Corporate Governance
Monday, November 25, 2013
When you see company scandal, corruption, and
fraud splashed across the headlines, you can be pretty sure that
the term ‘corporate governance' will follow.
It's a phrase we've
been familiar with since the high-profile collapse of energy
company Enron and communications giant WorldCom in 2001 and 2002,
which exposed the inner workings of these companies to public
scrutiny.
Their downfalls also shone the spotlight on how other
companies are governed – and how managers are kept accountable.
Companies are typically governed according to a set of rules and
regulations – rules that have been subject to tighter control
since the Enron scandal. These rules are expected to protect the
assets and resources of the company – and hold top managers and
executives accountable for their decisions and actions.
In this article, we look at how corporate governance began, what
its implications are in today's world, and the people and
processes that support it.
Corporate Governance – the Beginning
When companies first started forming during the industrial age,
greed and a lack of ethics were common. Company executives often
got rich – while customers were taken advantage of, workers
remained poor, and investors lost money. It became clear that laws
were needed to protect the interests of stakeholders.
With the rise of public corporations, corporate governance was
born. People at the highest levels of organizations were made
accountable to a group of elected representatives: the board of
directors. The board became the head of the organization –
responsible for hiring professional managers to run the company,
overseeing the corporate systems, and protecting investors'
interests.
This system of representation is the basis of corporate governance
– the system by which organizations are directed and controlled
today.
Today's World
In the modern world, corporate governance protects more than
investors' interests. It also represents the public interest,
through environmental and social standards and practices.
Post-Enron, the United States government passed the Sarbanes-Oxley
Act (SOX) in 2002, to help prevent similar corporate catastrophes
in future. And recent financial crises in the US and United
Kingdom have created an even stricter regulatory environment.
Now, more than ever, there's an increasing emphasis on improving
corporate processes, accountabilities, and controls – all in an
effort to decrease abuses of power, and increase the integrity of
decision making within corporations. This is part of a more
general trend toward more openness and accountability for all
organizations in the public and private sector.
Corporate governance is a major factor in overall organizational
health and sustainability because it does the following:
Protects shareholders rights.
Encourages investment.
Increases accountability.
Increases transparency.
Ensures disclosure.
Creates better relationships with stakeholders.
The People of Corporate Governance
Corporate governance is carried out by people – and each has
duties and responsibilities that ensure open, honest, and
compliant corporate behavior. The key individuals and groups are
as follows:
Board of directors – The shareholders elect this group to
oversee corporate performance on their behalf. Directors should be
independent, and they should have the incentive to create value
within the corporation. Their main task is to appoint a chief
executive officer, and hold him or her accountable for the
company's daily operations.
Independence means freedom from material
ties to the company, managers, and external auditors.
Independent directors theoretically act in the best
interests of the company and its shareholders, because they
have no ties to prevent objective decision making and
behavior. In the UK, the 2003 Higgs Report said
non-executive directors – who are not involved in the
day-to-day running of the business – should monitor and
challenge company strategy and managerial performance.
Chief executive officer (CEO) – The board
hires this individual to manage the corporation's day-to-day
operations – including strategic planning, financial reporting,
and risk management. The CEO is also responsible for keeping the
board informed of what's happening in the organization.
Senior managers – The CEO hires these people to manage the
various functions of the business. They're responsible for
creating and supervising internal control systems, developing an
effective corporate structure, setting a 'tone at the top' that
emphasizes integrity and ethical behavior, and ensuring that
processes are in place to avoid and detect misconduct.
Shareholders – These are the financial investors in the
organization. They don't directly participate in corporate
operations, so they need to elect informed, qualified, and
independent directors to protect their interests.
Stakeholders – These are other organizations and people who are
affected by a company's operations. Stakeholders can include
people the organization does day-to-day business with, such as
employees, customers, and suppliers. They can also include people
outside the organization who have a particular interest in how the
company operates, such as lobbying and campaigning organizations.
For example, social and environmental concerns are now part of the
responsibility of corporate governance, so the stakeholders'
overall area of influence is increasingly global.
Audit committee – This team of independent directors oversees
the corporation's financial reporting. At least one of these
committee members should be an accountant. The committee meets
regularly to make sure the outside auditors perform their duties,
and to review internal controls and financial systems for
reliability.
Governance committee – This group of several independent
directors oversees the corporation's governance activities. It
recommends board nominees, ensures that board members remain
independent, and reviews governance practices for effectiveness.
Compensation committee – This team of independent directors
oversees senior management compensation packages, as well as
compensation policies in general. Its key role is to ensure that
overall compensation is competitive, and that performance
incentives are good value for the corporation.
