Corporate Governance – Concept, Need and Principles

Corporate governance can be defined as a set of rules and regulations according to which the behavior of a company is affected. Another aspect of it is that it is also concerned with the relationships which exists among different stakeholders of the company and with the goals which the company has in view. Shareholders, board of directors, employees, customers, creditors, suppliers, and the community at large are the main stakeholders of a business.

Gabrielle O’Donovan defines corporate governance as ‘an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business know-how, objectivity, accountability and integrity. Sound corporate governance is reliant on external marketplace commitment and legislation, plus a healthy board culture which safeguards policies and processes.

The most common definition of corporate governance has been provided by the Organization for Economic Cooperation and Development (OCED),  as ” a system by which business corporations are directed and controlled. Corporate governance structures specify the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company’s objectives are set and the means of attaining those objectives and monitoring performance.”

An essential part of corporate governance is to create a system that try to decrease or eradicate the principal agent problem which will ensure accountability of certain individuals in the business. Corporate governance has several areas of discussion such as the effect of a system of corporate governance in economic efficiency whereby more emphasis has to be put on shareholders’ welfare.  Following recent accounting and ethical scandals in firms such as Enron, WorldCom and Parmalat, corporate governance is being regarded as an important issue in the business world due to the fact that rules and regulations have become stricter with regard to societal expectations.

Need of Corporate Governance

As a result of globalization and the increasing complexity of business there is a greater reliance on the private sector as the engine of growth in both developed and developing countries. Organizations do not exist in a vacuum; they rather interrelate with a number of interest groups, known as stakeholders. These stakeholders include shareholders, governments, regulatory bodies, creditors and the general public. Stakeholders are impacted by the activities of companies. In this regard, and in the context of this study, adequate and effective corporate governance disclosure becomes relevant to investors and other stakeholders from a number of standpoints.

Effective corporate governance disclosure promotes transparency in corporate structures and operations. It strengthens accountability and oversight among managers and board members to shareholders. This oversight and accountability combined with the efficient use of resources, improved access to lower-cost capital and increased responsiveness to societal needs and expectations leads to improved corporate performance. Good corporate governance helps to bridge the gap between the interests of those that a company, by increasing investor confidence and lowering the cost of capital for the company. Furthermore, it also helps in ensuring company honors, its legal commitments and forms value-creating relations with stakeholders. Companies with better corporate governance enjoy higher valuation. A good corporate governance, result in better decisions at all levels of the organization, not at top-management and board levels, but also in the better performance of the organization

Again adequate and effective corporate governance disclosure ensures that corporate activities are run in an open and transparent manner. Last, corporate governance practices boost market confidence and ensure effective allocation of capital in the market.

Principles of Corporate Governance

A number of principles underpin effective corporate governance.  Honesty, trust and integrity, openness, performance orientation, responsibility and accountability, mutual respect, and commitment to the organization forms an essential part of corporate governance.

The most important part in corporate governance is to see whether the management has been able to develop a model which is in line with the standards of the corporate participants. In addition to this they must evaluate this model from time to time to ensure that it is effective. Hence the management should do their wok honestly and ethically, particularly concerning conflicts of interest and disclosure in financial reports.

Commonly accepted principles of corporate governance include:

  1. Rights and equitable treatment of shareholders: company should respect the rights of shareholders and help shareholders to implement those rights. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings.
  2. Interests of other stakeholders: Organizations should be aware of the legal and other obligations that all legitimate stakeholders have.
  3. Role and responsibilities of the board: The board needs a variety of skills and understanding to be able to deal with various business issues and have the aptitude to review and challenge management performance. It needs to be of adequate size and have an apt level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors.
  4. Integrity and ethical behavior: Ethical and responsible decision making is not only important for public relations, but it is also a crucial part in risk management and avoiding lawsuits. businesses should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. Because of this, many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries.
  5. Disclosure and transparency: Organizations should simplify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement measures to independently validate and safeguard the integrity of the company’s financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

Nevertheless “corporate governance,” despite some weak attempts from various quarters, remains a vague and often misunderstood expression. For quite some time it was confined only to corporate management. It is something much broader, for it must include a fair, efficient and transparent administration and strive to meet certain well defined, written objectives. Corporate governance must go well beyond law. The quantity, quality and frequency of financial and managerial disclosure, the degree and extent to which the board of Director (BOD) exercise their trustee responsibilities (largely an ethical commitment), and the commitment to run a transparent organization- these should be constantly evolving due to interplay of many factors and the roles played by the more progressive/responsible elements within the corporate sector.

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