Corporate Governance

Corporate governance is a term used to describe the mechanisms in place that are used to control a company both directly and indirectly, but what are these mechanisms and what principles are they dictated by? This article seeks to explore what corporate governance is, the framework in which it operates and the benefits that arise from it. Finally, it will consider the link between corporate governance and political theory.

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Table of contents

    Corporate Governance meaning

    Corporate governance refers to mechanisms in place, specifically the rules, regulations and processes, that are used to control a company both directly and indirectly. The aim of corporate governance is to take into consideration and balance the varying interests of those associated with a company. For example, the stakeholders could involve those at the very top such as shareholders and senior management, but also those at the bottom of the corporate pyramid such as the customers and consumers. This is important as it describes a company’s objectives and the ways it aims to achieve them. It also ensures that there are no conflicts of interest, and dictates the way that rights and responsibilities are distributed within a corporation.

    Corporate governance is important for ensuring that stakeholders subscribe to good ethical practices. This links to the ‘4 Ps’ of corporate governance: people, process, performance and purpose.

    What is the difference between stakeholders and shareholders?

    The former refers to a person or body that has a vested interest in the success or failure of something, most commonly a business. The latter is a more specific term that refers to someone who can be considered the owner of a company as they hold shares within the company.

    Corporate governance benefits

    Having considered what corporate governance is, it is worth examining what the benefits of good corporate governance are. In a capitalist system, it may seem counter-intuitive to have more rules and restrictions in place for corporations because this will likely lead to greater costs and therefore less profits. This is why it is important to understand what the incentives are for companies to impose greater regulations but also why it is important for the state to step in and impose such rules where it may not be in a company's interest to impose them.

    Good corporate governance ensures:

    1. Positive behaviour: Having good corporate governance creates a more positive culture within a workplace because it encourages transparency and communication as a foundation for governance. It means people are more inclined to act correctly and that the organisation aims to prioritise the benefits of all the necessary stakeholders.
    2. Better top-level decision-making: Corporate governance encourages stronger communication between the different levels of corporations. This means that the top-level is able to react and adjust quickly and make the necessary structural changes. The strength of the communication also means that the top-level are better informed of how their policies will impact the different levels when making their decisions.
    3. Less corruption and mismanagement: Good corporate governance ensures that there are frameworks in place that keep people accountable. The accountability and transparency mean it is less likely for people to engage in corrupt practices but also that when there is mismanagement or unethical conduct it can be easily picked up on.

    Capitalism:

    This is a general term describing a political and economic model where a country’s industry is controlled not by the state but by private individuals and corporations. The market is therefore motivated primarily by the desire to make a profit.

    The role of the state in corporate governance

    The state has a key part to play in how corporations can govern themselves which ultimately impacts the financial gains of their company. The state is the key actor in this relationship because of two key roles the state plays, which are:

    1. Enabler:

    Firstly, the government sets the climate, specifically the social, political and economic policies, that enable a corporation to operate. In other words, it sets the framework from which companies are able to operate. Having a democratic and stable state also means that companies are aware that policies will not change randomly and that they will be subject to fair democratic processes.

    2. Provides resources:

    The state provides help to corporations by assisting them in achieving their objectives. This may include legislation that provides a framework for companies to base their internal frameworks on, such as in the UK, 'The Companies Act 2006'. It can also include economic resources, for example, the state may provide aid in the form of grants and financial incentives that will help a corporation in its governance.

    Case study example:

    Regulations and rules that a state impose have the potential to seriously impact a company both positively and negatively. With part of the state's role being enabling these companies, the sheer number of regulations combined with the severity of the rules in place can have the effect of restricting a company's profits. Therefore, more fiscally conservative stakeholders will argue for more relaxed restrictions. For example, in 2017 in the United States the freedom caucus, a group of fiscally conservative politicians, came together to send President Trump a list of 228 regulations that they wanted to see removed. This included both environmental and corporate regulations that they believed impacted their profits.

