What is Corporate Governance?

Corporate governance is the system of rules, practices, and processes by which

a firm is directed and controlled. 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. 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.

Corporate Governance refers to the way a corporation is governed. It is the

technique by which companies are directed and managed. It means carrying
the business as per the stakeholders’ desires. It is actually conducted by the
board of Directors and the concerned committees for the company’s
stakeholder’s benefit. It is all about balancing individual and societal goals,
as well as, economic and social goals.
Corporate Governance is the interaction between various participants
(shareholders, board of directors, and company’s management) in shaping
corporation’s performance and the way it is proceeding towards. The
relationship between the owners and the managers in an organization must be
healthy and there should be no conflict between the two. The owners must see
that individual’s actual performance is according to the standard performance.
These dimensions of corporate governance should not be overlooked.
Corporate Governance deals with the manner the providers of finance guarantee
themselves of getting a fair return on their investment. Corporate Governance
clearly distinguishes between the owners and the managers. The managers are
the deciding authority. In modern corporations, the functions/ tasks of owners
and managers should be clearly defined, rather, harmonizing.
Corporate Governance deals with determining ways to take effective strategic
decisions. It gives ultimate authority and complete responsibility to the Board of
Directors. In today’s market- oriented economy, the need for corporate
governance arises. Also, efficiency as well as globalization are significant
factors urging corporate governance. Corporate Governance is essential to
develop added value to the stakeholders.
Corporate Governance ensures transparency which ensures strong and balanced
economic development. This also ensures that the interests of all shareholders
(majority as well as minority shareholders) are safeguarded. It ensures that all
shareholders fully exercise their rights and that the organization fully recognizes
their rights.
Corporate Governance has a broad scope. It includes both social and
institutional aspects. Corporate Governance encourages a trustworthy, moral, as
well as ethical environment.

The Basics of Corporate Governance

Governance refers specifically to the set of rules, controls, policies, and
resolutions put in place to dictate corporate behavior. Proxy advisors and
shareholders are important stakeholders who indirectly affect governance, but
these are not examples of governance itself. The board of directors is pivotal in
governance, and it can have major ramifications for equity valuation.

Communicating a firm's corporate governance is a key component of

community and investor relations. On Apple Inc.'s investor relations site, for
example, the firm outlines its corporate leadership—its executive team, its
board of directors—and its corporate governance, including its committee
charters and governance documents, such as bylaws, stock ownership guidelines
and articles of incorporation.

Most companies strive to have a high level of corporate governance. For many
shareholders, it is not enough for a company to merely be profitable; it also
needs to demonstrate good corporate citizenship through environmental
awareness, ethical behavior, and sound corporate governance practices. Good
corporate governance creates a transparent set of rules and controls in which
shareholders, directors, and officers have aligned incentives.

KEY TAKEAWAYS

 Corporate governance is the structure of rules, practices, and processes

used to direct and manage a company.
 A company's board of directors is the primary force influencing corporate
governance.
 Bad corporate governance can cast doubt on a company's reliability,
integrity, and transparency—all of which can have implications on its
financial health.

Corporate Governance and the Board of Directors

The board of directors is the primary direct stakeholder influencing corporate
governance. Directors are elected by shareholders or appointed by other board
members, and they represent shareholders of the company. The board is tasked
with making important decisions, such as corporate officer appointments,
executive compensation, and dividend policy. In some instances, board
obligations stretch beyond financial optimization, as when shareholder
resolutions call for certain social or environmental concerns to be prioritized.

Boards are often made up of inside and independent members. Insiders are
major shareholders, founders and executives. Independent directors do not share
the ties of the insiders, but they are chosen because of their experience
managing or directing other large companies. Independents are considered
helpful for governance because they dilute the concentration of power and help
align shareholder interest with those of the insiders.

Bad Corporate Governance

Bad corporate governance can cast doubt on a company's reliability, integrity or
obligation to shareholders—all of which can have implications on the firm's
financial health. Tolerance or support of illegal activities can create
scandals like the one that rocked Volkswagen AG starting in September 2015.
The development of the details of "Dieselgate" (as the affair came to be known)
revealed that for years, the automaker had deliberately and systematically
rigged engine emission equipment in its cars in order to manipulate pollution
test results, in America and Europe. Volkswagen saw its stock shed nearly half
its value in the days following the start of the scandal, and its global sales in the
first full month following the news fell 4.5%.

