
– The elements of a financial system,
– Property rights,
– Competition.
 The link between finance and
growth
• Finance is one of the measure element of
production. If there is sufficient finance
available in the market certainly the
economic activities will increase
consequently the growth will go up.
• The importance of the financial system for
growth and poverty reduction has been
clearly established by empirical studies
(Levine 1997; World Bank 2001).
 The link between banking and
financial system and growth
• The development of both banking systems
and market finance helps economic
growth.
• Banks and securities markets are
complementary in their functions, although
markets will naturally play a greater role
for listed firms.
 The link between legal foundation
and growth
• The role of legal foundations is now better understood
and documented. Legal foundations matter crucially for a
variety of factors that lead to higher growth, including
financial market development, external financing, and
the quality of investment.
• Legal foundations include property rights that are clearly
defined and enforced and other key regulations
(disclosure, accounting, and financial sector regulation
and supervision).
(La Porta and others 1997, 1998 has imperially proved the
importance of legal foundation in development).
 Competition
• Markets need to function well to prevent
corporate governance problems.
• Markets include all output and input markets,
including labor, raw materials, intermediate
products, energy, and distribution services.
• Firms subject to more discipline in the real factor
markets are more likely to adjust their operations
and management to maximize value added.
• Corporate governance problems are therefore
less severe when competition is already high in
real factor markets.
 CG and Financial System
Soundness
Financial system soundness is necessary for the
overall development of any nation.
This can be affected by different factors like: legal
system, economic policy, regulatory regime,
effectiveness of different principles like corporate
governance, availability of financial and other
resources, etc.
It is also necessary for the prevention of systemic
crisis.
 Systemic Crisis
• A systemic crisis is a situation where an
economy faces large-scale banking and
corporate distress within a short period. It
is typically characterized by large-scale
defaults, sharp increases in nonperforming
loans, and often a general economic
slowdown.
• A systemic crisis involves complicated
coordination problems.
 Nexus of Financial Crisis
• The fate of an individual corporation or financial institution and
the best course of action for its owners and managers will
depend on the actions of many others and the general
economic outlook.
• A crisis is typically aggravated by institutional weaknesses,
many of which likely contributed to the emergence of the crisis
in the first place.
– Bankruptcy and restructuring frameworks are often deficient.
– Disclosure and accounting rules for financial institutions and
corporations may be weak.
– Equity and creditor rights may be poorly defined or weakly
enforced.
– The judicial system is often inefficient.
– The government itself may face credibility problems.
– Corruption may be large.
 Efforts for the Reduction of
Systematic Crisis

• Sound Corporate Governance Practices

• The corporate governance of banks (Basel
Committee Principles)
• The Role of Supervisor
 Sound Corporate Governance
Practices
Different corporate governance principles and
practices are recommended for the prevention of
systematic crisis.
– OECD and ADB principles of corporate governance
are examples of this fact in international level.
– In national level, company law, rules of stock
exchange, directives of the regulator and voluntary
code include different elements of corporate
governance for this.
– In corporate level different firms and corporations
have prepared set of corporate governance for
respective company.
Some Product of Basel Committee
• Basel Core Principle for banking supervision
• Basel Capital Accord
• Basel Capital Accord III (generally known as
Basel III). This includes:
– Minimum Capital Requirements
– Supervisory Review Process
– Market Discipline
• Enhancing Corporate Governance for Banking
Organizations
Corporate Governance and Capital
Market

• Ensuring supportive environment, and

• Other different aspects
 Ensuring Supportive Environment
• By promoting principles of corporate governance
participants of capital markets can promote
corporate governance.
• Different institutional investors and Stock
Exchange are involved for the determination of
corporate governance principles applicable to
them.
• UK Code on Corporate Governance, Rules of
New Work stock Exchange, Clause 49 of listing
agreement in India are some examples of this
fact.
 Ensuring Supportive Environment
• Fair play in market.
• Increased transparency.
• Compliance of rules and regulation.
• Commitment to the principles of corporate
governance.
 Why CG Considered as Burden?
• The analysis so far suggests that better corporate
governance generally pays for firms, markets, and
countries. The question then arises why firms, markets,
and countries do not adjust and adopt voluntarily better
corporate governance measures. The answer is that
firms, markets, and countries do adjust to some extent,
but that these steps fail to provide the full impact.
• The main reasons for lack of sufficient reform are
entrenched owners and managers at the level of firms
and political economy factors at the level of markets
and countries.
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