Corporate Governance
Corporate governance is a broad term that refers to the mechanisms, processes, and relationships that govern and direct corporations. The rules and procedures for making decisions in corporate affairs are identified in governance structures, which include the distribution of rights and responsibilities among various participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders).
• Corporate governance is a set of systems, processes, and principles that ensure a company is run in the best interests of all stakeholders. It's the system for directing and controlling businesses.
• It's all about promoting corporate accountability, transparency, and fairness. 'Good corporate governance,' in other words, is simply 'good business.'
• Corporate governance is a system that allows companies to run smoothly; at the heart of the system is the board of directors, whose actions are governed by the law, regulations, and general meetings of shareholders.
• Shareholders appoint the board of directors and auditors, and it is to them that the board of directors reports on its stewardship at the annual general meeting.
Corporate governance ensures the following:
1. Adequate disclosures and effective decision-making in order to meet corporate goals
2. Transparency in the business world
3. Compliance with the law and the statutes
4. Protection of the interests of shareholders
5. A commitment to values and ethical business practises.
• In other words, corporate governance is management's acceptance of shareholders' inalienable rights as the true owners of the company and of their own role as trustees on their behalf.
• It is concerned with conducting a company's affairs in such a way that all stakeholders are treated fairly and that the company's actions benefit the greatest number of stakeholders.
• In this regard, management must avoid asymmetry of benefits between different segments of shareholders, particularly between the owner-managers and the rest of the stockholders.
• It's about adhering to values, conducting business ethically, and distinguishing between personal and corporate funds in the management of a business.
• Conflicting interests of the parties involved create ethical dilemmas.
• Managers make decisions in this regard based on a set of principles influenced by the organization's values, context, and culture.
• Ethical leadership is beneficial to business because it demonstrates that the organisation is committed to meeting the expectations of all stakeholders.
• The processes by which corporations' objectives are set and pursued in the context of the social, regulatory, and market environment are referred to as corporate governance.
• Corporations and their agents' actions, policies, and decisions are monitored through governance mechanisms.
• The way a company polices itself is called corporate governance. In a nutshell, it is a method of running a business like a sovereign state, enforcing the company's own standards, policies, and laws on all levels of the organisation.
• Corporate governance aims to increase a company's accountability and prevent major disasters before they happen.
FOUR PILLARS OF CORPORATE GOVERNANCE
The four pillars on which the OECD Principles of Corporate Governance are based may well be the most valuable aspect of corporate governance.
1. ACCOUNTABILITY: The corporate governance framework should include provisions for the company's strategic direction, the board's effective management oversight, and the board's accountability to the company and its shareholders.
2. TRANSPARENCY: “Sunlight is the best disinfectant“. The corporate governance framework should ensure that all aspects of the company, including its financial situation, performance, ownership, and governance structure, are disclosed in a timely and accurate manner.
3. RESPONSIBILITY: The self-interests of managers, directors, and the advisers on whom they rely must be channelled into alignment with corporate, shareholder, and public interests in an effective system of corporate governance.
• To put it another way, an effective corporate governance system must encourage collaboration between the company and its stakeholders in the creation of wealth, jobs, and economic sustainability, i.e. full recognition and enforcement of stakeholder rights.
4. FAIRNESS: Investor protection and, in particular, the prevention of improper trading practises, which leads to market confidence, are closely linked to market fairness.
• The corporate governance framework should safeguard shareholder rights and ensure that all stakeholders, including minority and foreign shareholders, are treated fairly.
STAKEHOLDERS AND AGENCY DILEMMA IN CORPORATE GOVERNANCE
• Shareholders, debt holders, trade creditors and suppliers, customers, and communities affected by the corporation's activities are the main external stakeholders in corporations. The board of directors, executives, and other employees are all internal stakeholders.
• All parties involved in corporate governance have a direct or indirect interest in the company's financial performance. Directors, employees, and management receive salaries, benefits, and a good reputation, while investors expect a profit.