Public and government concern about corporate governance tends to wax and
wane. Often, however, highly publicized revelations of corporate malfeasance
revive interest in the subject. For example, corporate governance became a
pressing issue in the United States at the turn of the 21st century, after fraudulent
practices bankrupted high-profile companies such as Enron and WorldCom. It
resulted in the 2002 passage of the Sarbanes-Oxley Act, which imposed more
stringent recordkeeping requirements on companies, along with stiff criminal
penalties for violating them and other securities laws. The aim was to restore
public confidence in public companies and how they operate.

Other types of bad governance practices include:

 Companies do not cooperate sufficiently with auditors or do not select

auditors with the appropriate scale, resulting in the publication of
spurious or noncompliant financial documents.
 Bad executive compensation packages fail to create an optimal incentive
for corporate officers.
 Poorly structured boards make it too difficult for shareholders to oust
ineffective incumbents.
 Objectives of Corporate Governance

Alan Calder, in his book, “Corporate Governance: A Practical Guide to

the Legal Frameworks," states, "Effective corporate governance is
transparent, protects the rights of shareholders, includes both strategic
and operational risk management, is as interested in long-term earning
potential as it is in actual short-term earnings and holds directors
accountable for their stewardship of the business." These guidelines
include most objectives of a corporate governance policy in any
organization.

Transparency and Full Disclosure

Good corporate governance aims at ensuring a higher degree of transparency

in an organization by encouraging full disclosure of transactions in the
company accounts. Full disclosure includes compliance with regulations and
disclosing any information important to the shareholders. For example, if a
manager has close ties with suppliers or has a vested interest in a contract, it
must be disclosed. Also, directors should be independent so that the oversight
of the company management is unbiased. Transparency involves disclosure of
all forms of conflict of interest.

Accountability

Jean Du Plessis, James McConvill and Mirko Bagaric, in their book,

"Principles of Contemporary Corporate Governance," point out that a
corporate governance structure encourages accountability of the management
to the company directors and the accountability of the directors to the
shareholders. Through hiring independent directors, a company aims to create
good corporate governance. The compensation of the chief executive officer
has to be approved by the company directors to ensure that the compensation
structure is fair and in the best interests of the shareholders. Any discrepancies
in the company accounts or malfunctioning of the company is closely watched
by the board of directors. The board has a right to question strategic decisions.

Equitable Treatment of Shareholders

A corporate governance structure ensures equitable treatment of all the

shareholders of the company. In some organizations, a particular group of
shareholders remains active due to their concentrated position and may be
better able to guard their interests; such groups include high-net-worth
individuals and institutions that have a substantial proportion of their
portfolios invested in the company. However, all shareholders deserve
equitable treatment, and this equity is ensured by a good corporate governance
structure in any organization.

Self Evaluation

Corporate governance allows firms to evaluate their behavior before they are
scrutinized by regulatory bodies. Firms with a strong corporate governance
system are better able to limit their exposure to regulatory risks and fines. An
active and independent board can successfully point out the loopholes in the
company operations and help solve issues internally.

Increasing Shareholders' Wealth

The main objective of corporate governance is to protect the long-term

interests of the shareholders. Ira Millstein, in his book, "Corporate
Governance: Improving Competitiveness and Access to Capital in Global
Markets," mentions that firms with strong corporate governance structures are
seen to have higher valuation premiums attached to their shares. This shows
that good corporate governance is perceived by the market as an incentive for
shareholders to invest in the company.

