Corporate Governance

What Is Corporate Governance?

Photo courtesy of Rose RyanOpens in new window Corporate governance is essentially concerned about the way power is exercised over corporate entities. It covers the activities of the board and its relationships with the shareholders or members, and with those managing the enterprise, as well as with the external auditors, regulators, and other legitimate stakeholders.

All corporate entities, including profit-orientated companies, both public and private, joint ventures, cooperatives, and partnerships, and not-for-profit organizations such as voluntary and community organizations, charities, and academic institutions, as well as governmental corporate entities and quangos, have to be governed. They all need a governing body. In the case of a company, this is its board of directors.

Directors are so-called because they are responsible for setting the organization’s direction, formulating strategy and policymaking. Further, the board is responsible for supervising management and being accountable.

Overall, the board is responsible for the organization’s decisions and its performance. Other corporate entities may call their governing body a council, a court, a committee, a board of governors, or, in the case of some Oxford colleges, just the governing body.

Corporate governance is a broad topic — it encompasses the structures and processes that define and guide the roles and relationships of the key players in a corporation — including shareholders, directors, managers and wider stakeholders such as employees and creditors. As explained by a respected Australian judge, ‘the expression corporate governance embraces not only the models or systems themselves but also the practices by which that exercise and control of authority is in fact effected’ (Owen 2003, p. xxxiii).

According to the OECD’s definition,

Early attempts to define the concept of corporate governance appear in the United Kingdom Cadbury Report (1992) and the South African King Report (1994) where it is defined at its simplest as “the system by which companies are directed and controlled”. Since then, there have been many attempts to elaborate the concept in more detail.

Table X-1 and X-2 include a selection of definitions of corporate governance both from academic scholarship and corporate governance codes.

Corporate governance is different from management. Executive management is responsible for running the enterprise, but the government body ensures that it is running in the right direction and being run well.

Mechanisms of corporate governance are often distinguished as either internal or external (Hopt 2011; Kingsford Smith 2012).

This is an important distinction because corporate governance codesOpens in new window, as well as comprising an external regulatory force themselves, can be aimed at both improving internal organizational processes and disclosing information to enable other external forces to exert an influence.

As Kingsford Smith comments, corporate governance codes,Opens in new window as well as being an external influence ideally have an internal governance effect — ‘incorporation into the company’s internal rules, norms and culture’ (2012, p. 382).

Regulation of Corporate Governance

This includes most corporate legislation but also the codes and standards set by stock exchanges, prudential regulators and accounting bodies, which may be mandatory or voluntary.

The role of this new soft regulation should not be underestimated, Branson comments that ‘at the level of large publicly held and multinational corporations, a principal determinant of corporate behavior has become ‘soft law’ rather than law itself (2000, p. 670).

Corporate governance regulation spans jurisdictional boundaries and includes a burgeoning body of international initiatives — principles, frameworks and standards — quasi-legal instruments that do not have any legally binding force. Corporate governance regulation is an area where the regulatory rules versus principles debate is often aired.

Some countries, notably the United States, take a more prescriptive, rules-based approach, and others rely on voluntary or semi-voluntary principles.

Corbett and Bottomley claim that it is useful to think of corporate governance regulation as a body or category of law as well as a body of governance practices, processes and structures (2004, p. 61).

Corporate governance regulation in many countries involves layers of rules and standards working in parallel, a contemporary form of regulation that falls within the category of new governance or meta-regulation rather than traditional command-and-control regulation (Lobel 2004).

John Farrar depicts this as concentric circles of corporate governance regulation: legal regulation at the centre surrounded by stock exchange listing rules, then codes of conduct and business ethics as the other circle (2008, p. 4).

Role of the Board of Directors

Corporate law in most countries provides for a board of directors, formally elected by the shareholders, to act as the mind of the corporation and direct and supervise the managers of the company.

In Australia, section 198A(1) of the Corporations Act 2001 provides that ‘The business of a company is to be managed by or under the direction of the directors’, reflecting the fact that the historic role of the board was to manage (Farrar 2008, p. 89).

Boards of smaller, private companies may still be made up of executive managers, but in large public companies the modern norm is for a separation between board and management, with boards comprised of a majority of independent non-executive members who supervise, monitor and guide the executive management team (Gordon 2007). They lead and represent the company and ensure that it is accountable to its shareholders and other relevant stakeholders.

Core board functions include approving executive appointments and remuneration; monitoring the performance of the executive team; and providing advice and resources such as industry knowledge or access to networks (Anderson et al. 2007). The board plays a vital role in corporate governance reflected in the fact that most regulatory reforms in recent years have been designed to improve board performance.

Corporate governance as a whole, including the role of the board within it, is aimed at both creating value and maintaining control. This is reflected in the well-known framework developed by Hilmer and Tricker (1991), which depicts the role of the board as balancing conformance (monitoring and accountability) with performance (strategy and policy).

It is commonly recognized that the role of the board is multi-faceted, combining different functions, each of which may rise in priority depending on the company’s circumstances (Lynall et al. 2003). The dilemma for regulatory policy-makers is how to facilitate the fulfillment of these different roles when they may conflict with each other.

Corporate Responsibility and Governance

As companies have grown, spread across national boundaries and become hugely powerful, concerns over their social and environmental impact have increased and renewed interest in corporate responsibility has emerged.

The purpose of the corporation is not a new topic, famously debated in 1932 by Berle and Dodd in the Harvard Law Review, yet it has arguably been redefined over the last two decades, and there is a growing expectation that companies should take action and report on their efforts to be better corporate citizens.

Corporate governance and corporate responsibilityOpens in new window were for many years seen as different issues but, as corporate responsibility has become more mainstream, the overlap between the two has become increasingly evident.

Corporate responsibility has moved from being a marketing response to specific events towards being a key element of business strategy. This change requires leadership from the top and integration of corporate responsibility across all aspects of the business.

In 2006, John Elkington, co-founder of SustainAbilityOpens in new window, wrote about the merging of corporate social responsibility with corporate governance that was then occurring: ‘The centre of gravity of the sustainable business debate is in the process of shifting from public relations to competitive advantage and corporate governance – and, in the process, from the factory fence to the boardroom’ (2006, p. 524).

Confirming this development, a 2008 report by the Conference Board of Canada suggested that ‘good corporate governance will be redefined over this decade to include ways in which a board provides oversight and strategic direction on the firm’s social and environmental performance’. This process of redefinition is beginning to be seen in codes of corporate governanceOpens in new window as they start to incorporate aspects of corporate responsibilityOpens in new window.