Unit 5: Corporate Governance

K.S Shiburi

12 September 2023
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 Study Outcomes

• Define corporate governance.

• List the themes from the various definitions of corporate governance.
• Briefly discuss the history of corporate governance.
• Briefly discuss the etymology of corporate governance.
• List and discuss the benefits of good corporate governance.
• Discuss, explain and apply the different types of corporate governance models.
• Discuss, explain and apply the different types of corporate governance theories.
• Discuss, explain and apply the principles of corporate governance.

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Definition of Corporate governance
 Definition of Corporate governance
Corporate governance refers to the manner in which corporations (corporate) are
run and controlled (steered).
It can be a legislation (SOX in the USA) or a code (South African King Reports)
describing the relationship between managers (agents) and owners (principals)
(separation of management and ownership).
It represents the framework within which corporations operate.
At the centre of corporate governance, is the need to protect different stakeholders
(Not shareholders?) that include shareholders, managers, customers, creditors,
environment etc.
Various definitions exists as follows:
• Procedures and processes according to which an organisation is directed and
controlled. The corporate governance structure specifies the distribution of rights
and responsibilities among the different participants in the organisation – such as
the board, managers, shareholders and other stakeholders – and lays down the
rules and procedures for decision-making (OECD, 2004).

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 Definition of Corporate governance
Various definitions exists as follows:
• The exercise of ethical and effective leadership by the governing body towards the
achievement of the following governance outcomes: ethical culture, good
performance, effective control and legitimacy (IoDSA, 2016:11).
• The combination of processes and structures implemented by the board to inform,
direct, manage, and monitor the activities of the organization toward the
achievement of its objectives (IIA, 2017a: 13).

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 Definition of Corporate governance
Thematical analysis of the definitions:
• Corporate governance is the responsibility of the board, other parties are also
involved including managers, directors, employees etc.
• Board responsibilities include:
• Strategic direction;
• Ensure objectives are achieved;
• Ensure risk is managed well.
• Verify resources are used responsibly.
• It can be a process, rule, or a procedure.
• It describes how an organisation should be run and controlled by allocating rights
and responsibilities. (how an organisation should be steered)
• It is concerned with protecting stakeholders including employees, directors,
owners etc.
• It is also concerned with ensuring that organisations achieve their objectives.

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 Definition of Corporate governance
Etymology of corporate governance.
• Two words id est. “corporate” and “governance.”
• Corporate covers multiple aspects relating to theories and practices of the boards
and its directors.
• The word ‘governance’ is derived from the Latin verb gubernare, derived from the
Greek word kubernaein, which means ‘to steer’.

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Cornerstone of corporate
governance
 Definition of Corporate governance
Executive management
• People who are responsible for the day to day running of the organisation.
• They represent the interests of the shareholders.
• Independent directors must dominate the board. (This will ensure that the power
of the executive management is limited.)
• In the past, executive management had too much power and neglected the
interests of shareholders.
Audit committees and non- executive directors
• Independent directors unbiased, independent varied and experienced perspective.
• Assist the board exercise oversight over financial reporting, internal controls, audit
process, and compliance.
Internal auditors
• Assess and make recommendations for improving governance processes.
External auditors
• Fair presentation of financial statements.

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History of corporate governance
 History of corporate governance
No definitive account of where corporate governance emerged.
• 1600s when the East Indian Company was established.
Why?
• Corporate governance means different things to different people. (Trusts vs
“Inheritance system” in Africa.)
• Corporate governance means different things to different people in different times.
• The concept of corporate governance is very broad.
Modern Corporate Governance
• Adam Smith’s PhD Study entitled “An Inquiry into the Nature and Causes of the
Wealth of Nations.”
• Berle and Means’ work in 1932 entitled “The Modern Corporation and Private
Property.” (discussed separation of ownership and management)
• 1970s in the USA. (Growing influence of Corporate Social Responsibility
Movements and the Role of Corporations in political parties.)

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Corporate governance in South
Africa
 History of corporate governance
• Corporate governance in South Africa can be traced to 1994.
• This is against the formation of the King Commission in 1992 and the subsequent
release of the King I Report in 1994.
• Was corporate governance an issue in South Africa prior to 1994?
• Yes. Companies Act of 1973 serves as an example.
• What is special about 1994?
King I Report
• In an anticipation of a democratic South Africa, Judge Marvin King was tasked
with the responsibility to chair a “private section body” that would develop
guidelines informing corporate governance practices in South Africa in 1992.
• The report itself was issued in 1994.
• Guidelines in the report drew extensively from the British Cadbury Report.
• However, the King I Report went a step further and developed guidelines on
disclosures and advocated for transparency.

