Introduction to Corporate Governance

Expected Learning Outcomes

After studying the chapter, you should be able to:

1. Describe what governance involves

2. Enumerate the different contexts in which governance can be applied
3. Name and explain the characteristics of good governance
4. Explain the meaning, purpose and objectives of corporate governance
5. Know and describe the principles of effective corporate governance
6. Understand how the principles of good corporate governance can be applied

What is Governance?

Generally, governance refers to a process whereby elements in society wield power, authority
and influence and enact policies and decisions concerning public life and social upliftment. It
comprises all the processes of governing – whether undertaken by the government of a
country, by a market or by a network – over a social system and whether through the laws,
norms, power, or language of an organized society. Therefore, governance means the process
of decision-making and the process by which decisions are implemented (or not implemented)
through the exercise of power or authority by leaders of the country and/or organizations.
Further, it can be used in several context such as corporate governance, international
governance, national governance, and local governance.

Characteristics of Good Governance

• Participation

Participation by both men and women is a key cornerstone of good governance.

Participation could be either direct or through legitimate institutions or representatives.
It is important to point out that representative democracy does not necessarily mean that
the concern of the most vulnerable in society would not be taken into consideration in
decision making. Participation needs to be informed and organized. This means freedom

Reference: Cabrera, Ma. Elenita Balatbat. Corporate Governance, Business Ethics,

Risk Management, and Internal Control. Manila: GIC Enterprise & Co., Inc. © 2019
 of association and expression on one hand and an organized civil society on the other
hand.

• Rule of Law

Good governance requires fair legal frameworks that are enforced impartially. It also
requires full protection of human rights, particularly those of minorities. Impartial
enforcement of laws requires an independent judiciary and an impartial and incorruptible
police force.

• Transparency

Transparency means that decisions taken and their enforcement are done in a manner
that follows rules and regulations. It means that information is freely available and
directly accessible to those who will be affected by such decisions and their
enforcement. It also means that enough information is provided and that it is provided in
easily understandable forms and media.

• Responsiveness

Good governance requires that institutions and processes try to serve the needs of all
stakeholders within a reasonable timeframe.

• Consensus Oriented

Good governance requires mediation of the different interests in society to reach a broad
consensus on what is in the best interest of the whole community and how this can be
achieved. It also requires a broad and long-term perspective on what is needed for
sustainable human development and how to achieve the goals of such development.
This can only result from an understanding of the historical, cultural and societal contexts
of a given society or community.

• Equity & Inclusiveness

Ensures that all its members feel that they have a stake in it and do not feel excluded
from the mainstream of society. This requires all groups, but particularly the most
vulnerable, have opportunities to improve or maintain their wellbeing.

• Effectiveness & Efficiency

Good governance means that processes and institutions produce results that meet the
needs of society while making the best use of resources at their disposal. The concept
of efficiency in the context of good governance also covers the sustainable use of natural
resources and the protection of the environment.

• Accountability

Accountability is a key requirement of good governance. Not only governmental

institutions but also the private sector and civil society organizations must be
accountable to the public and to their institutional stakeholders. Who is accountable to
whom varies depending on whether decisions or actions taken are internal or external
to an organization or institution. In general, an organization or an institution is

Reference: Cabrera, Ma. Elenita Balatbat. Corporate Governance, Business Ethics,

Risk Management, and Internal Control. Manila: GIC Enterprise & Co., Inc. © 2019
 accountable to those who will be affected by its decisions or actions. Accountability
cannot be enforced without transparency and the rule of law.

Corporate Governance: An Overview

Corporate governance is defined as the system of rules, practices and processes by which
business corporations are directed and controlled. It basically involves balancing the interests
of a company's many stakeholders, such as shareholders, management, customers,
suppliers, financiers, government, and the community.

Moreover, corporate governance is a topic that has received growing attention in the public in
recent years as policy makers and others become more aware of the contribution good
corporate governance makes to financial market stability and economic growth. Good
corporate governance is all about controlling one's business and so is relevant, and indeed
vital, for all organizations, whatever size or structure.

The corporate governance structure specifies the distribution of rights and responsibilities
among different participants in the corporation, such as the board, managers, shareholders,
and other stakeholders, and spells out the rules and procedures for making decisions on
corporate affairs. By doing this, it also provides the structure through which the objectives are
set and the means of attaining those objectives and monitoring performance.

