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What is Corporate Governance?

Corporate Governance refers to the accountability of the Board of Directors to all stakeholders of the corporation i.e. shareholders, employees, suppliers, customers, and society in general; towards giving the corporation a fair, efficient, and transparent administration.

Definition of Corporate Governance

These are the simple definitions of corporate governance:

Corporate governance means that a company manages its business in a manner that is accountable and responsible to the shareholders. In a wider interpretation, corporate governance includes company’s accountability to shareholders and other stakeholders such as employees, suppliers, customers, and the local community.

Frederick Catherwood

Corporate governance is the system by which companies are directed and controlled.

The Cadbury Committee (U.K.)

Corporate Governance Guidelines

The corporate governance guidelines are as follows:

1. Clear Identification of Roles and Powers
2. Laws should be Clear and Specific
3. Code of Conduct
4. Board Independence
5. Board Skills
6. Management Environment

Clear Identification of Roles and Powers

Proper and clear communication of powers, roles, responsibilities, and accountability of the Board, CEO, and the Chairman of the board is an important requirement of good corporate governance.

Laws should be Clear and Specific

All the rules and laws of the regulatory framework should be clearly specified. This is a must for effective corporate governance.

Code of Conduct

It is important that an organization’s code of conduct is communicated to all stakeholders and is clearly understood by them.

Board Independence

For sound corporate governance, an independent board is essential. It means that the board is capable of analyzing the performance of managers with an objective perspective. A completely independent board is needed for the organization so the members of board members reflect their effectiveness in dealings with other organizations.

Board Skills

The board must possess the necessary blend of qualities, skills, knowledge, and experience so as to make a quality contribution. It includes operational or technical expertise, financial skills, legal skills as well as knowledge of government and regulatory requirements.

Management Environment

A transparent, responsible, and objective-oriented framework should be established. This type of management environment implements robust business and operational planning, and establishes a clear communication system, making opportunities in a manner that the human resources engage with as per their skill sets.

Need for Corporate Governance

The need for corporate governance is highlighted by the following factors:

1. Wide Spread of Shareholders
2. Changing Ownership Structure
3. Corporate Scams or Scandals
4. Greater Expectations of Society of Corporate Sector
5. Hostile Take-Overs
6. Huge Increase in Top Management Compensation
7. Globalization

Wide Spread of Shareholders

Today a company has a very large number of shareholders spread all over the nation and even the world, and a majority of shareholders are unorganized and have an indifferent attitude toward corporate affairs.

The idea of shareholders’ democracy remains confined only to the law and the Articles of Association; which requires a practical implementation through a code of conduct of corporate governance.

Changing Ownership Structure

The pattern of corporate ownership has changed considerably, in the present-day times; with institutional investors (foreign as well Indian) and mutual funds becoming the largest shareholders in the large corporate private sector. These investors have become the greatest challenge to corporate management, forcing the latter to abide by some established code of corporate governance to build up its image in society.

Corporate Scams or Scandals

Corporate scams (or frauds) in recent years of the past have shaken public confidence in corporate management. The event of the Harshad Mehta scandal, which is perhaps, one biggest scandals, is in the hearts and minds of all, connected with corporate shareholding or otherwise being educated and socially conscious. The need for corporate governance is, then, imperative for reviving investors’ confidence in the corporate sector towards the economic development of society.

Greater Expectations of Society of Corporate Sector

Society of today holds greater expectations of the corporate sector in terms of reasonable prices, better quality, pollution control, the best utilization of resources, etc. To meet social expectations, there is a need for a code of corporate governance, for the best management of the company in economic and social terms.

Hostile Take-Overs

Hostile takeovers of corporations witnessed in several countries, put a question mark on the efficiency of management of take-over companies. These factors also point out the need for corporate governance, in the form of an efficient code of conduct for corporate management.

Huge Increase in Top Management Compensation

It has been observed in both developing and developed economies that there has been a great increase in the monetary payments (compensation) packages of top-level corporate executives.

There is no justification for exorbitant payments to top-ranking managers, out of corporate funds, which are the property of shareholders and society. This factor necessitates corporate governance to contain the ill practices of top management of companies.

Globalization

The desire of more and more Indian companies to get listed on international stock exchanges also focuses on a need for corporate governance. In fact, corporate governance has become a buzzword in the corporate sector. There is no doubt that the international capital market recognizes only companies well-managed according to standard codes of corporate governance.

Principles of Corporate Governance

The fundamental or key principles of corporate governance are described below:

1. Transparency
2. Accountability
3. Independence

Transparency

Transparency means the quality of something which enables one to understand the truth easily. In the context of corporate governance, it implies an accurate, adequate, and timely disclosure of relevant information about the operating results, etc. of the corporate enterprise to the stakeholders.

In fact, transparency is the foundation of corporate governance; which helps to develop a high level of public confidence in the corporate sector. To ensure transparency in corporate administration, a company should publish relevant information about corporate affairs in leading newspapers, e.g., on a quarterly or half yearly, or annual basis.

Accountability

Accountability is a liability to explain the results of one’s decisions taken in the interest of others. In the context of corporate governance, accountability implies the responsibility of the Chairman, the Board of Directors, and the chief executive for the use of the company’s resources (over which they have authority) in the best interest of the company and its stakeholders.

Independence

Good corporate governance requires independence on the part of the top management of the corporation i.e. the Board of Directors must be a strong non-partisan body; so that it can make all corporate decisions based on business prudence. Without the top management of the company being independent; good corporate governance is only a mere dream.

Objectives of Corporate Governance

Good governance is integral to the very existence of a company. It inspires and strengthens investor’s confidence by ensuring the company’s commitment to higher growth and profits. It seeks to achieve the following objectives of corporate governance:

1. A properly structured Board capable of making independent and objective decisions is in place at the helm of affairs.
   
   
2. The Board is balanced as regards the representation of an adequate number of non-executive and independent directors who will take care of the interests and well-being of all the stakeholders.
   
   
3. The Board adopts transparent procedures and practices and arrives at decisions on the strength of adequate information.
   
   
4. The Board has an effective machinery to sub-serve the concerns of stakeholders.
   
   
5. The Board keeps the shareholders informed of relevant developments impacting the company.
   
   
6. The Board effectively and regularly monitors the functioning of the management team.
   
   
7. The Board remains in effective control of the affairs of the company at all times. The overall endeavor of the Board should be to take the organization forward and maximize long-term values and shareholders’ wealth.

FAQs About the Corporate Governance