Corporate Governance: Theories, Definition, Examples

Corporate governance refers to the collection of rules, practices, and processes to manage a company. Corporate governance is important to maintain the stability and integrity of companies as it promotes trust in the business environment. Studies suggest that there is a positive relationship between Corporate Governance and shareholders value.

What is Corporate Governance?

Investing is risky but information and warning signals need to be given with integrity, which was missing in the past financial scandals e.g. Maxwell, BCCI, Enron.

Corporate governance is getting increased attention from all quarters, and several countries have passed legislations for regulating corporate governance.

For example, America has passed Sarbanes-Oxley Act for regulating corporate governance due to governance failure. There are laws in various countries that require quota for female directors.

Corporate governance is the system, the set of practices and rules, by which companies are directed, controlled and managed. It influences how the objectives of the company are set and achieved, how risk is monitored & assessed, & how performance is optimized.

The primary objectives are to ensure transparency, accountability, and responsibility so that the interests of various stakeholders such as shareholders, management, customers, suppliers, financiers, government, and the community, are balanced.

The concept of transparency means accountability and explanation to outsiders of the workings of a firm (W. Scarff’s definition).

• The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company
• Corporate governance is therefore about what the board of a company does and how it sets the values of the company
• The Financial Reporting Council’s code is a guide to a number of key components of effective board practice
• It highlights issues such as decisions being affected by “groupthink”; the need for a sufficiently diverse board; clear culture, values and ethics; the need for Directors to lead by example
• However it is important to remember that governance is much wider than just finance. It is about transparency, accountability, and commitment.

Corporate governance involves principles, policies, procedures, and clearly defined responsibilities and accountabilities used by stakeholders to overcome the conflicts of interest inherent in the corporate form. Corporate governance often includes both social and institutional aspects.

The Board of Directors generally plays a vital role in the development of corporate governance policies. It needs to engage with the management of the business to provide clarity of strategic purpose. Good management is in fact critical for the operation of a company but managers also need direction in order to prioritise operations and to allocate funds.

• It is the board of directors that is the principal agent for corporate governance: The board is given a mission by shareholders, translates that mission into specific elements of strategy, and then provides direction for management, which makes it all happen.
• The board also ensures that good strategy is backed by proper compliance, to make sure it plays by the rules; and the board also evaluates the risks involved in strategy implementation, and uses appropriate tools of corporate governance, like the audit committee and internal controls, to ensure no dangerous risks are left unmanaged.

Developing and setting a clear strategy and then implementing it effectively are vital to any organisation’s success. Shareholders also play an important role in governance as they need to ensure the right directors are appointed to their Board.

Read: More Business ethics and Responsibility Topics

Developments in Corporate Governance

• Cadbury 1992: Increased use of non executive directors to counter internal untrustworthiness
• Greenbury 1995: Examination of director pay; not linked to share price; stock options used as part of pay package
• Hampel and combined code 1998: Board has responsibility for relations to stakeholders but director responsibility is to shareholders
• Turnbull 1999: Audit controls
• OECD principles 1999 – like combined codes: Combined code via London Stock Exchange: corporate governance practices for listings
• Myners 2001: Role of institutional investors – activism against directors needed, but little change

• Sarbanes-Oxley Act of 2002 (USA):

  Comply or explain – requirements on chief executives for personal signing off of accounts
  Andersen’s, Enron’s auditors made as much non-audit income from Enron as from audit – loss of independence?

• Smith & Higgs and combined code 2003: Higgs – roles of non executive directors. Smith – role of audit committees

• Issues with Enron:

  Where were the (NEDs) non executive directors?
  NEDs occasional attendance
  NEDs are also executive directors of their own companies. Are they thus really trustworthy?

However, the ground reality is that there’s little change but many reports.

Fisher and Lovell (2006, p.307) offers an expanded definition of corporate governance.

King 2002 – companies should no longer act independently of the societies and environment in which they operate:

Spiritual collectiveness, Humility and helpfulness, Fairness to all human beings, High standards of morality based on close kinship clans etc., Corporate governance is about leadership.