Purpose of Corporate Governance

The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent

management that can deliver long-term success of the company. In simple terms, the
fundamental aim of corporate governance is to enhance shareholders' value and protect the
interests of other stakeholders by improving the corporate performance and accountability. It
is also about what the board of directors of a company does, how it sets the values of the
business firm.

Objectives of Corporate Governance

1. Fair and Equitable Treatment of Shareholders

A corporate governance structure ensures equitable and fair treatment of all
shareholders of the company. In some organizations, a group of high-net-worth
individual and institutions who have a substantial proportion of their portfolios invested
in the company, remain active through occupation of top-level positions that enable
them to guard their interest. However, all shareholders deserve equitable treatment,
and this equity is safeguarded by a good governance structure in any organization.

2. Self-Assessment
Corporate governance enables firms to assess their behavior and actions before they
are scrutinized by regulatory agencies. Business establishments with a strong
corporate governance system are better able to limit exposure to regulatory risks and
fines. An active and independent board can successfully point out deficiencies or
loopholes in the company operations and help solve issues internally on a timely basis.

Reference: Cabrera, Ma. Elenita Balatbat. Corporate Governance, Business Ethics,

Risk Management, and Internal Control. Manila: GIC Enterprise & Co., Inc. © 2019
 3. Increase Shareholders' Wealth
Another corporate governance's main objective is to protect the long-term interests of
the shareholders. Firms with strong corporate governance structure are seen to have
higher valuation attached to their shares by businessmen. This only reflects the
positive perception that good corporate governance induces potential investors to
decide to invest in a company.

4. 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.

Basic Principles of Effective Corporate Governance

Effective corporate governance is transparent, protects the rights of shareholders and includes
both strategic and operational risk management. It is concerned in both the long-term earning
potential as well as actual short-term earnings and holds directors accountable for their
stewardship of the business.

The basic principles of effective corporate governance are threefold as presented below:

Positive answers to the following questions indicate a firm’s conformance and compliance with
the basic principles of good corporate governance:

A. Transparency and Full Disclosure

• Does the board meet the information needs of investment communities?
• Does it safeguard integrity in financial reporting?
• Does the board have sound disclosure policies and practices?
➢ Does it make timely and balanced disclosure?
➢ Can an outsider meaningfully analyze the organization's actions and
performance?
B. Accountability
• Does the board clarify its role and that of management?
➢ Does it promote objective, ethical and responsible decision making?
➢ Does it lay solid foundations for management oversight?
➢ Does the composition mix of board membership ensure an appropriate range
and mix of expertise, diversity, knowledge and added value?

Reference: Cabrera, Ma. Elenita Balatbat. Corporate Governance, Business Ethics,

Risk Management, and Internal Control. Manila: GIC Enterprise & Co., Inc. © 2019
 ➢ Is the organization's senior official committed to widely accepted standards of
correct and proper behavior?
C. Corporate Control
• Has the board built long-term sustainable growth in shareholders' value for the
corporation?
• Does it create an environment to take risk?
➢ Does it encourage enhanced performance?
➢ Does it recognize and manage risk?
➢ Does it remunerate fairly and responsibly?
➢ Does it recognize the legitimate interests of stakeholders?
➢ Are conflicts of interest avoided such that the organization's best interests
prevail at all times?

Illustrative Application of the Basic Principles of Corporate Governance and Best

Practice Recommendations

Principles of Good Corporate Best Practice Recommendations

Governance
1. A company should lay solid foundation
for management and oversight. It should
recognize and publish the respective roles
and responsibilities of board and
management.
2. Structure the board to add value. Have a
board of an effective composition, size and
commitment to adequately discharge its
responsibilities and duties.
3. Promote ethical and responsible
decision-making. Actively promote ethical
and responsible decision-making.
4. Safeguard integrity in financial reporting.
Have a structure to independently verify
and safeguard the integrity of the
company's financial reporting.
1-a. Formalize and disclose the functions
reserved to the board and those delegated
to management.
2-a. A board should have independent
directors.
2-b. The roles of chairperson and chief
executive officer should not be exercised by
the same individual.
2-c. The board should establish a
nomination committee.
3-a. Establish a code of conduct to guide
the directors, the chief executive officer (or
equivalent), the chief financial officer (or
equivalent) and any other key executives
as to:
• The practices necessary to maintain
confidence in the company's
integrity; and
• The responsibility and accountability
of individuals for reporting and
investigating reports of unethical
practices.
3-b. Disclose the policy concerning trading
in company securities by directors, officers
and employees.
4-a. Require the chief executive (or
equivalent) and the chief financial officer (or
equivalent) to state in writing to the board
that the company's financial reports present
a true and fair view, in all material respects,
of the company's financial condition and
operational results and are in accordance
with relevant accounting standards.

