THE NATURE OF CORPO-

RATE GOVERNANCE
Chapter 2
 CORPORATE GOVERNANCE

Corporate Governance is a system of processes,

policies and rules that direct and control for the good
management of companies.

Corporate governance consists of the relationship

between the numerous stakeholders involved in the
goal for which the corporation is directed.
 CORPORATE GOVERNANCE

Corporate governance is also a process that aims to apportion corpo-

rate resources in a way that enhances value for all stakeholders, such
as shareholders, investors, employees, customers, suppliers, environ-
ment, and the community in general.

The main objective of corporate governance is to put an end to the

abusive and somehow unlawful and improper activities of some en-
trepreneurs and business owners.
STRATEGIC AIMS OF CORPORATE GOVERNANCE

• Ensuring a higher degree of transparency in an organization by encouraging full dis-

closure of transactions in the company accounts.
• Encourages accountability of the management to the company directors and the ac-
countability of the directors to the shareholders.
• Ensures equitable treatment of all the shareholders of the company.
• Allows firms to evaluate their behavior before they are scrutinized by regulatory bod-
ies.
• Protect the long term interests of the shareholders.
ELEMENTS OF CORPORATE GOVERNANCE

1. Direction – Providing overall direction for the business, its lead-

ers and employees is a major part of corporate governance.
2. Oversight – The corporate governance role also provides some
level of leadership oversight in companies.
3. Stakeholders relations – Corporate governance encompasses a
business’ accountability to each of its stakeholder group.
4. Corporate citizenship – Companies commonly include a corpo-
rate citizenship statement on corporate governance or investor re-
lationships web pages.
 ELEMENTS OF CORPORATE GOVERNANCE

5. Independence of directors – If the directors of a 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 – Even if a company implements smart
policy, competitors might cripple its operations and economy fluctua-
tions might erode the buying capabilities of its target market.
7. Solid structure and organization – A solid structure and organiza-
tion within the company is essential to fluidly implementing and dis-
persing corporate governance objectives.
 ELEMENTS OF CORPORATE GOVERNANCE

8. Transparency – Managers sometimes keep their own counsel, lim-

iting the information that filters down to employees.
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.
 Who is responsible for Corporate Governance?

The board of directors is pivotal for the governance of its company.

The board’s role is to set the company’s strategic direction, provide
the leadership to put those strategies into effect and supervise the
management of the company. Consequently, corporate governance is
about the way the board behaves and how it sets the values of the
business.
 Who is responsible for Corporate Governance?

Shareholders play a role, too, and must actively participate in corpo-

rate governance for it to have any bite. Their role is to appoint the right
directors and approved major decision such as mergers and buyouts.
From legal perspective, corporate governance here in the Philippines
is regulated by Securities and Exchange Commission (SEC).
POTENTIAL CHALLENGES IN CORPORATE GOVER-
NANCE
1. Conflict of Interest – Avoiding conflict of interest is vital. A conflict of inter-
est within the framework of corporate governance occurs when an officer
or other controlling member of a corporation has other financial interest
that directly conflict with the objectives of the corporation.
2. Oversight issues – Effective oversight is a broad term that encompasses
the executive staff reporting to the board and the board’s awareness of
the daily operation of the company and the way in which its objectives are
achieved.
POTENTIAL CHALLENGES IN CORPORATE GOVER-
NANCE
3. Accountability issues – Accountability is necessary for effective corporate
governance. Without accountability, one division of the corporation might en-
danger the success of the entire company or cause the stockholder to lose the
desire to continue the investment.
4. Transparency – in order to be transparent, a corporation must accurately
report its profits and losses and make those figures available to those who in-
vest in their company. A lack of transparency can also expose the company to
fines from regulatory agencies.
POTENTIAL CHALLENGES IN CORPORATE GOVER-
NANCE
5. Ethics violations – members of the executive board have an ethical duty to make decision
based on the best interest of the stockholders.
6. Governance standards – A board should always produce unbiased rules and policies and
disseminate those standards in the business.
7. Short-termism – In order to implement effectively good corporate governance, it must need
boards that can manage the company on continuing years to produce sustainable value for
the company
8. Diversity – Based on good judgement and practicalities, boards should possess a good
combination of skills and perspectives to ensure the success of any organization.
THE TWO DISTINCT APPROACHES TO CORPORATE GOVER-
NANCE

RULES-BASED APPROACH
In a rules-based, all provisions are legally rules, supported by law which attracts punishment from the law,
if there is failure to comply. Here are the usual characteristics of a rules-based approach, namely:
a. Approved set of requirements
b. Fast approach of ensuring conformity
c. Implements a checklist method
d. Clear difference between conformity and non-conformity
e. Easy to observe that entity is conforming
f. Lessening of flexibility on the part of management and auditors
g. Challenging to set rules entirely for all situations
h. Likely to misunderstand the rules
i. Similar rules apply to all, whatsoever their sizes are
THE TWO DISTINCT APPROACHES TO CORPORATE GOVER-
NANCE
Advantage Disadvantage
Companies do not have the choice of ignoring The same rules might not be suitable for every
the rules. 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.
All companies are required to make the same There are some aspects of corporate
minimum standards of corporate governance. governance that cannot be regulated easily,
such as negotiating the remuneration of
directors, deciding the most suitable range of
Investor confidence in the stock market might skills and experience for the board of direc-
be improved if all stock market companies are tors, and assessing the performance of the
required to comply with recognized corporate board and its directors.
governance rules.
THE TWO DISTINCT APPROACHES TO CORPORATE GOVER-
NANCE

