Show When you see company scandal, corruption, and fraud splashed across the headlines, you can be pretty sure that the term "corporate governance" will follow very soon after. It's a phrase we've been familiar with since the high-profile collapse of energy company Enron in 2001 and communications giant WorldCom in 2002, which exposed the inner workings of these companies to public scrutiny. Their downfalls also shone the spotlight on how other companies are governed – and how managers are kept accountable. Companies are typically governed according to a set of rules and regulations – rules that have been subject to tighter control since the Enron scandal. These rules are expected to protect the assets and resources of the company and to hold top managers and executives accountable for their decisions and actions. In this article, we look at why corporate governance is important, its implications in today's world, and the people and processes that support it. Corporate Governance DefinitionCorporate governance refers to the rules, practices and processes used to govern a company. It also identifies key stakeholders who are accountable for decision making and work practices. In general, corporate governance is there to ensure that all stakeholders (including shareholders, board members, employees, customers, suppliers and the wider market) are protected. Corporate governance processes are there to ensure that a company is run in an accountable and transparent way that enables it to fulfil its key objectives, and to ensure trust is maintained by shareholders.
In the U.K., corporate governance is overseen by the Financial Reporting Council (FRC) and organizations must adhere to the U.K. Corporate Governance Code in order to comply. [1] In the U.S., organizations are directly governed by state laws, which can vary. However, the exchange (offering and trading) of securities in corporations, including shares, is governed by federal legislation and enforced by the U.S. Securities and Exchange Committee (SEC). Many countries across the world also adhere to the Organization for Economic Co-operation and Development's (OECD's) Principles of Corporate Governance, which are designed to help policymakers to evaluate and improve corporate governance policies and procedures. [2] Why Is Corporate Governance Important?In the modern world, corporate governance protects more than investors' interests. It also represents the public interest, through environmental and social standards and practices. Post-Enron, the U.S. government passed the Sarbanes-Oxley Act (SOX) in 2002, to prevent similar corporate catastrophes occurring in the future. In recent years, growing concerns have been raised about executive pay and a lack of diversity on boards, as well as poor work practices that mean issues such as sexual harassment, racism and exploitation of workers are not managed correctly. Now, more than ever, there's an increasing emphasis on improving corporate processes, accountabilities, and controls – all in an effort to reduce abuses of power, and increase the integrity of decision making within corporations. This is part of a more general trend toward transparency and accountability for all organizations in the public and private sector. Corporate governance is a major factor in overall organizational health and sustainability because it does the following:
Who Is Responsible for Corporate Governance?In order to be truly effective, corporate governance must be managed from the top down in an organization to ensure open, honest, and compliant corporate behavior. The key individuals and groups involved in complying with corporate governance include:
The board may also decide to delegate some governance responsibilities to committees. These usually include an:
In some countries, such as the U.K. and the U.S., organizations operate a single-tier board (made up of independent executive and non-executive directors). However, in other countries, such as Germany, the Netherlands, China and Finland, organizations tend to have a dual board or two-tier structure, which consists of a management board (that is concerned with operational issues and performance) and a supervisory board (that overseas corporate governance practices). The European Corporate Governance Institute provides governance reports from countries all around the world. How Does Corporate Governance Work?Managers and directors can use a variety of tools and strategies to support corporate governance activities. Internal control systemsThese processes are designed to ensure the following:
Risk managementThis is a formal system to identify, measure, and control risk. It should assess both financial and non-financial risk. Disclosure systemsA disclosure policy should encourage a culture of openness and transparency. It often includes elements such as these:
Corporate ResponsibilityThis refers to a company's commitment to be accountable and transparent to its customers, employees, shareholders, and communities. This can be typically illustrated by and through:
For more on corporate social responsibility, read our article here. Corporate Governance ExamplesWells FargoIn 2013, a story began to unfold of unethical cross-selling practices at U.S. bank, Wells Fargo, which had led to the creation of millions of unauthorized and fraudulent accounts. It was revealed that these practices, along with overly-demanding sales targets and an unhealthy sales environment, had caused the problem. [3] Originally, the blame had largely been put on sales managers. But it was later found to be caused by "top down" pressure from higher-level management, as well by the board, which had failed to fully investigate the matter properly. The scandal ended in the resignation of a number of senior executives, as well as the CEO. And it resulted in Wells Fargo being fined a combined $185m for its illegal activity. Since the scandal, the bank has attempted to improve its corporate governance processes. Bylaws were amended to ensure that the chairperson is an independent director, and a mechanism of self-review for directors has been introduced, assisted by a third party. The bank has also set up a stakeholder advisory council, which is tasked with giving feedback to the board from the perspective of various stakeholders. VolkswagenIn 2015, German car manufacturer Volkswagen admitted to installing "defeat devices" on at least 11 million of its vehicles to ensure that they passed emissions tests. The cars actually emitted up to 40 times above recommended levels in the U.S. [4] Although senior management admitted fault, Volkswagen's supervisory board have shown an unwillingness to accept any blame. Even though governing boards do have a responsibility to be well informed, provide oversight and be involved in key decisions. One of the main reasons cited as a cause of the scandal is the lack of independent directors on the company's board. The board also failed to set up robust compliance and risk management processes, that would have been able to detect and investigate such issues.
Corporate governance refers to the rules, practices and processes used by an organization to ensure that it complies with regulations. And that it operates in an open and transparent way, that is fair to stakeholders (including shareholders, customers, employees and suppliers). It also means assigning accountability for these responsibilities to specific people in the organization – namely board members. Corporate governance is necessary to ensure the integrity and credibility of all kinds of organizations – public, private, nonprofit, and institutional. Good corporate governance builds confidence and trust. It allows the corporation to have access to investor financing, and it assures creditors and employees that the company is reliable and sustainable. Corporate governance is also the foundation of trust in our market economy, so it's important to evaluate the performance of directors and corporations to ensure that the governance system is robust and effective. |