The Three Pillars of Corporate Governance

he three pillars of corporate governance are: transparency, accountability, and

security. All three are critical in successfully running a company and forming
solid professional relationships among its stakeholders which include board
directors, managers, employees, and most importantly, shareholders.
First Pillar of Corporate Governance: Transparency
In simplest terms, transparency means having nothing to hide. For a company,
this means it allows its processes and transactions observable to outsiders. It
also makes necessary disclosures, informs everyone affected about its decisions,
and complies with legal requirements. After the financial scandals in the early
2000s, transparency has played a bigger role in preventing fraud from
happening again, especially at such a large scale. But aside from stopping the
next illegal moneymaking scheme, transparency also builds a good reputation of
the company in question. When shareholders feel they can trust a company, they
are willing to invest more, and this greatly helps in lowering cost of capital.
Therefore, a company gets its ROI on the money it spent on improving
transparency.
Transparency is a critical component of corporate governance because it ensures
that all of a company’s actions can be checked at any given time by an outside
observer. This makes its processes and transactions verifiable, so if a question
does come up about a step, the company can provide a clear answer. And after
the Enron scandal in 2001, transparency is no longer just an option, but a legal
requirement that a company has to comply with.
But although transparency is a necessity for the whole company, its presence is
even more important at the top where strategies are planned and decisions are
made. Shareholders expect that the corporate board is open about their actions;
otherwise, distrust will form. And when trust breaks, shareholders tend to stay
away and invest somewhere else.
How transparent is your corporate board? Are directors’ actions readily
verifiable by internal and external audit? Is their leadership visible from the top
to all the way down? Is transparency applicable to everyone? Transparency
should have no exceptions, especially when your company’s goals are involved.
All stakeholders — from employees to investors — have the right to know
about the direction your company is headed for.
For easy implementation of a transparency policy, consider using board portal
software that doubles as corporate governance software.
Second Pillar of Corporate Governance: Accountability
It takes more than transparency to build integrity as a company. It also takes
accountability, which can also mean answerability or liability. Shareholders are
deeply interested in who will take the blame when something goes wrong in one
of a company’s many processes. And even when everything goes smoothly as
expected, knowing that someone will be held accountable for future mishaps
increases shareholders’ confidence, which in turn increases their desire to invest
more. Again, this concern over accountability goes back to the financial
scandals in the early 2000s, in which there had been a lot of money stolen, but
not enough people to answer for the crime.
Accountability can have a negative connotation because many people associate
it with blame. “Who’s responsible for when something goes wrong?” is just one
of the many questions that accountability seeks to answer. But accountability is
more than that. It’s about having ownership over one’s actions whether the
consequences of those actions are good or bad. Thus, accountability covers not
only failings, but also accomplishments. When the idea of accountability is
approached with this positive outlook, people will be more open to it as a means
to improve their performance. This applies from the staff all the way up to the
corporate board.
How can accountability improve performance? People who have no sense of
ownership over their tasks don’t feel the motivation to do more than what’s
expected of them. There’s no incentive to work hard and achieve something.
But when they understand the weight of their responsibilities, they’re more
inclined to make sure that they carry out their tasks properly. And when they’re
successful in this regard, they’re likely to feel a sense of accomplishment, and
this further fuels their desire to do better.
So how’s the level of accountability in your corporate board? Are you directors
there to simply fill in a seat while leafing through their board packs and board
books, or are they actively engaged in decisions and strategies for your
company?
Third Pillar of Corporate Governance: Security
A company is expected to make their processes transparent and their people
accountable while keeping their enterprise data secure from unauthorized
access. There is simply no compromise for this. Companies that experience
security breaches involving the exposure of their clients’ personal information
quickly lose their credibility. To get back the public’s trust, extensive damage
control is called for — just look at what had to be done after Neiman
Marcus and Target suffered from data leak.age Thus, even with accountability
and transparency, a company without inadequate security measures will have a
hard time attracting shareholders. After all, any scandal — even a breach caused
by third-party hackers — can have a negative effect on a company’s stock
market performance.
The increasing threat of cyber crime in recent years puts security at a high
priority for many companies. Complying with security standards isn’t enough
— a company needs to imbibe a culture of security to ensure that trade secrets,
corporate data, and client information are all kept safe from unauthorized access
from inside and out. Security is not just an IT concern anymore, unlike in the
past.
Nowadays, everyone in a company has a responsibility to adhere to strict
security standards. Even entry-level staff members usually have their own
company email addresses. But are they trained enough to conscientiously keep
their accounts safe? And that’s just scratching the surface. Think of how much
confidential data there is at the hands of directors in the corporate board, and
suddenly, the stakes are much higher.
Thus, directors should be made aware of the seriousness of cyber crime and the
gravity of its consequences. A security breach — especially involving client
information — can make the public easily lose their trust. Trust is a big factor
would-be shareholders consider before making an investment in a company.
How high is the awareness level of your company’s directors when it comes to
security? Don’t let them take their chances — make sure that they’re
using board portal software and board governance software to keep meeting
documents secure all the time, even when they’re using their iPads or Android
tablets for virtual collaborative sessions and electronic board meetings. The
system does away with paper-based board packs and board books and digitizes
everything, making encryption (both in transmission and storage) as a means of
protection possible.
Combining All Three Pillars of Corporate Governance
Taken together, transparency, accountability, and security define a company’s
integrity. Achieving all three isn’t an easy thing to do, but fortunately,
companies now have an partner in board portal software that also doubles as
corporate governance software. A board portal doesn’t just digitize the whole
board meeting process; it also makes the process more transparent by keeping
clear and complete documentation at all times. For example, a director who
wants to review the details surrounding the decision for a recent merger can pull
out the meeting minutes from the archive. An outside auditor authorized to
request the same kind of documentation will have access to it, too. In short,
information needed by anyone with authorization — whether they’re part of the
company or an outsider — can get what they need quickly and easily.
Aside from being readily available, documents and other meeting files are
version-controlled and comes with audit trails. This means that when different
versions of a file exist, each version carries a record of what changers were
made and who made those changes. This feature of board portals address the
need for accountability.
As for security, a board portal has to adhere to industry standards to keep files
safe whether in transmission or in storage. With features such as access right
control, authentication procedures, password requirements, encryption, and
auto-purge for lost devices, a board portal turns iPads and Androud tablets the
most secure briefcase a director can ever have.