Reference: Cabrera, Ma. Elenita Balatbat. Corporate Governance, Business Ethics,

Risk Management, and Internal Control. Manila: GIC Enterprise & Co., Inc. © 2019

5. Make timely and balanced disclosure.
Promote timely and balanced disclosure of
all material matters concerning the
company.
6. Respect the rights of shareholders and
facilitate the effective exercise of those
rights.
7. Recognize and manage risk. Establish a
sound system of risk oversight and
management and internal control.
8. Encourage enhanced performance.
Fairly review and actively encourage
enhanced board and management
effectiveness.
9. Remunerate fairly and responsibly.
Ensure that the level and composition of
remuneration is sufficient and reasonable
and that its relationship to corporate and
individual performance is defined.
Reference: Cabrera, Ma. Elenita Balatbat. Corporate Governance, Business Ethics,
Risk Management, and Internal Control. Manila: GIC Enterprise & Co., Inc. © 2019
4-b. The board should establish an audit
committee.
4-c. Structure the audit committee so that it
consists of:
• Only non-executive or independent
directors;
• An independent chairperson, who is
not chairperson of the board; and
• At least three (3) members.
5-a. Establish written policies and
procedures designed to ensure compliance
with IFRS.
5-b. Listing Rule disclosure requirements
and to ensure accountability at a senior
management level for compliance.
6-a. Design and disclose a communications
strategy to promote effective
communication with shareholders and
encourage effective participation at general
meetings.
6-b. Request the external auditor to attend
the annual general meeting and be
available to answer shareholder questions
about the audit.
7-a. The board or appropriate board
committee should establish policies on
risk oversight and management.
2-a. The chief executive officer (or
equivalent) and the chief financial officer (or
equivalent) should state to the board in
writing that:
• The statement given in accordance
with best practice recommendation
4-a (the integrity of financial
statements) is founded on a sound
system of risk management and
internal compliance and control
which implements the policies
adopted by the board; and
• The company's risk management
and internal compliance and control
system is operating efficiently in all
material respects.
8-a. Disclose the process for performance
evaluation of the board, its committees
and individual directors, and key
executives.
9-a. Provide disclosure in relation to the
company's remuneration policies to enable
investors to understand:
• The costs and benefits of those
policies; and

10. Recognize the legitimate interests of
stakeholders. Recognize legal and other
obligations to all legitimate stakeholders.
• The link between remuneration paid
to directors and key executives and
corporate performance.
9-b. The board should establish a
remuneration committee.
9-c. Clearly distinguish the structure of non-
executive director's remuneration from that
of executives.
9-d. Ensure that payment of equity-based
executive remuneration is made in
accordance with thresholds set in plans
approved by shareholders.
10-a. Establish and disclose a code of
conduct to guide compliance with legal
and other obligations to legitimate
stakeholders.

Review Questions

1. What does governance mean?

2. Explain whether the following statement is true or false.
“Governance is exercised only by the government of a country.”
3. Explain how governance can be used in the following contexts and give appropriate
examples:
a. national governance
b. local governance
c. corporate governance
d. international governance
4. Explain briefly the eight (8) bask characteristics of good governance.
5. Transparency and accountability arc synonymous. Explain whether the statement is
correct or not.
6. Explain whether the following statement is true or false.
“Responsiveness usually results to effectiveness and efficiency.”
7. Define corporate governance.
8. What does corporate governance structure involve?
9. State the purpose of corporate governance.
10. Explain the basic objectives of corporate governance.
11. Explain the three basic principles of effective corporate governance.

Prepared by:

Donald P. Sam-it
Faculty, College of Accountancy
University of the Cordilleras

Reference: Cabrera, Ma. Elenita Balatbat. Corporate Governance, Business Ethics,

Risk Management, and Internal Control. Manila: GIC Enterprise & Co., Inc. © 2019