    Corporate Governance principles

    As stated above, the most basic principles of corporate governance are accountability, transparency, fairness and responsibility. More specifically, the Sarbanes-Oxley Act, was an act introduced by the US federal government in an attempt to provide more specific principles of corporate governance. These are based on a report by Cadbury and the OECD. The five principles are summarised below.

    1. Integrity and ethical behaviour: This relates to the code of ethics that a company uses to regulate key processes in their company such as how they choose board members.

    2. Interests of stakeholders: This describes the responsibilities that an organisation has including the legal, contractual and social responsibilities they have to their stakeholders.

    3. Roles and responsibilities of the board: This ensures that those on the board of a company are able to adequately perform their functions and that they have the correct skills, experience and expertise to manage the performance of the company.

    4. Disclosure and transparency: This has a number of different functions. Firstly, it is about ensuring that those on the board of a company are publicly known so that they can remain accountable to the necessary stakeholders. Similarly, information such as financial decisions should be disclosed to all the relevant stakeholders so that a company remains transparent.

    5. Rights and equitable treatment of shareholders: Organisations should ensure that all within a company have their rights respected and upheld (this is particularly important for shareholders).

    Corporate governance framework

    In the UK there is a universal framework. 'The UK Corporate Governance Code', imposed through the Financial Reporting Council. The FRC defines corporate governance as, '‘the system by which companies are directed and controlled.' They recognise the significance of good governance because 'Companies do not exist in isolation. Successful and sustainable businesses underpin our economy and society by providing employment and creating prosperity.'

    While the framework is incredibly long, the FRC states that at 'heart of the Code is an updated set of Principles that emphasise the value of good corporate governance to long-term sustainable success.' These can be seen below:

    Principles of good governance, Financial Reporting Council & StudySmarter

    Fig. 1 - Principles of good governance, Financial Reporting Council

    It should be noted that every country does not impose a legal framework for their corporations to follow. For example, the United States does not adopt a formal, universal corporate governance code. This does not mean that there are no rules are regulations but rather that they will vary across companies based on factors such as state laws. This lack of a top-down universal framework highlights how the role of the state can vary from country to country when it comes to corporate governance.

    Political theory of corporate governance

    The political model of corporate governance can have an influence on the development of said corporate governance. This is because the policies and laws enacted by a government have a huge impact on the way in which corporate governance exists. For example, one country may have stronger laws around ethical and safe practice and this may impact the way in which a company organises its workers.

    We can consider this in more detail by considering some of the former-communist countries, which are still struggling to do away with the political influence of the state. Take, for example, the case of Romania which still faces major problems related to government shareholding in the governance structures of Romanian companies.

    This is why research by (Roe, 1994; Thomsen, 2008) shows that the policies adopted by the governments have a huge impact in explaining how corporate governance has developed in these areas.

    Corporate Governance - Key takeaways

    • Corporate governance refers to the mechanisms in place, specifically rules, regulations and processes that are in place to control a company both directly and indirectly.

    • The state's two key roles are enabling corporations to operate through the economic climate they have created. Secondly, they provide resources for companies such as economic incentives to succeed.

    • The political model of corporate governance can have a huge influence on the development of corporate governance.

    • The 4 Ps of corporate governance are people, process, performance and purpose.

    Frequently Asked Questions about Corporate Governance

    What is the role of the government in promoting corporate governance?

    The state's two key roles are enabling corporations to operate through the economic climate they have created. Secondly, they provide resources for companies such as economic incentives to succeed. 

    What are the 4 P's of corporate governance?

    The four P's of corporate governance are people, process, performance, and purpose.

    What is the main objective of corporate governance?

    Corporate governance is important for ensuring that stakeholders subscribe to good ethical practice. It also describes a company’s objectives and the ways it aims to achieve them. It also  ensures that there are no conflicts of interests and dictates the way that rights and responsibilities are distributed within a corporation. 

    What is corporate governance example?


    An example of corporate governance is the framework set out by the Financial Reporting Council. 'The UK Corporate Governance Code.'

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