What is Corporate Governance?

Introduction:

The Concept of governance is not new one, but today we hear many words such as corporate governance,organizational governance or good governance.Basically corporate governance is defined in ISO FDIS 26000 as

"Organizational Governance is the system by which an organization makes and implements decision in pursuits of its objectives."

If we simply take "governance" which mean it is the process of a company decision making and the process by which decision are implemented(not implemented).And According to ISO FDIS 26000"It is the most crucial factor in enabling an organization to take responsibility for the impact of it decisions and activities and to integrate social responsibilities through-out the organization and its relationship."

 

Approaches to Corporate Governance:

There are two main approaches of corporate governance:

• Institutional

• Functional

 

 1.Institutional Corporate Governance:

Institutional corporate governance involves examining the existing institution to see how they can produce the services they offer more efficiently.In corporate governance, institution generally refer to the regulatory,legal and financial framework that underpins the governance system.An institutional approach would therefore look at each of these areas and see how they could be improved upon in order to improve governance generally. More recently, there has been increasing focus on legal institutions to see how they can be strengthened to protect investors against corporate fraud. 

 2.Functional Corporate Governance:

Functional approach takes the view that there are different ways to address similar governance concerns. It implies a more open-minded approach to examining different possibilities. The core function is to facilitate investment. However, there are many different ways by which investment can be facilitated.

 

What is a Corporation?

Corporate governance is primarily concerned with the study of the governance of the corporation. Here are some of the definition of corporation presented by Monks and Minow(2004:9)

• ‘An ingenious device for obtaining individual profit without individual responsibility’ Ambrose Bierce, The Devil’s Dictionary.

• ‘... one person in law – a person that never dies: in like manner as the River Thames is still the same river, though the parts which compose it are changing every instant’ Blackstone.

• ‘A mechanism established to allow different parties to contribute capital, expertise, and labour, for the maximum benefit of all of them.’

  None of these definitions is necessarily better than the others. What you understand at this stage is that the diversity of definitions is illustrative of the many different perspectives and approaches to the corporation. For example, economists have typically viewed the corporation as a ‘nexus’ or collection of contracts. Those from the management discipline may, how- ever, prefer to see it as a series of complex business relationships.

  Another example illustrates how the corporation is viewed by different classes of stakeholders. Take the case of investors, managers and workers:

  • Investors are mainly concerned with access to the corporation’s profits. They have no responsibility for operational matters. This responsibility is delegated to managers.

  • Managers run the company on behalf of investors. They have no responsibility for personally providing funds. Providing funds is the responsibility of investors.

  • For workers, the corporation represents a job opportunity and a wage. They have no responsibility for providing funds or for running the business.

 

Essential Characteristics of the Corporate Form:

Some of the characteristics of corporate firms are:

• Limited Liability

• Tranferability of investor interests

• Legal Personality

• Centralised management

 

• Limited Liability:

One of the key features of the modern corporation is limited liability. Lim- ited liability has its origins in the separation of ownership and control. The corporation is separate from its owners and employees. If a corporation goes bankrupt, its individual members are not individually liable.

This is important for investors, as whatever happens, the risk of loss is limited to the amount of their investment. The downside of limited liability is that it comes with limited control. Remember how we noted in the intro- duction that the separation of ownership and control led to a specialisation in risk bearing and management. Limited liability comes with limited authority: shareholders’ low-level risk corresponds to the low level control by shareholders. 

 

• Transferability of Investor Interests:

A second important characteristic of the corporate form is the ability of the investor to exit the company with ease. In listed corporations, stock is almost as liquid as cash. In other words, investors can easily sell their investment for cash. Because of this, shareholders possess exit rights: they can ‘vote with their feet’ and sell their shares. 

 

• Legal Personality:

Not only is the corporation separate from its owners and employees, it also has a legal entity of its own. The following points are important:

• A corporation lives on for as long as it has capital.

• Corporate structure protects its individual participants from direct

  legal responsibility in its business operation.

• ‘Shareholders own shares, not the corporation’: this enables limited collective control by shareholders.

• A corporation owns its own assets and property.

  To help you answer the next set of questions, please read the following citation from Douglass Bandow, a former aide of US President Ronald Reagan:

  Corporations are specialized institutions created for a specific purpose. They are only one form of enterprise in a very diverse society with lots of different organizations. Churches exist to help people fulfil their responsibilities toward God in community with one another. Governments are instituted most basically to prevent people from violating the rights of others. Philanthropic institutions are created to do good works. Community associations are to promote one or another shared goal. And businesses are established to make a profit by meeting people’s needs and wants.