The Tools
Managers and directors can use a variety of tools and strategies
to support corporate governance activities.
Internal control systems
These processes are designed to assure the following:
Effective and efficient operations.
Reliable financial reporting.
Compliance with applicable laws and regulations.
Risk management
This is a formal system to identify, measure,
and control risk. It should assess both financial and nonfinancial
risk.
Disclosure systems
A disclosure policy should encourage a
culture of openness and transparency. It often includes elements
such as these:
Anonymous disclosure – often referred to as ‘ whistleblowing .'
No negative consequences for disclosure.
Independent review of disclosures.
Regular audits of disclosure risks.
Corporate responsibility
This refers to the company's overall
commitment to be accountable to customers, workers, shareholders,
and communities through activities like these:
Business ethics.
Brand management.
Investor relations.
Stakeholder communications.
Environmental affairs.
Socially responsible investing.
Corporate philanthropy.
For more on corporate social responsibility, listen to our Expert Interview on the subject with Andrew Crane.
Corporate Governance Around the World
The governance practices described above are typical of North
American corporations (although we've also touched on UK
practice). The Organisation for Economic Cooperation and
Development (OECD) prepared Principles of Corporate Governance in
1999 to set global standards, mostly because investors in the
United States and United Kingdom wanted reform. This resulted in
two different models of corporate governance:
Outsider Systems – here the owners of the company (shareholders)
are not involved in management decisions, and individual investors
own very little of the company. This model relies on the strength
of the markets to allocate resources correctly. The market is very
liquid, meaning that shares can be sold easily if investors aren't
happy. Incentives and external control systems are used to align
management's interests with those of the shareholders. This system
is found in countries like the UK, US, Canada, and Australia.
Insider Systems – here the owners exercise control from inside the
company. Owners typically have large stakes, and they actively
cooperate with the company's managers. However, as these owners
are focusing their capital in one organization, as opposed to
spreading their investment across a portfolio, they face higher
risks, and so will expect greater returns from their investment
than outside investors would. The markets for insider ownership
are relatively illiquid. The large owners are often banking
institutions, industrial firms, large family networks, or even 'the State.' Insider systems may be more motivated by broader
obligations to all the stakeholders of a company.
Member countries of the OECD are
Austria, Belgium, Canada, Denmark,
France, Germany, Greece, Iceland, Ireland, Italy,
Luxembourg, the Netherlands, Norway, Portugal, Spain,
Sweden, Switzerland, Turkey, the United Kingdom, the United
States, Japan, Finland, Australia, New Zealand, Mexico, the
Czech Republic, Hungary, Poland, Korea, and the Slovak
Republic. You can use the following link to read the
Principles of Corporate Governance updated in 2004:
http://www.oecd.org/DATAOECD/32/18/31557724.pdf
Here are a few examples of global differences:
United States
Outsider system.
No insider trading allowed.
Sarbanes Oxley Act (SOX) passed in 2002, outlining a demanding
set of rules and regulations for compliance.
United Kingdom
Outsider system.
No insider trading allowed.
The UK has pioneered a flexible form of regulation that asks
companies either to comply with a set of best practices, or to
explain why, if they do not apply those principles.
Continental Europe (Germany, France, Italy)
Insider.
Stakeholder claims are typically taken into account in top
management decisions.
Japan
Sub type of an insider system – no insider trading is allowed.
High employee/stakeholder consideration in corporate
decision making.
Public trading is regulated by the government, and it can be
suspended if uncertainty is high.
The gap between insider and outsider systems is decreasing. The
underpinning legal, political, and social structures are key
determinants of the type of corporate governance system used.
Regardless of the system used, as the world's markets rely more on
one another, the need for high global standards is clear.
The European Corporate Governance Institute has a web guide to governance reports from countries all around the world.
Key Points
Corporate governance refers to both the structure and the
relationships that determine corporate direction and performance.
The board of directors is typically central to corporate
governance. Its relationship to stakeholders – including
shareholders, managers, workers, customers, and society in general
– is critical. The corporate governance framework also depends on
the legal, regulatory, institutional, and ethical environment of
the community.
Good corporate governance ensures transparency, fairness, and
accountability. It's necessary for the integrity and credibility
of all kinds of organizations – public, private, nonprofit, and
institutional. Good governance builds confidence and trust. It
allows the corporation to have access to investor financing, and
it assures creditors and workers that the company is reliable and
sustainable. Corporate governance is the foundation of trust in
our market economy, so it's important to evaluate the performance
of directors and corporations to ensure that the governance system
is working.