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 History of corporate governance
King I Report criticism
• At the time, many Johannesburg Stock Exchange listed companies developed
compliance checklists and ticking off the relevant codes to guard against non-
compliance with the King Report without necessarily buying into the corporate
governance guidelines as contained therein. (Compliance checklist.)
• It is argued that the purpose of King I was to protect the vested interests of
corporations and prevent government from involvement in corporate governance
matters. (Prevent government from involvement.)
• It was flawed consequent upon its recommendations not being informed by
consultations, debates, and not drawn from the possibly widely available
knowledge at the time. (Consultations and knowledge.)
Need to update King I
• Changes in legislation.
• Shortcomings as addressed above.
• Overhaul of the South African Constitution.
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 History of corporate governance
King II
• King II was released in March of 2002.
• It advocated for a triple bottom line reporting. (Organisation must report on its
profit, planet and people influences.)
• For this reason, organisation are required to engage in sustainability reporting.
King II Criticism
• Self regulation and Lack of enforcement through the law. (what happens if a
bank does not comply?)
• Separate sustainability reporting leading companies to report on sustainability
separate from other matters.
King II review
• Amending of the Companies Act 61 of 1973.
• Changes in corporate governance practices internationally.

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 History of corporate governance
King III
• King III was applicable to all entities irrespective of size, manner of incorporation,
sector etc.
King IV
• Thursday.

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Benefits of good corporate
governance
 Benefits of good corporate governance
Excellent management
• Company practicing good governance allows people not linked to organisations to
be able to assess its governance due to transparency
High level of transparency
• Companies following a set of best practices are encouraged to be highly
transparent about their business.
Stakeholder benefits
• Under corporate governance, companies tend to act in the best of itself and its
stakeholders.
Reputation and recognition
• Good governance allows companies to gain the trust of the investors, customers
and the community at large.
Reduced wastage
• Employees that are trained to follow a good ethical practice will avoid excess
wastage of company resources.
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 Benefits of good corporate governance
Reduced risks, mismanagement and corruption
• An amount of transparency applied in companies following good governance
practices has reduced amount of risks of corruption and mismanagement.
Economic benefit
• A company following a good governance practice will be able to achieve the trust
of the community and thus gaining success in the long run.

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Corporate Governance Models
 Corporate Governance Models.
There are three well known corporate governance models.
1. Anglo-American Model.
2. Continental Model.
3. Japanese Model. (Self study.)

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 Theories of Corporate Governance.
The Anglo-American Model
• By design, the board of directors and the shareholders are in charge. (Definition)
• Other stakeholders such as customers, lenders and supplies lack control over the
organisation. They are nevertheless acknowledged. (Definition)
• Management is tasked with the responsibility to run the organisation in such a
way that they maximise shareholder value. (Shareholders must benefit.)
• Incentives must be put in place to align the interests of management and
shareholders. (Remuneration policy must be structured well.)
• The model is underpinned by the assumption that shareholders provide capital
and may withdraw the capital at will. (Shareholder focused model.)
• There is one board comprised of internal and external members.
• External / independent members must dominate. (limit executive power)
• The role of the CEO and the board chair are separated. (King III).
• Important decisions are decided upon by the shareholders through a vote.

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 Theories of Corporate Governance.
Continental Model.
• Under the continental model, there are two boards namely, the management and
supervisory board. (Supervisory vs Management Board.)
• Supervisory board consists of external members. (Independent directors.)
• Management board consists of management. (Executive directors.)
• This is widely known as the two-tiered system.
• The two boards remain completely separated.
• It is said the model considers stakeholder engagement as very important.
• For this reason, a variety of stakeholders can serve on the supervisory board
including lenders and suppliers.

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Corporate Governance Theories
 Theories of Corporate Governance.
Agent theory
There is a relationship between owners (principlas) of organisations and managers
(managers). (Must do what the owner says)
• Owners hire managers to act on their behalf / represent their interest. (Example
make money.)
• They act on their behalf when? Take reasonable actions to maximise the
wealth of shareholders.
• The problem? Managers will not be as careful as they would be had they
been representing their own interest. Thus, wastages and negligence are
present.
• Managers also have their own interests. Thus, this brings about conflict of
interest / competing interests. (They are human beings with goals.)
• Agency theory leads to the need for harmonization of the interests of managers
with those of shareholders for the objective of maximizing the company value.
• Thus, shareholders have to incur agency costs.

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 Theories of Corporate Governance.
Agent theory
Agency costs:
• Monitoring Costs / governance costs: Principals monitor the behaviour of
agents (Audits, oversight, budget restrictions, independent directors);
• Bonding Costs/ Alignment costs: Remuneration paid to the agent.
• Residual costs: Biggest cost suffered by the principal when agent act in-line with
their own interests.

