What is Corporate Governance and why does it matter?

TBS 909 Autumn 2011 Lecture 2 Dr Ross Clifton

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Critical Questions
What is corporate governance? Why does it matter? Whos responsible for corporate governance? Whos affected by corporate governance? Whats involved in corporate governance?
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Some Definitions of Corporate Governance:

OECD: Procedures and processes according to which an organisation is directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organisation such as the board, managers, shareholders and other stakeholders and lays down the rules and procedures for decision-making. (European Central Bank, 2004, Annual Report: 2004, ECB, Frankfurt, Glossary)
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Transparency International:
Procedures and processes for how private sector organisations are directed, managed and controlled, including the relationships between, responsibilities of and legitimate expectations among different stakeholders (Board of Directors, management, shareholders, and other interested groups). (Institute of Chartered Accountants)

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Two More Definitions:

Sir Adrian Cadbury (in 'Global Corporate Governance Forum', World Bank, 2000): "Corporate Governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The corporate governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations and society."

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International Chamber of Commerce:

Corporate governance is the relationship between corporate managers, directors and the providers of equity, people and institutions who save and invest their capital to earn a return. It ensures that the board of directors is accountable for the pursuit of corporate objectives and that the corporation itself conforms to the law and regulations.
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What Does Corporate Governance Mean to You? As an investor As a shareholder? As an employee As a manager As a director As a member of another stakeholder group As a citizen, a taxpayer, a voter As a consumer
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 Corporate entities always need governing Corporate governance is necessary whenever ownership or membership is separated from management control
16th century traders and joint ventures 17th/18th century trading companies East India Company Hudson Bay Company 19th century limited liability company

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The corporation is a creation of the law and has legal standing independent of its owners. Three features have made the corporation attractive and durable: 1. its unlimited life, 2. the limited liability of the owners, and 3. the divisibility of ownership that permits transfer of ownership interests without disrupting the structure of the organization.
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The Joint Stock, Limited Liability Company

A concept of the 19thCcentury Incorporate a legal corporate entity Separate from its owners, but with similar legal rights - to buy and sell own assets - to employ people - to contract and incur debts - to sue and be sued Companies have an existence independent of owners Shares can be transferred, traded Liability of shareholders for company debts limited Directors stewards for shareholders directors fiduciary duty to act on their behalf 10
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Evolution of Corporate Governance

Owner managers Other employees Owner-managed entity Owners Managers Employees Separate legal entity

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Evolution Of Company (cont.)

Owners (shareholders)

Board of Directors Managers Employees Limited liability company

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Economic Foundations of the Corporation

Corporate governance bound up with economic development of industrial capitalism; 19th century increasing scale and complexity of organisations (1862-UK: incorporated liability); The growth of managerial capitalism; Growing concentration of economic power and an increased dispensing of stock ownership; The divorce of ownership from control has resulted in multiple layers of regulation as well as challenges to the principle that the principal responsibility of management and directors is to the firms stockholders; But does corporations law still tend to support the latter proposition?
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Elements of Governance
All bodies need to establish certain criteria for their governance. As a minimum these are likely to be: The identity of the body; Definition of its purpose; How the purpose is to be achieved; Membership criteria; How the body is to be administered; How the body relates externally; How success is measured; Termination arrangements.
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1. 2. 3. 4. 5. 6. 7. 8.

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An overall perspective on corporate governance and the factors affecting it:

The relationship between individual, enterprise and state A broader definition of corporate entities to cover every organisation where governance and management are separate from the members A mapping of all the elements that affect and are affected by the governance of such organisations The expectations, requirements, and demands of each participant The duties and responsibilities of each participant The powers, sanctions, and accountabilities of each participant
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An overall perspective on corporate governance and the factors affecting it (cont): Corporate governance theory needs a taxonomy of organisational types public, private, family, subsidiary associate, joint venture, complex ownership structures pyramids, chains, nets, and the rest To be able to present a comprehensive and coherent view of the governance arrangements and structures around the world Systems theory and cybernetic-based control system concepts such as networks, system boundaries, goals, and sub-optimisation might provide insights
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Some of the major aspects of corporate governance

Corporate governance principles and codes of practice Board's performance roles - strategy formulation and policy making Board's conformance roles - executive supervision and accountability Understand the board's responsibility for handling corporate risk Assessment of board and director performance Corporate governance rating systems
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Corporate governance decisions thus require analysis from several perspectives

These include: The legal issues: What does the law require? The ethical dimension: How does the organization define and fulfil its obligations to its constituencies or stakeholders in view of conflicting interests? Effectiveness: How does the board ensure that it and its management make effective decisions in an efficient and timely manner? The boards relationships. How does the board maintain effective relationships with its constituencies, particularly shareholders and management? The group dynamics. How well does the board function as a group or team?
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Other Issues and Factors Affecting Corporate Governance

Strategic risk management Corporate social responsibility Sustainability Business ethics Regulatory regimesnational and global
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Some Other Key Governance Issues:

Should the CEO ever also be chairman of the board? Should a retiring CEO go on as chairman? Can outside directors be genuinely independent? Should shareholders be able to nominate directors? Should institutional investors exercise more power? Are external auditors really independent?
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Key Governance Issues (contd.)

How should directors remuneration be determined? How should new complex, dynamic, and often global corporate entities be governed? Are governance processes around the world converging? Are rules for governance of listed companies appropriate to family companies, small firms, partnerships, and public and not-for-profit (NFP) entities?
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Codes of Best Practice

UK codes Cadbury (1992) Greenbury (1995) Hampel (1998) Turnbull (1999) Myners (2001) Higgs (2003) Smith (2003) Tyson (2003) UK Combined Code (1998 and 2003)
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Codes of Best Practice (contd)

Codes around the world *Australia (1993) Canada (1994) Holland (1997) Hong Kong, Italy, India, Japan (1998) Russia (2001) Codes from international agencies OECD/World Bank, Commonwealth (1999) Codes from institutional investors CalPERS, PIRC, Hermes
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References:
Tricker, B. 2009 Corporate Governance: Principles, Policies, and Practices, Oxford University Press. Introduction and Chapter 1

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