What is Corporate Governance?

The primary purpose of corporate Governance is the safeguarding of stakeholders’ interests. This includes the Board of Directors, senior management, creditors, suppliers, shareholders, customers, employees, government, banks, and society. It ensures the diversity of the board. It safeguards shareholders’ rights—for example, the right to dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more or the right to vote.

Key Takeaways

  • Corporate governance is an organization’s modus operandi comprising rules, practices, regulations, policies, and procedures. These guidelines control businesses. A company with good governance reflects fair business practices. This is made possible by employing robust risk management systems, diversity, independent auditors, satisfied stakeholders, progressive compensation models, transparency, and accountability. Poor corporate governance can be destructive. Shareholders and investors will lose faith, consumers will be dissatisfied, and ultimately the brand image will be tarnished.

Corporate Governance Explained

Corporate Governance is the foundation of an organization’s functioning and business conduct. Effective Governance includes the following elements:

  • A seamless corporate structure— clear roles, responsibilities, policies, practices, procedures, and code of conduct;The diversity of the board;Strategically designed risk management mechanisms;Cordial relations and trust among the different stakeholders;Complete disclosure of corporate information, including the sustainability report on the ESG practices (Environmental, Social and Governance);Safeguarding and centralizing shareholders’ rights— right to dividend and right to vote;Containing proxy, influenced voting and other unfair practices;Timely review and revision of remunerationRemunerationRemuneration refers to overall monetary and non-monetary compensation that employees or independent contractors receive for providing services to an organization or company.read more; andGiving freedom to auditors— to check company’s accounts—prepare fair audit reports.

Corporate Governance Structure

The key players in the corporate governance framework are as follows:

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  • Board of Directors: Board of DirectorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals.
  • read more takes crucial decisions to attain long-term business objectives. They are also referred to as “Those Charged With Governance” (TCWG).Management: The management is a subset of the BOD led by the Chief Executive Officer (CEO) of the company. The CEO is responsible for business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company’s goals like profit generation.read more, formulation of strategies, and evaluation of associated risks.Shareholders: The stockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company’s owners, but their liability is limited to the value of their shares.read more are investors who put their hard-earned money into the company anticipating positive returns. They cannot track corporate affairs on a daily basis, and therefore, rely on the directors. Further, shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more appoint auditorsAuditorsAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country’s local operating laws.read more to dig into the business’s financial affairs—provide the audit reportAudit ReportAn audit report is a document prepared by an external auditor at the end of the auditing process that consolidates all of his findings and observations about a company’s financial statements.read more.

The US has a “best practices” approach when it comes to corporate governance. Although there is no particular code of conduct, the state and federal authorities state various rules, regulations, and laws in this regard. The regulations are as follows.

#1 – Federal Securities Law

  • The Securities and Exchange Commission (SEC) has put forward the Securities Act 1933 and the Securities Exchange Act 1934. The 1933 Act controls the registration of securities with SEC and national stock markets. The 1934 Act controls the secondary trading of securities. It also established the SEC as the agency primarily responsible for the enforcement of United States federal securities law.Sarbanes-Oxley ActSarbanes-Oxley ActThe Sarbanes-Oxley Act (Sox) of 2002 was enacted by the US Federal Law for increased corporate governance, strengthening the financial and capital markets at its core and boost the confidence of general users of financial reporting information and protect investors from scandals like that of Enron, WorldCom, and Tyco.read more was formed in the 2000s to protect and restore the interest of the shareholders.Gramm-Leach-Bliley Act changed the public perception of financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more. The act improved faith in the financial systemFinancial SystemA financial system is an economic arrangement wherein financial institutions facilitate the transfer of funds and assets between borrowers, lenders, and investors.read more.

