What is Corporate Governance?

Corporate governance represents the collection of mechanisms and relationships used by various parties to control and operate a company. Governance structures and principles determine the distribution of rights and responsibilities. There are rules and procedures for making decisions in corporate affairs which guide the direction of the company. Good corporate governance helps to build trust between companies and shareholders, it’s workers, the environment and the communities it serves. Bad corporate governance creates doubt in a company’s ability to operate in good faith and therefore threatens profitability. Investing in a company doesn’t just need to be profitable. It also needs to demonstrate good corporate citizenship through environmental responsibility, ethical behavior, risk management and other corporate governance practices which will make it sustainable.

Corporate Strategy and Governance

Ideas about corporate governance vary greatly. People disagree mainly about fundamental issues including the purpose of the corporation, the role of corporate board members and shareholders, and what can be measured within the company. How these controversies are resolved to affect positive business operations and risk management in the real world are debated by the company’s board. There may also be independent directors, corporate officers and an executive team. Nonetheless, with the tectonic shift to ESG principles within corporate behavior, a company’s financial health and future sustainability will be based on an effective corporate governance strategy.

Corporate Governance And Sustainable Development

Recently, the pandemic has highlighted the glaring inequities of our societies. It has also laid bare the damage that our species has incurred on the planet. Members of the board of directors of many businesses are beginning to wake up to the changes occurring through Environmental, Social and Governance pressures. Most corporations have a corporate social responsibility strategy and communication plan, but how old are they? Today, financial institutions are shifting their investment strategies to supporting sustainable business models because of increased demand for SRI’s. Socially responsible investing begins with good corporate governance.

A board of directors who want to be on top in their market must think more about long-term sustainability. A good corporate governance model needs to report their commitment to sustainability and develop disclosure practices of the company’s operations. Moving forward, long-term profits must have CSR policies if businesses are to flourish and succeed. So sustainability development must be integrated into an organisation’s corporate governance.

The 3 Pillars of Sustainable Development

Good corporate governance is built on sustainability. Sustainability is built on three important pillars that companies must meet: economic development, social safety and environmental protection. It is defined as the ability to be competitive and profitable today, without costing future generations the ability to do the same. The key tenets are that sustainability is of great concern with today’s investors who are looking for economic profit but who also wish to be socially responsible. Also know as a win-win for shareholders interests.

The role of shareholders

Shareholders are the owners of a company. They may be individuals, groups or companies who own parts of the company through shares in it. When shareholders invest in business they do so with an expectation that their investment will provide some financial return. All corporations have to be managed according to rules and regulations which are set out by laws under the company’s jurisdiction. For most companies this means that they are run for the benefit of their shareholders, since these are the people who own the company.   The majority shareholder also has a right to appoint and remove members of the board of directors, which controls how the business is run.

Today, investors want businesses to behave responsibly, both in terms of how they operate and also in their relationships with customers, employees, suppliers and the communities around them. They also expect leadership from companies on environmental issues such as climate change. So it follows that if businesses want to attract investors today they need to be able to show these characteristics.

Defining Governance performance

in relation to corporate governance Business performance is defined in many ways. First, it can be seen as the efficiency of an organisation’s production function. Or, Second, it can be defined in terms of how well managers allocate resources or inputs to achieve objectives (outputs). Thirdly, business performance is concerned with measuring what happens in a company, or what is going on there.

Measuring Performance

Performance is generally measured using Key Performance Indicators. These are the measures used to assess a business’s performance relative to its competitors and/or industry averages. In the public sector, a key performance indicator would be a school’s or hospital’s percent of students or patients with a minimum standard of literacy and health. In the private sector, an example might be how long it takes for a company to produce their product from when an order is received.

Overseeing risk and ensuring accountability

Shareholders are not the only party that has a interest in whether a company is performing well. One of the key responsibilities of a board of directors is to ensure that management does not take too much risk and that they do repay shareholders for this risk, if necessary. The threat of lawsuits from shareholders about poor performance or mismanagement serves as an important form of corporate governance. Directors, officers and managers are accountable to the board of directors for their actions. Both the board of directors and executive management are responsible for ensuring that they carry out their responsibilities responsibly. The role of risk management in business operations is multi-faceted. Although there are some common themes surrounding it at a high level, it does vary quite a bit.

