Understanding corporate governance: definition in business
At its simplest, corporate governance is defined as the structure of customs, processes, practices, policies, and rules that affect the way people direct, administer, and manage a corporation. It’s a commitment to ensure that accountability, diversity, transparency, and fairness are upheld by the company. It also refers to the relationships between stakeholders and corporate goals.
Primarily, this responsibility falls to a company’s board of directors. This system of checks and balances aims to minimize conflicts of interest and ensure that shareholders are treated equally.
However, this is a delicate balance of power that relies on three critical anchors. This triangular relationship consists of shareholders, management, and the board of directors. Each has its own responsibilities, but they need to work together for the system to be balanced and effective.
Conflict may arise between executives and shareholders – for instance, shareholders wanting to focus on profit while the chief executive officer may want to invest in bettering employee engagement. Corporate governance would guide how this is settled.
All three relationships in the governance triangle (shareholders–management, management–board of directors, and board of directors–shareholders) depend on mutual accountability and a free-flowing exchange of information.
Other stakeholders include management, employees, suppliers, and customers, as well as external forces such as creditors, regulators and the community.
The Anglo-American model of corporate governance, also known as the Unitary System or Anglo-Saxon approach, prioritizes the interests of shareholders. The shareholders elect members of the Board of Directors, which directs management of the company. This is the basis of corporate governance in multiple countries, including Britain, Canada, the US, Australia, and Commonwealth countries.
Features of this corporate governance model include:
- Directors are rarely independent of management
- Non-executive directors are expected to outnumber executive directors and hold key roles, such as audit committees
- Companies are run by professional managers who have negligible ownership stake.
- There is clear separation of ownership and management.
- Institutional investors like banks and mutual funds are portfolio investors. If they are unsatisfied with the company’s performance, they have the ability to sell their shares.
- Disclosure norms are comprehensive and rules against insider trading are firm.
- Small investors are protected.
Members of a governance team
The board of directors is the main influence here, composed of major shareholders, founders, and executives. However, it may include independent directors.
One of the main goals of corporate governance is ensuring that the leaders of a company are managing the organization’s finances effectively and acting in the interest of all stakeholders. Most companies also need to comply with external laws and policies governing their particular industry.
The board and the management apparatus put in place below it are responsible for setting a goal or purpose to work towards, developing a consistent process to achieve it, organizing operations to support that process, evaluating performance outcomes, and using those outcomes to grow themselves and employees as individuals or teams.
Purpose and process
Every policy and project should support the mission statement, or purpose, of a company. This guiding principle embeds itself in the foundation of corporate governance and should be transparent and clearly exemplified in any actions taken by the company.
The governance processes may be refined over time, and critical performance analysis is key in determining their effectiveness.
This performance analysis and the process of governance itself are instances where automation can streamline a company’s operations for greater efficiency. A policy management software solution, for instance, might be adopted in order to conserve time and costs by expediting policy and procedure processes and removing complexities and errors in order to create a compliance program that is more defensible in the eyes of regulators.
Why is corporate governance important?
Corporate governance is, in a very real way, synonymous with risk mitigation. It holds companies accountable and makes them more transparent to investors, which in turn improves access to capital and protects stakeholders.
- It ensures the rights and responsibilities of each entity are suitably distributed, avoiding discrimination in any manner.
- It provides a specific framework to outline and achieve company goals.
- It dictates corporate behavior by limiting the amount of control and power each entity possesses.
- It lays down the rules for decision-making activities related to corporate affairs.
- It monitors the actions of the corporation, as well as its stakeholders.
On the other hand, a lack of proper corporate governance can lead to conflicts of interest between members that can cause long-lasting harm, such as poor company image and a loss of profit.
Good corporate governance protects a corporation’s integrity and public image; these may be questioned if there’s a lack of transparency demanded by external and internal entities. With poor governance, minority stakeholders may be discriminated against as majority stakeholders and executives give their own interests priority, or short-sighted decisions may be made for similar reasons. This can undermine public confidence and lead to disastrous results.
