Chapter 8.

Corporate Governance

Asres A. (PhD)
 Focus Questions
• What is corporate governance?
• What governance mechanisms are used by corporates?
• What is the relationship between owners and managers?
• What are the roles of BODs?
• How corporate governance mechanisms foster ethical
decisions?
• How owners use the various mechanisms to govern
managers?
• What is corporate social responsibility?
• What mechanisms are used for social responsibility
discharge?

Asres A. (PhD)
 Corporate Governance - Definition
• Governance is the manner in which power is exercised in the
management of economic and social resources for sustainable
human development (KPMG, 2005).
• Corporate Governance is a system by which Corporations are
directed, controlled (or led) and held to account (KPMG, 2005).
• Corporate Governance represents the relationship among
stakeholders that is used to determine and control the strategic
decision and performance of organizations.
• Corporate Governance is the form of relationship established
between the firms and its top level managers.
• Corporate Governance can be thought as a means used by
corporations to establish order between parties: the firms owners
and its top level managers whose interest may be in conflict.
Asres A. (PhD)
 Corporate Governance - Definition
- A vehicle for building partnership with key players in managing
divergent aspects of risk-prone sectors of an entity (Greuning
and Bratanovic, 2003).
- A process and structure employed to direct and manage a
business, enhance shareholders value and ensure financial
stability (Roberts, 2003).
- The act of entrenching accountability, credibility, transparency,
integrity and trust in an organization (Roberts, 2003).
- A system by which companies are directed and controlled in
order to align economic and social goals with those of the
individuals and the community (Cadbury, 1999).
- CG applies to all types of organizations not just companies in
the private sector but also in the not for profit and public
sectors. Asres A. (PhD)
 Corporate Governance Mechanisms

1. Exogenous (External) CG Mechanisms: This deals with

control and monitoring by regulators through Laws and
Codes.

1. Endogenous (Internal) CG Mechanisms: This is about

mechanisms for the accountability, monitoring, and control
of a firm’s management with respect to the use of resources
and risk taking. Internal CG starts with the board of
directors.

Asres A. (PhD)
Corporate Governance Model

Asres A. (PhD)
 Internal Governance Mechanisms
1. Ownership concentration:
• Relative amounts of shares owned by individual
shareholders and institutional investors having different
incentives to monitor managers.
2. Board of directors:
• Individuals responsible for representing the firm’s
owners by monitoring top-level managers.
3. Executive compensation:
• The use of salary, bonuses and long-term incentives to
align managers’ interests with shareholders’ interests.

Asres A. (PhD)
 External Governance Mechanisms
Market for corporate control:
• The purpose of a firm that is underperforming relative to
industry rivals and improve its strategic competitiveness.
 Acquiring undervalued firms and improving their
performance by replacing ineffective top-level management
teams.
This is done by potential owners in order to earn above-
average returns on their investments.

Asres A. (PhD)
 Corporate Governance
In modern corporations the primary objective of corporate
governance is:
• To ensure that the interests of top-level managers are
aligned with the interests of the shareholders.
• To reflect and ensure the company’s values.
• Concerned with identifying ways to ensure that strategic
decisions are made effectively.
• Is increasingly important as part of the strategic
management process.
• CG involves oversight in areas where owners, managers
and members of board of directors may have conflicts of
interest.
Asres A. (PhD)
 Corporate Governance
• Evidence suggests that a well-functioning corporate
governance and control system can result in a competitive
advantage for individual firms.
• One governance mechanism – the board of directors – has
been suggested to be rapidly evolving into a major strategic
force in firms.
• CG reflects the standards of a company, which in turn,
collectively reflect societal standards.
• Separation of ownership and management control –
delegating decision making responsibility to a second party
for compensation.
• Thus, an agency relationship exists between owners and
company managers.
Asres A. (PhD)
 Benefits of Corporate Governance
ON THE
ON THE SOCIETY ON THE ECONOMY
CORPORATION

•Increasing firm • More open, •Revitalizing

value transparent society market economy
•Lowering cost •Corruption •Sustainable
of capital prevention economic growth
•Enhancing •Rule of law : fair & •Positive
capital efficiency orderly development on
•Protection of •Promoting ethical capital market,
shareholders’ wealth creation more globally
rights competitive
•Increasing
competitiveness
through fair
Asres A. (PhD)
competition
 Benefits of Corporate Governance

More institutional Risks minimized

investors are over long term More equity
attracted to invest in participation
Public Limited from Govt.
Liability Companies agencies

Attract more individual investors for long-term

investments

Higher sustainable market capitalization

More activities in equity market

Capital market reacts positively, and

become more dynamic

More economic activity = EVERYONE

benefits
 LOSS OF
REVENGE

JEALOUSY GREED

CORRUPTION BIAS
EFFECTS OF BAD
CORPORATE
DISHONESTY DISCRIMINATION
GOVERNANCE

INCOMPETENCE SELF INTEREST

HYPOCRISY
Pillars of Corporate Governance

• Discipline
• Transparency
• Independence
• Accountability
• Responsibility
• Fairness
• Social Responsibility

Asres A. (PhD)
 Board of Directors
• Board of directors are a group of elected individuals whose
primary responsibility is to act in the owner’s interests by
formally monitoring and controlling the corporation’s top-
level executives.
• This responsibility is a product of the legal system which
confers board powers on corporate boards to:
- direct the affairs of the organization
- punish and reward managers
- protect the rights and interest of shareholders
• An appropriately structured and effective board of directors
protects owners from managerial opportunism.

Asres A. (PhD)
 Board of Directors
Board members are classified into one of three groups:
• Insiders: the firm’s CEO & top-level managers – they are sources of
information about the firm’s day-to-day operations.

• Related outsiders: individuals not involved with the firm’s day-to-day

operations, but who have a relationship with the company.

• Outsiders: individuals who are independent of the firm in terms of day-

to-day operations and other relationships (elected to the board to provide
independent counsel).

Asres A. (PhD)
 Good Board Practices

• Clearly defined roles and authorities

• Duties and responsibilities of Directors understood
• Board is well structured
• Appropriate composition and mix of skills
• Appropriate Board procedures
• Director Remuneration in line with best practice
• Board self-evaluation and training conducted

Asres A. (PhD)
 Control Environment
• Internal control procedures
• Risk management framework present
• Disaster recovery systems in place
• Media management techniques in use
• Business continuity procedures in place
• Independent external auditor conducts audits
• Independent audit committee established
• Internal Audit Function
• Management Information systems established
• Compliance Function established

Asres A. (PhD)
 Social Responsibility of Businesses
• Issues such as elimination of solid and liquid waste, pollution and
conservation of natural resources should be principal
considerations.
• Businesses must decide on their approaches in trying to meet
perceived social responsibilities.
• Mechanisms of businesses to discharge their social responsibilities
might include:
- reducing accidents and injuries
- establish health insurance
- establish appropriate environmental protection standards
- informing customers as well as the public about the potential health and
environmental effects of products.
• Strong enforcement of a corporate code of ethics.
• To operate ethically, companies must display a social conscience in
decisions that affect all stakeholders, especially the society.

Asres A. (PhD)
 Social Responsibility of Businesses
• Corporate citizenship and socially responsible decision
making are demonstrated in a number of ways:

- Fair employment practices

- Operating a safe workplace
- Protecting the environment beyond what is required by law.
- Taking active role in community affairs
- Interacting with community officials to minimize the impact of
layoffs and creating new employment for local people.
- Being a generous supporter of charitable causes and projects
that benefit the society.

Asres A. (PhD)
 Questions

Asres A. (PhD)