Common Corporate Disclosure Practises

Although there are many ways of disclosing information related to corporate governance, some common practises include but are not limited to annual reports, shareholder updates, press releases and board meeting agendas. Annual reports usually provide management’s discussion on the state of the company by means of a letter from the CEO addressed to shareholders. Shareholder updates consist of letters sent out quarterly in which the company’s performance is discussed in regards to its environment. Press releases are issued to announce major corporate events such as merger and acquisitions, revenues or profits. Lastly, board meeting agendas outline what topics will be discussed at upcoming board meetings.

What can investors get out of this?

Investors should always know what is going on with the company they invested in and be kept up to date with events and any changes that may occur. Most importantly, investors should know if their investment has generated returns for them over time, while simultaneously minimising risk.

What is there that governments can get out of this?

Governments should be able to assess that the companies they invest in are transparent enough with their shareholders and stakeholders in terms of performance and financials, while also keeping up to date in regards to any changes and events occurring. Furthermore, shareholders and stakeholders should feel like they are being treated fairly by companies.

Governance and Corporate Transparency

In the business world, transparency is a measure of how well information about a company is communicated to its shareholders and creditors. In other words, it reflects how much information an organization shares with those outside the organization. The concept stands in opposition to opacity or opaqueness, which describes conditions where there is little or no clarity concerning what actions have been undertaken, how policies are created, what products are offered, etc.

A desirable outcome

Transparency is a desirable outcome for any organization as it can build trust and avoid adverse selection in the marketplace. The concept has taken on particular importance due to efforts at corporate social responsibility (CSR), which stress that firms should communicate their value propositions clearly so that their customers know what to expect.

“While transparency is arguably an imperative for companies in liberal market economies, where the values of democracy and capitalism take precedence, it also has benefits for other kinds of organizations, including political ones,” writes Lawrence Chickering. The concept finds supporters on both the political left and political right.

A skelton key floating before a white wall with a keyhole, representing the key governance issues

The Anglo-American model of corporate governance

In the American model of corporate governance, they have what is known as the Shareholder model. This refers to the dominance of shareholder value in shaping decisions, monitoring performance and rewarding managers. This model is based on maximizing share prices for the benefit of investors by ensuring that the corporations are run to maximize shareholder value. The power of shareholders is upheld through controlling mechanisms such as voting rights, board representation and appointment mechanisms. The Anglo-American model has been supported by institutions such as the US Security and Exchange Commission, the UK’s Financial Reporting Council and the OECD.

The Continental European model of corporate governance

In continental Europe, there is a different approach to corporate governance that advocates a multi-stakeholder approach. This has given rise to the stakeholder model which involves all those who have a stake in the company, thus placing emphasis on broader interests than just that of shareholders. The objective is to maximize not just shareholder value but also the interest of all other stakeholders such as workers, suppliers and even customers. Under this model, directors are seen as representatives with loyalty owed to all stakeholders rather than only to shareholders.

The bottom line on Governance

The bottom line is that governance is a management task and ultimately boards have to be responsible for how their companies are run. Boards have to ensure that the right choices are being made about which risks get taken, what resources should be devoted to what projects and how various stakeholders’ interests should be balanced. Boards have to take a long- term view and ensure that they are making decisions that will work in the future.

Therefore, governance is important because it helps control risk and ensure accountability to the shareholders. It gives a better understanding of company policy and how it will affect their stakeholders. It also shows transparency, promotes trust and builds relationships with the community around them.

Caveats and Disclaimers on Good Corporate Governance

We have covered many topics in this article and want to be clear that any reference to, or mention of corporate governance, good corporate governance, management board, shareholder interests, executive compensation, board of directors, company’s board, public companies, represent shareholders, corporate leadership, about governance structure, bad corporate governance, supervisory board, corporate social responsibility, business integrity, fewer companies, principles of corporate governance, capital markets, disclosure practices, best interests, two tier board system, executive board, leadership structure, continental european countries, major shareholders, company’s objectives, board composition or ethical behavior in the content of this article is purely for informational purposes and not to be misconstrued with investment advice. Thank you for reading.