1 What is corporate governance?
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.
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.