Tags:
Skills, Strategy Tools
fraud splashed across the headlines, you can be pretty sure that
the term ‘corporate governance' will follow.
It's a phrase we've
been familiar with since the high-profile collapse of energy
company Enron and communications giant WorldCom in 2001 and 2002,
which exposed the inner workings of these companies to public
scrutiny.
Their downfalls also shone the spotlight on how other
companies are governed – and how managers are kept accountable.
Companies are typically governed according to a set of rules and
regulations – rules that have been subject to tighter control
since the Enron scandal. These rules are expected to protect the
assets and resources of the company – and hold top managers and
executives accountable for their decisions and actions.
In this article, we look at how corporate governance began, what
its implications are in today's world, and the people and
processes that support it.
Corporate Governance – the Beginning
When companies first started forming during the industrial age,
greed and a lack of ethics were common. Company executives often
got rich – while customers were taken advantage of, workers
remained poor, and investors lost money. It became clear that laws
were needed to protect the interests of stakeholders.
With the rise of public corporations, corporate governance was
born. People at the highest levels of organizations were made
accountable to a group of elected representatives: the board of
directors. The board became the head of the organization –
responsible for hiring professional managers to run the company,
overseeing the corporate systems, and protecting investors'
interests.
This system of representation is the basis of corporate governance
– the system by which organizations are directed and controlled
today.
Today's World
In the modern world, corporate governance protects more than
investors' interests. It also represents the public interest,
through environmental and social standards and practices.
Post-Enron, the United States government passed the Sarbanes-Oxley
Act (SOX) in 2002, to help prevent similar corporate catastrophes
in future. And recent financial crises in the US and United
Kingdom have created an even stricter regulatory environment.
Now, more than ever, there's an increasing emphasis on improving
corporate processes, accountabilities, and controls – all in an
effort to decrease abuses of power, and increase the integrity of
decision making within corporations. This is part of a more
general trend toward more openness and accountability for all
organizations in the public and private sector.
Corporate governance is a major factor in overall organizational
health and sustainability because it does the following:
Protects shareholders rights.
Encourages investment.
Increases accountability.
Increases transparency.
Ensures disclosure.
Creates better relationships with stakeholders.
The People of Corporate Governance
Corporate governance is carried out by people – and each has
duties and responsibilities that ensure open, honest, and
compliant corporate behavior. The key individuals and groups are
as follows:
Board of directors – The shareholders elect this group to
oversee corporate performance on their behalf. Directors should be
independent, and they should have the incentive to create value
within the corporation. Their main task is to appoint a chief
executive officer, and hold him or her accountable for the
company's daily operations.
Independence means freedom from material
ties to the company, managers, and external auditors.
Independent directors theoretically act in the best
interests of the company and its shareholders, because they
have no ties to prevent objective decision making and
behavior. In the UK, the 2003 Higgs Report said
non-executive directors – who are not involved in the
day-to-day running of the business – should monitor and
challenge company strategy and managerial performance.
Chief executive officer (CEO) – The board
hires this individual to manage the corporation's day-to-day
operations – including strategic planning, financial reporting,
and risk management. The CEO is also responsible for keeping the
board informed of what's happening in the organization.
Senior managers – The CEO hires these people to manage the
various functions of the business. They're responsible for
creating and supervising internal control systems, developing an
effective corporate structure, setting a 'tone at the top' that
emphasizes integrity and ethical behavior, and ensuring that
processes are in place to avoid and detect misconduct.
Shareholders – These are the financial investors in the
organization. They don't directly participate in corporate
operations, so they need to elect informed, qualified, and
independent directors to protect their interests.
Stakeholders – These are other organizations and people who are
affected by a company's operations. Stakeholders can include
people the organization does day-to-day business with, such as
employees, customers, and suppliers. They can also include people
outside the organization who have a particular interest in how the
company operates, such as lobbying and campaigning organizations.
For example, social and environmental concerns are now part of the
responsibility of corporate governance, so the stakeholders'
overall area of influence is increasingly global.
Audit committee – This team of independent directors oversees
the corporation's financial reporting. At least one of these
committee members should be an accountant. The committee meets
regularly to make sure the outside auditors perform their duties,
and to review internal controls and financial systems for
reliability.
Governance committee – This group of several independent
directors oversees the corporation's governance activities. It
recommends board nominees, ensures that board members remain
independent, and reviews governance practices for effectiveness.
Compensation committee – This team of independent directors
oversees senior management compensation packages, as well as
compensation policies in general. Its key role is to ensure that
overall compensation is competitive, and that performance
incentives are good value for the corporation.
