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• Introduction
  

  Introduction

  The topic of ‘governance’ is one that has gained popularity, and the term is now used to embrace a range of concepts. This unit establishes some basic principles that will form the basis of your study. You will have the opportunity to consider how well these principles match up with your own observations of corporate organisations and behaviour

  Learning Outcomes

  On successful completion of this unit, you should be able to:

  • provide a range of definitions of corporate governance;
  • identify issues usually addressed by corporate governance structures;
  • summarise recent scandals and abuses and the regulatory reaction;
  • identify the other drivers of corporate governance, such as capital markets, shareholders and rating agencies.
• 1.1 Definitions
  

  1 What is corporate governance?

  1.1 Definitions

  The need for corporate governance arises out of the divorce in modern corporations between the rights of shareholders and other suppliers of capital on the one hand, and the operational control, which is in the hands of professional managers, on the other. This can be described as the ‘principal–agent’ problem. Put simply, the question is: will the managers run the corporation exclusively for the long-term benefit of the shareholders, and what mechanisms can be put in place to ensure this takes place? Most individuals involved in business are basically honest and principled. Gandhi is said to have observed that India's British rulers believed they could set up a system that was so perfect that people would no longer need to be good. Systems of corporate governance are designed to provide a framework for managing companies that embodies best practice rather than relying on individuals' integrity.

  The most well-known definition of corporate governance originates from the Cadbury Committee, which was set up in the UK in 1991 to raise standards in corporate governance: ‘Corporate governance is the system by which companies are directed and controlled' (Cadbury Committee, 1992). Corporate governance is about relationships and structures. First, it is the relationship between a company's management, its board of directors, its auditors, its shareholders, its creditors and other stakeholders. Corporate governance is based on structures through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Recently, an International Federation of Accountants (IFAC) report gave the following definition for ‘enterprise governance':

  …the set of responsibilities and practices exercised by the board and executive management with the goal of providing strategic direction, ensuring that objectives are achieved, ascertaining that risks are managed appropriately and verifying that the organization's resources are used responsibly.

  (IFAC, 2004)

  For IFAC, enterprise governance has two dimensions that need to be in balance: conformance or conformity (i.e. with laws, codes, structures and roles) and performance. They believe that good corporate governance on its own cannot make a company successful. Companies must balance the two. However, without good corporate governance, the long-term success of the company is in serious doubt. In other words, good corporate governance is necessary but not sufficient for business success.

  Other, broader definitions would extend the concept of control beyond that exercised by the managers, the board of directors and the shareholders to a larger number of stakeholders, including creditors, employees and business partners, such as suppliers and the local community. The nub of corporate governance remains the relationships between management and shareholders, with the auditors (and their impact on the financial statements) playing a key role. Shareholders want to ensure that the company is run to maximise long-term shareholder wealth, and therefore that managers do this and do not reward themselves to the detriment of shareholders. The auditors need to be protected from undue management influence so that their role as guardian of the accuracy of the financial statements is not put in jeopardy. However, it is now more explicitly accepted that the shareholders have responsibilities towards other stakeholders, and in particular the host communities within which the company operates. Failure to respect these obligations is likely to provoke negative interventions from government or negative market reactions in the long term. If the interests of all the relevant stakeholders are balanced, good corporate governance should maximise the shareholders’ wealth and maintain the company's surrounding relationships.

  Typical corporate governance structures usually address issues such as:

  • roles of the CEO and chairman
  • board of directors – composition, independence, qualifications, training, remuneration and representation of shareholders
  • audit committee – selection and role
  • rights and treatment of shareholders and stakeholders
  • external auditors – selection, duties and liability
  • disclosure and transparency.
• 1.2 Conclusion
  

  1 What is corporate governance?

  1.2 Conclusion

  The annual financial reports commonly contain a statement on corporate governance, so it is useful to have an awareness of what this involves. This has important implications for interpreting the financial statements: a company with a weak system of corporate governance will provide greater opportunities for the manipulation of financial statements, with adverse consequences for users.

  Go to the OECD website and download its 2004 principles of corporate governance. What are the main principles identified by the OECD?

  Now read the discussion

  Discussion

  Spend some time reflecting on these guidelines in the light of your own experience. Have you come across examples of the effect of the presence or absence of these principles?

  The OECD guidelines cover six main principles:

• The corporate governance framework (of a company) should promote transparent and efficient markets, be consistent with the rule of law, and articulate the division of responsibilities among different supervisory, regulatory and enforcement bodies.
• The corporate governance framework should protect and facilitate the exercise of shareholders' rights.
• The framework should ensure the equitable treatment of all shareholders and all shareholders should have the opportunity to obtain redress for any violation of their rights.
• The framework should recognise the rights of other stakeholders granted by law or mutual agreement and encourage active cooperation between the corporation and other stakeholders in creating wealth, jobs and the sustainability of financially sound business.
• The framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership and governance of the company.
• Corporate governance should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board's accountability to the company and the shareholders.

Your own experience of corporate governance will vary, but you should be able to draw on it as you work through this unit. You may benefit from sharing your experiences with other people studying this unit. You may find it helpful to post a message to the discussion forum associated with this