• Specified interest payments are the source of returns for lenders, while dividend distributions or capital gains on stock are the source of returns for equity investors.
• Customers are concerned about receiving high-quality goods and services, while suppliers are concerned about receiving fair compensation for their goods or services.
• Much of today's interest in corporate governance is focused on resolving stakeholder conflicts of interest. In large firms with a separation of ownership and management and no controlling shareholder, the principal–agent problem arises between upper management (the "agent") and shareholders (the "principals"), who may have very different interests and, by definition, have significantly more information (information asymmetry). The shareholder relinquishes decision-making authority (control) and trusts the manager to act in the best (joint) interests of the shareholders.
• The risk is that the board of directors, rather than overseeing management on behalf of shareholders, will become insulated from them and beholden to management. This aspect is particularly prominent in current public debates and regulatory policy developments.
• Corporate governance mechanisms include a system of controls intended to help align managers' incentives with those of shareholders, partly as a result of this separation between shareholders and managers.
• Processes, customs, policies, laws, and institutions that have an impact on how a company is controlled can all be used to mitigate or prevent these conflicts of interest. The nature and scope of corporate accountability is an important theme in governance.
• A party's confidence in a corporation's ability to deliver the expected outcomes is a key factor in their decision to participate in or engage with it.
• When groups of people (stakeholders) lack confidence that a corporation is being managed and directed in a way that achieves their goals, they are less likely to engage with it.
• When this becomes an endemic system feature, many other stakeholders may suffer from a loss of confidence and participation in markets.
• When one person or entity (the "agent") has the ability to make decisions that affect, or on behalf of, another person or entity (the "principal"), the principal–agent problem or agency dilemma arises. Because the agent is sometimes motivated to act in his own best interests rather than the principal's, the dilemma exists.
• Corporate management (agent) and shareholders (principal) are common examples of this relationship, as are politicians (agent) and voters (principal).
OBJECTIVES OF CORPORATE GOVERNANCE
• The goal of "Good Corporate Governance" is to ensure that the board of directors is committed to managing the company in a transparent manner in order to maximise long-term value for its shareholders and other stakeholders. It brings together all of the people involved in a process that is both economic and social.
• The primary goal of corporate governance is to improve corporate performance and accountability in order to increase shareholder value and protect the interests of other stakeholders.
• As a result, it harmonises the need for a company to strike a constant balance between the need to increase shareholder wealth while not jeopardising the interests of other stakeholders in the company.
• Its goal is also to create a climate of trust and confidence among those with competing and conflicting interests. It is essential to a company's survival and strengthens investor confidence by assuring the company's commitment to increased growth and profits.
• In general, Corporate Governance aims to achieve the following goals:
1. Transparency in board processes and independence in board operations. The Board of Directors should provide effective leadership and management to the company in order to achieve long-term wealth for all stakeholders. It should be able to make independent decisions in order to achieve the company's goals.
2. Accountability to stakeholders, with the goal of serving them and reporting on actions taken at regular intervals through strong and sustained communication processes.
3. Independence from all stakeholders.
4. Concerns about social, regulatory, and environmental issues.
5. Effective corporate governance requires clear and unambiguous legislation and regulations.
6. A healthy management environment in which clear objectives and an appropriate ethical framework are established, due processes are established, responsibility and accountability are clearly defined, sound business planning is done, clear boundaries for acceptable behaviour are established, and performance evaluation measures are established.
7. Explicitly prescribed ethical practises and a code of conduct are communicated to all stakeholders, and each member of the organisation should understand and follow them.
8. The company's goals must be spelled out in a long-term corporate strategy that includes an annual business plan as well as attainable and measurable performance goals and milestones.
9. A well-formed Audit Committee to serve as a liaison with management, internal and statutory auditors, reviewing the adequacy of internal control and compliance with key policies and procedures, and reporting to the Board on the most important issues.
10. Risk is an important aspect of corporate function and governance that should be identified and analysed so that appropriate remedial measures can be taken. The Board should create a mechanism for reviewing internal and external risks on a regular basis for this purpose.