#2 – State Corporate Laws

  • The state corporate laws govern the rights of the directors and shareholders in corporate management.The Delaware General Corporation Law (DGCL) applies mainly to the public companies Public Companies Publicly Traded Companies, also called Publicly Listed Companies, are the Companies which list their shares on the public stock exchange allowing the trading of shares to the common public. It means that anybody can sell or buy these companies’ shares from the open market.read moreset up in Delaware. Some other states also follow DGCL regulations.The American Bar Association puts forward another legislation, i.e., the Model Business Corporation Act, defining the various laws for running a corporation. It outlines everything; from the formation of a company to the voting rights of shareholders.

Example

  • Customer-centric approach;Increased cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more;Spending wisely;Continuous hiring of a talented workforce; andPrioritizing long-term considerations over short-term profits.

Principles of Corporate Governance

Following principles guide firms in developing a corporate governance framework:

  • Leadership: The board of directors and the CEO should be competent in decision-making.Risk Management: There should be a robust risk management mechanism for handling uncertainties.Transparency: The management should disclose the complete financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more of the company.Responsibility: The board of directors is responsible for running the business on behalf of the shareholders.Accountability: The board of directors and the CEO are accountable to the shareholders for their actions and their style of governance. At the same time, the management is answerable to the BOD.Fairness: All the stakeholders should be treated equally.Effectiveness and Efficiency: The policies and procedures should be clear and uniform. Moreover, it should be well-communicated.Independence: The shareholders should be free to vote, and the auditors should be given access to financial data. The auditors should be given the freedom to prepare transparent audit reports.Responsiveness: In addition to shareholders, crucial information should also be communicated to vendorsVendorsA vendor refers to an individual or an entity that sells products and services to businesses or consumers. It receives payments in exchange for making items available to end-users. They constitute an integral part of the supply chain management for providing raw materials to manufacturers and finished goods to customers.read more, customers, financers, and employees.

Importance

Corporate Governance ensures that stakeholders are not deprived of their rights. In addition, it facilitates compliance. It initiates the formulation of seamless procedures and practices ensuring transparency. It limits corruption and other malpractices.

An efficient framework facilitates better risk mitigation; such balanced firms attract more Investors. Good Governance attracts top talents. Ultimately, a well-run ship reflects into better share prices.

Issues

Poor Governance can destroy a business all the way to its shutdown. It paves the way for accounting scandalsAccounting ScandalsAccounting Scandals refer to situations which demonstrate intentional falsification or misrepresentation of financial documents. Some of the most famous ones are by Enron, Freddie Mac, HealthSouth, & American Insurance Group etc. read more, lack of internal control, dishonest managers, and non-disclosure of financial facts.

Without structure, running a business becomes difficult. Poorly run firms even restrict auditors from getting to the bottom of issues. It leads to inaccurate financial reportingFinancial ReportingFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more. In such firms, top management often plunders enormous amounts from the corporate funds.

Deciding on the compensation for the top-level executives is a crucial part of Governance. Sometimes, vague administration leads to favoritism and discrimination. Moreover, such a corporation loses the confidence of the investors, financiers, auditors, directors, and employees. Such lapses can severely tarnish a firm’s brand image.  

This has been a guide to What is Corporate Governance & its Meaning. Here we discuss corporate governance structure, legal frameworks, principles, Importance, issues, and examples. You can learn more about from the following articles –

Corporate Governance builds the framework for running a business. It serves the interest of its stakeholders and ensures fair business practices. Efficient structures ensure dynamism, ethical business practices, and transparency. The firm operates in the best interests of stakeholders.

Following are the four Ps of Governance:1. People2. Purpose 3. Process 4. Performance

The four pillars of Governance are as follows:1. Accountability: Ultimately, the CEO and the board is responsible for decisions; 2. Transparency of ownership, governance structure, financial condition, and business disclosures; 3. The Responsibility of centralizing stakeholder rights; and 4. Fairness: Eliminating discrimination in business practices, regulations, and procedures.

  • Corporate RaiderShareholder PrimacyWilliams ActWhistleblower Policy