PRINCIPLES-BASED APPROACH
Principle-based approach is grounded on the outlook that a distinct set rules is unfitting for every company. Circumstances
and situations vary from companies. The circumstances of a company can change every now and then. Here are the com -
mon characteristics:
1. Activities of entities must address major principles set out in codes of best practices
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 interests
6. More stretchy, and therefore better able to cope with different situations
7. Easier defense for obvious breach of principles
8. But principles may be construed in different ways
THEORIES OF CORPORATE
GOVERNANCE
THE AGENCY THEORY
THE AGENCY THEORY
 What is Agency Theory?
Agency theory is defined as the relationships between principals,
such as shareholders, and agents, such as corporate executives
and managers. The shareholders, who represent the owners or
principals of the business, are said to employ the agents to carry
out tasks. Directors or managers, are the shareholders’ agents
and are given authority by principals to manage the company.
According to the agency theory, shareholders expect agents to act
and make decisions in the best interests of the principal. On the
contrary, the agent may not always act in the best interests of the
principals.
 Purpose of agency theory
The purpose of agency theory is to highlight areas where
corporate interest groups are in conflict. Banks want to
reduce risk, whereas shareholders want to make the most
money possible. The ability of managers to turn profits and
then impress the board is what makes them even riskier
when it comes to maximizing profits. There are costs involved
with each group trying to control the others because modern
corporations are established on these relationships.
 Agency problems/conflicts
Conflicting interests of principals and agents may arise
because some agents may not always act in the best
interests of the principal. Miscommunication and
disagreement can lead to a variety of issues within busi-
nesses. Each stakeholder may become divided due to
incompatible desires, which can lead to inefficiencies
and financial losses. The principal- agent problem occurs
when a principal’s and an agent’s interests conflict.
THE STEWARDSHIP
THEORY
 THE STEWARDSHIP THEORY
Steward – is 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.

Stewardship theory is a framework which argues that people are

intrinsically motivated to work for others or for organizations to
accomplish the tasks and responsibilities with which they have
been entrusted. Stewardship theory therefore provides one frame-
work for characterizing the motivations of managerial behavior in
various types of organizations.
 THE STEWARDSHIP THEORY

In this theory, managers innately to do a good job, maximize

company profit and bring good returns to stockholders
because they feel a strong duty to the company, they do this
for the interest of the company not for their own financial
interest.
STEWARDSHIP THEORY IN CORPORATE GOVERNANCE

The main purpose of sterwardship theory of governance is to satisfy the

shareholders. With a single leader, a strong channel is formed to convey
business requirements to the shareholders and vice versa.
Significant applications:
1. On Business – A company dedicated to higher purpose will attract
customers who believe in similar purpose.
2. On employees – Company’ stewardship attitude can be cleary seen at
an instant by employees on the way they are treated.
3. On Customers – When customer sense that they are part of
something greater, they may likely stay connected with businesses
that are stewardship-driven.
THE STAKEHOLDER
THEORY
 THE STAKEHOLDER THEORY

Stakeholder – refers to any individual or group of individuals who

can affect or be affected by any action done by a business.

Stakeholder theory states that the purpose of a business is to

create value for wider group stakeholders other than just share-
holders. This theory considers the corporate environment as a net-
work of interconnected groups, all of which are required to be
pleased to sustain the health and success of the company in the
long term.
 THE STAKEHOLDER THEORY

This theory was originally coined by Edward Freeman as an

important element of Corporate Social Responsibility (CSR). CSR
is a concept that places bigger responsibilities on companies in the
form of economic, legal, ethical or even philanthropic.
Freeman’s Six Principles that must direct the connection
between the stakeholders and the corporation

1. The principle of the entry and exit – Based on this principle,

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 – How a group that does not gain
from the actions of the company has to undergo some
problems because of the said action.
Freeman’s Six Principles that must direct the connection
between the stakeholders and the corporation

4. The principle of contract cost – Each group to a contract should

either endure identical amount when it comes to cost or the cost
they enjoy should be proportionate to the benefits they have
earned in the company
5. Agency principle – This principle reflects on the manager of the
company as its agent and hence has responsibilities to the
stakeholders and shareholders.
6. The principles of limited immortality – this 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 in the company

1. Organizational stakeholders – are those people who are

present inside the company (such as the staff, employees,
stockholders, and managers). They have a direct interest on
how the company is doing and the smooth operations of a
company which could be supported by a CSR policy.
2. Economic Stakeholders – In this group, the customer, bankers,
creditors, and suppliers are the most important stakeholders.
Customer are regarded as very important because without the,
a company may not even exist.
 Categories of stakeholders in the company

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.
STAKEHOLDER THEORY IN CORPORATE GOVERNANCE

This theory suggests that corporate officers and directors must consider
the interests of every stakeholder in its governance practices. There are
certain general principles which businesses are expected to operate:
1. Right and equitable treatment of shareholders- Shareholders have
certain rights which a company must respect.
2. Interests of the stakeholders – companies must know that they have
legal, contractual, social, and market driven responsibilities to em-
ployees, investors, creditors, suppliers, local communities, customers,
and policy makers.
3. Roles and responsibilities of the board- the board requires adequate
pertinent skills and understanding to appraise and challenge man-
agement performance.
STAKEHOLDER THEORY IN CORPORATE GOVERNANCE

3. Integrity and ethical behavior – in selecting corporate officer and board

members, one of the fundamental requirements is integrity.
4. Disclosure and transparency – companies must explain and make
transparent to the public the roles and responsibilities of the board and
top management in order to offer stakeholders with a level of accountabil-
ity.

There is an assurance of good corporate governance following those

principles that is accommodating to all the needs of all the stakeholders in
the company
THANK YOU