  Shouldn’t business nevertheless ‘serve’ society? Yes, but the way it best does so is by satisfying people’s desires in an efficient manner... Does this mean that firms have no responsibilities other than making money? Of course not, just as individuals have obligations other than making money. But while firms have duty to respect the rights of others, they are under no obligation to promote the interest of others. The distinction is important. (Bandow, 1992) 

 

• Centralised Management:

In partnerships, each partner has an equal say in the management of the company. In a corporation, shareholders delegate this responsibility to the board of directors and management. It would be difficult, if not logistically impossible, to find consensus among dispersed individual shareholders on issues concerning the day-to-day affairs of the corporation. Delegation of responsibility works in the following manner: 

• The power to determine the company’s overall direction is given to the board of directors.

• The power to control the company’s day-to-day operation is given to the managers. 

• In order to allow the company to operate with maximum efficiency, the shareholders give up the right to make decisions on all but the most general issues facing the company. 

 

WHAT IS CORPORATE GOVERNANCE?

corporate governance mean ‘the ways suppliers of finance to corporations assure themselves of getting return on their invest- ment’ (Shleifer and Vishny, 1997: 736). However, just like the corporation, corporate governance can be defined or interpreted in numerous ways. Traditionally, corporate governance has focused on the share- holder/management relationship. This concerns mainly the internal governance relationships.

        Corporate governance refers to the systems, processes, and responsibilities involved in running and building value in a firm or organisation, and the way in which these are organised and directed at board level.

                                                                                                                                (Chartered Management Institute UK)

 

More recently, corporate governance has been used to describe a much broader relationship between institutions and stakeholders.Corporate Governance is concerned with the systems of laws, regulations, and practices which will promote     enterprise, ensure accountability and trigger performance.(World Council for Corporate Governance)  

 

Today, corporate governance is increasingly concerned with the role of stakeholders, and its impact on the collective welfare of society. For exam- ple, the OECD views the role of corporate governance as twofold:

 

• firstly, it covers the manner in which shareholders, managers, employees, creditors, customers and other stakeholders interact with one another in shaping corporate strategies.

• secondly, it relates to public policy, and an adequate legal regulatory framework, which are essential for the development of good systems of governance.

 

Taking these points into account, corporate governance is viewed as a key element in improving the microeconomic efficiency of a firm, affecting the functioning of capital markets and influencing resource allocation. Megginson (2001) thus defines corporate governance as a nation’s ‘set of laws, institutions, practices and regulations that determine how limited liability companies will be run and in whose interest’ (Megginson, 2001: 43).

 

From an academic perspective, a corporate governance system is the com- plex set of socially defined constraints that affect expectations for how authority in firms will be exercised or how the system affects the willingness to make investments in corporations in exchange for promises (e.g. William- son, 1985).

• A ‘good’ governance system supports a continual process of mobilising scarce resources to their most promising uses.

• The major components of the governance system are the legal, political, economic and social institutions that either constrain or enable the corporation. According to Holmstrom (1999), under this set-up the firm is viewed as a ‘sub-economy’, and is dependent on the macro environment.

• There is no perfect corporate governance structure that is able to provide optimal solutions to all trade-offs.

 

 

Less academically defined, corporate governance encompasses the combina- tion of laws, regulations, listing rules and voluntary private sector practices that enable the corporation to: 

• attract capital

• perform efficiently

• achieve the corporate objective

• meet both legal and obligations and general societal expectations.

 

Narrowlydefined, corporate governance concerns the interactive relation- ships between corporate managers, directors and the providers of equity capital. However, such a narrow interpretation is not enough to take account of the complex relationships between the corporation and its various stake- holders. Stakeholders include workers, suppliers, creditors and investors. In fact, stakeholders can, in a broad sense, refer to anyone whose life is affected in one way or another by the existence of the corporation.

 

A more constructive or long-term approach to defining corporate govern- ance should therefore take account of the relationship of the corporation to stakeholders and society. Such an approach should take account of the interests of both shareholders and stakeholders. Viewed in this manner, stakeholder interests (societal expectation) and shareholder interests are not mutually exclusive. Instead, they would appear to be dependent on each other in the long-term.

 

Corporate governance deals with the rights and responsibilities of a company’s management, its board, shareholders and various stakeholders. How well companies are run affects market confidence as well as company performance. Good corporate governance is therefore essential for companies that want access to capital and for countries that want to stimulate private sector investment. If companies are well run, they will prosper. This in turn will enable them to attract investors whose support can help to finance faster growth. Poor corporate governance on the other hand weakens a company’s potential and at worst can pave the way for financial difficulties and even fraud.