What is corporate governance?

Corporate governance refers to the set of systems, principles and processes by which a
company is governed. They provide the guidelines as to how the company can be
directed or controlled such that it can fulfil its goals and objectives in a manner that adds
to the value of the company and is also beneficial for all stakeholders in the long term.
Stakeholders in this case would include everyone ranging from the board of directors,
management, shareholders to customers, employees and society.
Fundamentally, there is a level of confidence that is associated with a company that is
known to have good corporate governance. The presence of an active group of
independent directors on the board contributes a great deal towards ensuring
confidence in the market. Corporate governance is known to be one of the criteria that
foreign institutional investors are increasingly depending on when deciding on which
companies to invest in. It is also known to have a positive influence on the share price
of the company. Having a clean image on the corporate governance front could also
make it easier for companies to source capital at more reasonable costs. Unfortunately,
corporate governance often becomes the centre of discussion only after the exposure of
a large scam.

Good corporate governance aligns the actions of executive management with the
interests of shareholders. In practical terms, corporate governance is intertwined with
decision queries as to whether corporate executive management's formulated strategy
and implemented tactics serve the best interests of the equity shareholders.
While there is some gray area in what makes good corporate governance, there are
certain litmus tests that help distinguish good corporate governance from poor
governance.

Among the characteristics of poor corporate governance are:

1. Inflating corporate earnings and camouflaging corporate debt and liabilities.

2. Engaging in egregious corporate executive compensation, usually via stock options.

3. Camouflaging relevant information about the value drivers of the firm's equity share
prices and the firm's future cash flow and risk characteristics.

4.Formulating strategies and implementing actions that inherently result in shareholders
being disadvantaged (i.e. having their share prices reduced). One such corporate
strategy is 'random' corporate diversification, usually by acquisitions and mergers that
expand the company's products and services.

Corporate governance must, at minimum, meet the twin criteria of corporate
accountability and corporate transparency. With regard to the previous list,
characteristics (2) and (4) would imply the lack of corporate accountability.
Characteristics (1) and (3) strongly indicate the lack of corporate transparency because
investors are misled, sometimes deliberately misled, regarding relevant and accurate
information affecting corporate value. Simply put, the presence of either a lack of
corporate accountability or corporate transparency signals poor corporate governance.

Both internal and external corporate governance mechanisms can help effectuate good
corporate governance. Each governance mechanism (see the following two lists) to
some degree helps ensure that corporate executive management is working in the best
interests of the shareowners. This is tantamount to allocating the scarce resources of
the firm in the most efficient manner and hence maximizing the equity share price for
the present owners.

External Corporate Governance Mechanisms

1. Market for corporate control

2.Executive labor market

3. Product market

Internal Corporate Governance Mechanisms

1. The board of directors

2. Corporate executive compensation

3. Voting rights of the common stock

4. Corporate debt/equity decision

he most fundamental definition for corporate governance is based on the idea that an
organisation is essentially a nexus of contractual agreements between many parties for
the purpose of achieving the organisation's objectives. These parties include
shareholders, directors, managers, suppliers, employees, customers, financiers,
government authorities, other stakeholders and the society in which the company
operates. Whilst some of these contractual agreements are formal written ones, many
are implicit. Likewise, some of these contractual agreements are financially based but
many are not.
Although the company enjoys the status of a person through legal ction, in reality a
company is constituted entirely by the actions and interactions of people with other
people, products of technology, systems, and the natural world. Corporate governance
involves managing the framework within which these complex relationships operate.
The quality and nature of these relationships has a strong influence on the long term
nancial interests of the organisation. It can be expected that the negotiation and
administration of these contractual agreements to the benefit of each of the parties
involved will maximise the long term results of the organisation.
So good corporate governance is all about ensuring that the needs and interests of all
of an organisation's stakeholders are taken into account in a balanced and transparent
manner.
Good corporate governance is also no guarantee of success. It is a necessary but not
sufficient foundation for success as strategic factors play a more important role in
determining the eventual success or failure of an organization. In the majority of large
business failures, it is essentially the failure of the underlying business strategy that
causes each business to fail. Corporate governance issues allow the awed businesses
to continue and amplify the magnitude of their eventual collapse.