Definition
Corporate Governance refers to the system of rules, practices, and procedures by which a company is directed and controlled. It involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Effective corporate governance can provide a framework for attaining a company’s objectives, and encompass practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure.
Key Takeaways
- Corporate Governance refers to the system by which companies are directed and controlled. It involves regulatory and market mechanisms and the roles and relationships between a company’s management, its board, its shareholders, and other stakeholders, and the goals for which the company is governed.
- Good corporate governance is vital for the healthy functioning of the corporate sector and capital markets. It helps companies to improve their operational efficiency, mitigate risk, and attract investment by enhancing their reputation and giving confidence to potential investors.
- There are well-established models of corporate governance across the world – typically such as the Shareholder Model (mainly in the U.S.) and the Stakeholder Model (mainly in Europe). Regardless of the model, transparency, accountability, and fairness are key principles of effective corporate governance.
Importance
Corporate Governance is important in finance because it regulates the manner in which corporations are managed and controlled.
It sets the rules and procedures for decision-making within a company, ensuring that there is a balanced approach to meeting the interests of all stakeholders such as shareholders, management, customers, suppliers, financiers, government, and the community.
Effective corporate governance curbs potential negative issues such as corruption and mishandling of resources, protects shareholders’ rights, and promotes transparency and accountability.
This builds stakeholder trust and confidence, enhancing a company’s reputation and financial stability, fostering sustainability and growth.
Explanation
Corporate Governance is essentially an internal mechanism that establishes rules and processes by which a company is directed and controlled. It plays an integral role in achieving a company’s objectives, safeguarding the interests of stakeholders, and ensuring business operational efficiency.
The main purpose of corporate governance is to facilitate effective, entrepreneurial, and proactive management that can deliver the long-term success of a company. Corporate Governance serves as a guideline for the company’s board of directors, helping them set up strategic aims for the company, providing the leadership required to place them into effect, and supervising the management’s performance.
It oversees business practices and policies, ensuring they are ethical and are aligned with the needs of shareholders, customers, employees, and the community. In essence, solid corporate governance contributes to a robust, growth-oriented, and transparent organization that is accountable to its stakeholders.
Examples of Corporate Governance
Enron Scandal (2001): Corporate governance wasn’t properly upheld in the American energy corporation, Enron. Executives used accounting loopholes, special purpose entities, and poor financial reporting to hide debt and inflate profits. The company’s bankruptcy in December 2001, resulted in shareholders losing $74 billion and thousands of employees and investors losing their retirement accounts. This failure of corporate governance prompted a strengthened Sarbanes-Oxley Act to enhance transparency and accuracy in corporate disclosures.
Volkswagen Emission Scandal (2015): Volkswagen (VW), the car manufacturing giant was found guilty of installing software in diesel engines that could be used to cheat on car emission tests. This raises questions of governance and ethics in the company. VW’s rigged diesel cars emitted 40 times over the legal pollution limit, which significantly impacted the environment and the company’s reputation. This scandal underlines the importance of corporate governance in business practices to maintain trust and credibility in the market.
Wells Fargo scandal (2016): The banking giant, Wells Fargo, was involved in a scandal where the bank employees secretly opened over
5 million unauthorized deposit and credit card accounts. They did this to meet high sales expectations and earn bonuses. This was a clear corporate governance failure since the board of directors and top management did not perform their duty to maintain the ethical conduct of business operations. This led to wide criticism, legal lawsuits, and a massive fine for Wells Fargo.
Frequently Asked Questions on Corporate Governance
What is corporate governance?
Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community.
Why is corporate governance important?
Corporate governance is important because it is a reflection of the company’s culture, policies, relationship with stakeholders, and commitment to values. Apart from this, corporate governance also provides the framework for attaining a company’s objectives.
What are the principles of good corporate governance?
The principles of good corporate governance include fairness, accountability, responsibility, and transparency. These principles ensure that a company uses its resources more efficiently, attracts investment, protects the rights of shareholders, and enhances its value.
What are the key components of corporate governance?
The key components of corporate governance are corporate fairness, transparency, accountability, and responsibility. All these components should work hand in hand in ensuring successful corporate governance.
Who is responsible for corporate governance in a company?
The board of directors is chiefly responsible for corporate governance in a company. The board ensures the company’s prosperity by collectively directing the company’s affairs and meeting the appropriate interests of shareholders and stakeholders.
Related Entrepreneurship Terms
- Board of Directors
- Shareholder Rights
- Disclosure and Transparency
- Corporate Ethics
- Regulatory Compliance
Sources for More Information
- Investopedia: It is a comprehensive website providing definitions, explanations, examples and video tutorials on a wide range of financial and investment terms including corporate governance.
- OECD (Organisation for Economic Co-operation and Development): This site contains research, statistics, and publications related to many economic topics including corporate governance. The OECD also publishes a set of principles for corporate governance that many countries adhere to.
- SEC (U.S. Securities and Exchange Commission): SEC provides information on laws and regulations pertaining to corporate governance in the United States. The agency’s website contains a variety of resources, including regulatory documents, news, and educational materials about corporate governance.
- CII (Council of Institutional Investors): The site offers information on best practices in corporate governance and shareholder rights. CII advocates for better corporate governance and stronger shareholder rights.