There are many theories of corporate governance which addressed the challenges
of governance of firms and companies from time to time. The Corporate
Governance is the process of decision making and the process by which
decisions are implemented in large businesses is known as Corporate
Governance. There are various theories which describe the relationship between
various stakeholders of the business while carrying out the activity of the
business.

Theories of Corporate Governance

We will discuss the following theories of corporate governance:

  Agency Theory
 Stewardship Theory
 Resource Dependency Theory
 Stakeholder Theory
 Transaction Cost Theory
 Political Theory

Agency Theory

Agency theory defines the relationship between the principals (such as

shareholders of company) and agents (such as directors of company). According
to this theory, the principals of the company hire the agents to perform work. The
principals delegate the work of running the business to the directors or managers,
who are agents of shareholders. The shareholders expect the agents to act and
make decisions in the best interest of principal. On the contrary, it is not necessary
that agent make decisions in the best interests of the principals. The agent may be
succumbed to self-interest, opportunistic behavior and fall short of expectations
of the principal. The key feature of agency theory is separation of ownership and
control. The theory prescribes that people or employees are held accountable in
their tasks and responsibilities. Rewards and Punishments can be used to correct
the priorities of agents.

Stewardship Theory

The steward theory states that a steward protects and maximises 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.
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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

Resource Dependency Theory

The Resource Dependency Theory focuses on the role of board directors in

providing access to resources needed by the firm. It states that directors play an
important role in providing or securing essential resources to an organization
through their linkages to the external environment. The provision of resources
enhances organizational functioning, firm’s performance and its survival. The
directors bring resources to the firm, such as information, skills, access to key
constituents such as suppliers, buyers, public policy makers, social groups as well
as legitimacy. Directors can be classified into four categories of insiders, business
experts, support specialists and community influentials.

Transaction Cost Theory

Transaction cost theory states that a company has number of contracts within the
company itself or with market through which it creates value for the company.
There is cost associated with each contract with external party; such cost is called
transaction cost. If transaction cost of using the market is higher, the company
would undertake that transaction itself.

Political Theory

Political theory brings the approach of developing voting support from

shareholders, rather by purchasing voting power. It highlights the allocation of
corporate power, profits and privileges are determined via the governments’ favor