Bad governance practices
Types of bad governance include:
- Companies that don’t cooperate with auditors or who select inappropriate auditors for the scale of project which leaves financial documents being created that do not follow compliance.
- Executive compensation packages that don’t offer the correct compensation for corporate officers
- Boards that are badly structured which make it challenging for shareholders to veto ineffective members.
Regulation of corporate governance software
With corporate governance playing such a fundamental role in any company, it receives attention when there are cases of abuse of corporate power. Regulations have been passed to address these issues, with some of the major ones including:
- Sarbanes-Oxley Act: This was passed when some high-profile company executives were caught committing fraud. The legislation helps protect shareholders, employees, and the public from accounting inaccuracies and fraudulent financial practices.
- Gramm-Leach-Bliley Act: Also known as the Financial Modernization Act of 1999, this is a US federal law that requires financial institutions to explain the ways in which they share and protect their customers’ private information.
- Basel II: This is a business standard that operates under three pillars – Capital adequacy requirements, supervisory review, and market discipline. It minimizes the financial effect of risky operational decisions and covers the rights of the shareholders.
Automating corporate governance
As alluded to above, process automation software is increasingly used to streamline and digitize various aspects of corporate governance-related processes. This can reduce human error and enhance speed and accuracy of these processes, lowering costs and mitigating risk for the organization.
As regulations evolve, it can be a challenge to stay compliant with changing policies. More organizations are turning to integrated, end-to-end suites of compliance solutions delivering top-down visibility and oversight to meet the multiplying corporate governance risks arising in the modern business environment.
Such corporate governance systems are adjuncts to sensible corporate governance, not substitutes, but aid in enforcing regulatory and corporate compliance throughout a business at a higher level of efficiency that possible with former/traditional measures.
The principles of good corporate governance
What principles should steer the direction of the organization? Here are some of the most important.
Fairness refers, for example, of all shareholders; each should receive equal treatment and consideration. This is often included in a shareholder agreement, but some countries have regulations to mandate it.
There should also be fairness in the treatment of all stakeholders, including employees, communities, and even public officials. The fairer an organization appears in the eyes of stakeholders and shareholders, the more likely it is to endure pressures from regulators, external interests, and competition.
A principle of good corporate governance? That stakeholders and shareholders are informed about the company’s activities, its future plans, and any risks involved in business strategies.
Transparency is about openness, as a company willingly provides this information clearly and freely to these parties. Financial performance disclosures are one example. Such disclosures ought to be timely and accurate when it comes to communicating investors; the roles, responsibilities, and potential conflicts of interest of board and management should be made visible, too. Such transparency gives stakeholders confidence in the probity and accountability of the people running the organization.
Corporate accountability refers to the obligation and responsibility that leadership has for giving explanations or reasons for a company’s conduct and activities.
Accountability touches on areas that include a board presenting a clear and balanced assessment of the company’s position and prospects, the board’s ultimate responsibility for deciding the nature and extent of risk involved in its actions, its maintenance of sound internal control systems and risk management frameworks, its establishment of formal, transparent reporting and audit management, and regular communication with shareholders about the direction and performance of the organization.
Since a board of directors are given the authority to act on behalf of a company and its shareholders, they’re expected to accept full responsibility for its powers and how it exercises them. A board is responsible for overseeing the management of company business matters, recruiting and appointing the CEO, and monitoring ongoing performance. All in the best interests of the company and its investors.
How the company performs is, therefore, a direct responsibility of the board, so that board is accountable to shareholders for the level of corporate performance.
What is the relationship between corporate governance and risk management? A company’s management is charged with identifying, evaluating, and managing risks the company undertakes in executing its strategies and conducting everyday business. Managers must decide if risk is consistent with the company’s established risk appetite, and are expected to keep the board and relevant committees, etc., apprised of significant risks and its risk management measure.
Increasingly, a company is expected to manage external risk from third- and fourth-party vendor networks, adding to the complexity of overall risk management.