11. A clear Whistle Blower Policy that allows employees to report unethical behaviour, actual or suspected frauds, or violations of the company's code of conduct to management without fear of retaliation. There should be some mechanism in place to protect employees who act as whistle-blowers from being victimised. The board's overall goal should be to move the company forward in order to maximise long-term value and shareholder wealth.
PREREQUISITES AND CONSTITUENTS OF CORPORATE GOVERNANCE
• Adoption of good Corporate Governance practises has become an essential component of doing business today.
• It is not only a pre-requisite for facing intense competition for long-term growth in the emerging global market scenario, but it is also an embodiment of the fairness, accountability, disclosures, and transparency parameters to maximise value for stakeholders.
• Corporate governance is not something that can be regulated solely through legislation.
• Legislation can only establish a common framework – the "form" – in order to ensure that standards are met. The "substance" of the process will ultimately determine its credibility and integrity.
• The mind set and ethical standards of management are inextricably linked to substance.
• The Asian Development Bank, the International Monetary Fund, the Organization for Economic Cooperation and Development, and the World Bank conducted studies of corporate governance practises in several countries and found that there is no single model of good corporate governance.
• The OECD Code also acknowledges that different legal systems, institutional frameworks, and traditions have led to the development of a variety of corporate governance approaches.
• The interests of shareholders, on the other hand, have been given top priority.
• There are three types of corporate responsibilities that all models respect, regardless of the model:
1. Political Responsibilities: Following legitimate law, respecting the system of rights, and adhering to constitutional principles are the most basic political obligations.
2. Social Responsibilities: the company's ethical responsibilities, which it recognises and promotes either as a community of shared values or as part of a larger community of shared values.
3. Economic Responsibilities: acting in accordance with the logic of competitive markets to earn profits through innovation and respect for the shareholders' rights/democracy, which can be expressed in terms of management's obligation to ‘maximize shareholders value.'
Furthermore, corporate ethics and awareness of the environmental and societal interests of the communities in which they operate can have an impact on a corporation's reputation and long-term performance.
The Board of Directors, Shareholders, and Management are the three main components of corporate governance.
1. A board of directors, also known as a board of governors, is a group of people who are elected or appointed to oversee the activities of a company or organization.
• The board of directors plays a critical role in any corporate governance system. It is responsible to the stakeholders and manages and directs the management.
• It manages the company, sets its strategic and financial goals, oversees their implementation, implements adequate internal controls, and reports the company's activities and progress to all stakeholders on a regular basis in a transparent manner.
• The board's responsibilities are described in the OECD Principles of Corporate Governance (2004), and some of them are summarised below:
a. Board members should be well-informed and act in the company's and shareholders' best interests by acting ethically and in good faith, with due diligence and care.
b. Review and guide corporate strategy, goal-setting, major action plans, risk management, capital plans, and annual budgets.
c. Supervise large-scale acquisitions and divestitures.
d. Oversee succession planning and select, compensate, monitor, and replace key executives.
e. Align key executive and board remuneration with the company's and shareholders' long-term interests.
f. Establish a formal and transparent nomination and election process for board members.
g. Ensure the integrity of the company's accounting and financial reporting systems, as well as independent auditing.
h. Ensure that appropriate internal control systems are in place.
i. Supervise the disclosure and communication processes.
j. Where board committees are formed, their mandate, composition, and working procedures should be clearly defined and made public.
2. The shareholders' role in corporate governance is to appoint the directors and auditors, as well as to hold the board of directors accountable for the company's proper governance by requiring the board to provide them with the necessary information on the company's activities and progress on a regular basis in a transparent manner.
3. Management's responsibility is to carry out the company's management in accordance with the board's direction, to put in place adequate control systems and ensure their operation, and to provide timely and transparent information to the board in order for the board to monitor management's accountability to it.
Corporate governance's underlying principles revolve around three interconnected segments. These are the following:
2. Disclosures and Transparency
3. Responsibilities and accountability