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 Theories of Corporate Governance.
Moral Hazard Theory
Conflict of interest due to a separation of ownership can cause opportunistic
behaviour by managers that is not convergent with the interests of the owners.
• What do owners want? Maximisation of their wealth.
• Managers?
• Thus, managers are prone to moral hazard and opportunistic behaviour guided by
their own interests.
• Hidden actions (by managers that is not convergent with the interests of owners)
arises due to information asymmetry and opportunistic actions occur due to
human inclinations.
• Thus, owners must limit moral hazards by developing remuneration policies that
ensures the mutual interests of owners and managers. (Incur Bondage costs)

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 Theories of Corporate Governance.
Stewardship Theory (Managers take the role of religious figures)
A steward is someone who is tasked with the responsibility to take care of
something id est. company that does not belong to him or her. (Agent) (Religion)
• Stewardship theory describes the role of management leadership in maintaining
and developing the organization's value. (Doing what the owner wants).
• 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. (Managers want to work)
• It argues that people are collective minded and pro-organizational rather than
individualistic and therefore work toward the attainment of organizational,
group, or societal goals because doing so gives them a higher level of satisfaction.
• When there is a conflict of interest, managers sacrifice their own interest and
act in the best interest of the shareholders.
• For this reason, managers are rational beings and there is no need to
excessively monitor their behaviour.
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 Theories of Corporate Governance.
Stewardship Theory
• The board must be composed of executive managers as they know the problems
and are in a position to react promptly. (Executive board.)
• If the board is composed of external directors, they will not be able to react to the
problems that affect the organisation.

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 Theories of Corporate Governance.
Stakeholder theory

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 Theories of Corporate Governance.
Stakeholder Theory
• Stakeholder theory is consequent upon the increasing need for corporate social
responsibility. (USA 1970s)
• Companies exists to create value for all stakeholders. (Milton Friedman views).
• Value is created when shareholders are happy with the return on investments,
customers are happy with the products and services and future of the company,
the employees are proud of where they work and society benefits of environmental
protection. (All stakeholders are happy.)

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 Theories of Corporate Governance.
Transaction Cost Theory
• Ideal corporate governance structures must limit transaction costs.
• What are transaction costs?
• Costs of sourcing for information. (Research costs)
• Negotiating costs.
• Monitoring costs. (enforce contracts)
• Decision making costs. (who should be appointed)
• What is an ideal board structure that will limit transaction costs?
• The board must be independent majority members.
• They are better placed to represent the interests of shareholders as they do not have a conflict of
interest.
• They should also form part of board committees such as audit, remuneration and risk.
• No CEO duality.
• The role of CEO and board chairperson must be separated.
• This will ensure a balance of power within the organisation.

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 Theories of Corporate Governance.
• Board diversity.
• Board members must be from different backgrounds id est. skills, qualifications, gender, race, age
etc.
• This will contribute to better decision making and good risk management.

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Principles of good corporate
governance.
 Principles of good corporate governance
Legitimacy and Voice
• Based on the UNDP’s principles of participation and consensus orientation,
legitimacy and voice require that a broad consensus which considers the best
interests of the group be accounted for.
• Through free association and speech, everyone must have the opportunity to
participate in reaching that consensus.
Direction
• Based on UNDP’s principle of strategic vision, good governance requires a broad
perspective and fundamental understanding of the cultural, historical, and social
complexities that exist alongside directional vision.
Performance
• Based on UNDP’s principles of responsiveness and effectiveness and efficiency,
organizational performance must meet the needs of stakeholders while best
utilizing resources.

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 Principles of good corporate governance
Accountability
• Based on UNDP’s principles of accountability and transparency, internal and
external accountability must exist alongside a free flow of information.
• Refers to the extent to which an outsider can make meaningful assessment of an
organization's operations (financial and non-financial operations), and decisions.
• This accountability is becoming increasingly premium in an increasingly
democratized society.
Fairness
• Based on UNDP’s principles of equity and rule of law, good governance must
consider the opportunities for everyone to maintain and improve their well-being,
while impartially enforcing legal frameworks.
• The mechanisms that exists in organisations must balance the needs and
demands of various stakeholders and the future of the organisation.

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 Principles of good corporate governance
Independence
• Independence refers to the extent to which companies have put in place
mechanisms to minimize or avoid potential conflict of interest such as a dominant
Chief Executive Officer or a major shareholder.
• These mechanisms relate to board compositions, board committee appointments,
and external parties such as auditors.
• Decisions made and internal processes established must be objective and not
allow any undue influence.
Discipline
• Corporate discipline refers to a company’s senior management commitment to
adhere to behaviour universally accepted as correct and proper.
• This encompasses a company’s awareness of, and commitment to, the underlying
principles of good governance, particularly at senior management level.

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 Principles of good corporate governance
Responsibility
• With regards to management, responsibility refers to action that allows for
corrective action and for penalising mismanagement.
• Responsible management would put in place mechanism that would set the
organisation on the right path.
• While the board is responsible to the organisation, it must nevertheless be
responsive to and with the and responsibility towards all shareholders.
Social responsibility
• A socially responsible organisation places high priority on social issues with ethics
emphasized.
• A good corporate citizen is increasingly seen as one that is non-discriminatory,
nonexploitative, and responsible with regard to environmental and human rights
issues.
• A company is likely to experience indirect economic benefits such as improved
productivity and corporate reputation by taking those factors into consideration.
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