The Tools
Managers and directors can use a variety of tools and strategies
to support corporate governance activities.
Internal control systems
These processes are designed to assure the following:
Effective and efficient operations.
Reliable financial reporting.
Compliance with applicable laws and regulations.
Risk management
This is a formal system to identify, measure,
and control risk. It should assess both financial and nonfinancial
risk.
Disclosure systems
A disclosure policy should encourage a
culture of openness and transparency. It often includes elements
such as these:
Anonymous disclosure – often referred to as ‘ whistleblowing .'
No negative consequences for disclosure.
Independent review of disclosures.
Regular audits of disclosure risks.
Corporate responsibility
This refers to the company's overall
commitment to be accountable to customers, workers, shareholders,
and communities through activities like these:
Business ethics.
Brand management.
Investor relations.
Stakeholder communications.
Environmental affairs.
Socially responsible investing.
Corporate philanthropy.
For more on corporate social responsibility, listen to our Expert Interview on the subject with Andrew Crane.
Corporate Governance Around the World
The governance practices described above are typical of North
American corporations (although we've also touched on UK
practice). The Organisation for Economic Cooperation and
Development (OECD) prepared Principles of Corporate Governance in
1999 to set global standards, mostly because investors in the
United States and United Kingdom wanted reform. This resulted in
two different models of corporate governance:
Outsider Systems – here the owners of the company (shareholders)
are not involved in management decisions, and individual investors
own very little of the company. This model relies on the strength
of the markets to allocate resources correctly. The market is very
liquid, meaning that shares can be sold easily if investors aren't
happy. Incentives and external control systems are used to align
management's interests with those of the shareholders. This system
is found in countries like the UK, US, Canada, and Australia.
Insider Systems – here the owners exercise control from inside the
company. Owners typically have large stakes, and they actively
cooperate with the company's managers. However, as these owners
are focusing their capital in one organization, as opposed to
spreading their investment across a portfolio, they face higher
risks, and so will expect greater returns from their investment
than outside investors would. The markets for insider ownership
are relatively illiquid. The large owners are often banking
institutions, industrial firms, large family networks, or even 'the State.' Insider systems may be more motivated by broader
obligations to all the stakeholders of a company.
Member countries of the OECD are
Austria, Belgium, Canada, Denmark,
France, Germany, Greece, Iceland, Ireland, Italy,
Luxembourg, the Netherlands, Norway, Portugal, Spain,
Sweden, Switzerland, Turkey, the United Kingdom, the United
States, Japan, Finland, Australia, New Zealand, Mexico, the
Czech Republic, Hungary, Poland, Korea, and the Slovak
Republic. You can use the following link to read the
Principles of Corporate Governance updated in 2004:
http://www.oecd.org/DATAOECD/32/18/31557724.pdf
Here are a few examples of global differences:
United States
Outsider system.
No insider trading allowed.
Sarbanes Oxley Act (SOX) passed in 2002, outlining a demanding
set of rules and regulations for compliance.
United Kingdom
Outsider system.
No insider trading allowed.
The UK has pioneered a flexible form of regulation that asks
companies either to comply with a set of best practices, or to
explain why, if they do not apply those principles.
Continental Europe (Germany, France, Italy)
Insider.
Stakeholder claims are typically taken into account in top
management decisions.
Japan
Sub type of an insider system – no insider trading is allowed.
High employee/stakeholder consideration in corporate
decision making.
Public trading is regulated by the government, and it can be
suspended if uncertainty is high.
The gap between insider and outsider systems is decreasing. The
underpinning legal, political, and social structures are key
determinants of the type of corporate governance system used.
Regardless of the system used, as the world's markets rely more on
one another, the need for high global standards is clear.
The European Corporate Governance Institute has a web guide to governance reports from countries all around the world.
Key Points
Corporate governance refers to both the structure and the
relationships that determine corporate direction and performance.
The board of directors is typically central to corporate
governance. Its relationship to stakeholders – including
shareholders, managers, workers, customers, and society in general
– is critical. The corporate governance framework also depends on
the legal, regulatory, institutional, and ethical environment of
the community.
Good corporate governance ensures transparency, fairness, and
accountability. It's necessary for the integrity and credibility
of all kinds of organizations – public, private, nonprofit, and
institutional. Good governance builds confidence and trust. It
allows the corporation to have access to investor financing, and
it assures creditors and workers that the company is reliable and
sustainable. Corporate governance is the foundation of trust in
our market economy, so it's important to evaluate the performance
of directors and corporations to ensure that the governance system
is working.
