What is Corporate Governance?
The term “corporate governance” refers to the set of guidelines, principles, and practices that governs the day-to-day working of an organization. Essentially, it ensures that a company’s activities don’t ignore the interests of its various stakeholders, such as senior management executives, shareholders, customers, the overall community, etc. Further, it also provides the framework that a company can use to attain its objectives encompassing different aspects of management, such as corporate disclosure, internal controls, action plans, performance measurement, etc.
Example of Corporate Governance
There are several examples available for describing it. But, first, let us look at two cases that epitomize two ends of the corporate governance spectrum.
Let us start with the illustration of this issue with Enron. In this case, the problem was that its board of directors (BoD) ignored major corporate governance red flags (conflict of interest) as they allowed the company CFO to create independent private entities that carried out business with Enron. Basically, these private entities were used to put Enron’s debt obligations and other liabilities under the veil, which positively impacted the company’s profit margins. This is a clear case of a lack of corporate governance. In an ideal scenario, Enron’s management should have prevented the CFO from creating these pretentious entities that just helped in hiding the losses.
Let us now take the example of PepsiCo that has been consistent in upholding good corporate governance. In 2020, PepsiCo incorporated inputs received from the investors while preparing the proxy statement. The inputs were primarily pertaining to the composition of the board and the company’s leadership structure. Consequently, the proxy statement had a section that described the current leadership structure along with their compensation structure.
There are several underlying principles that lay the foundation of any company’s corporate governance framework. Some of the major principles are as follows:
- All important company information should be communicated to the stakeholders in a timely manner. These company stakeholders include employees, vendors, customers, lenders, etc.
- The BoD should outline the ethical code for conducting business activities.
- Follow all necessary procedures while appointing new directors and make the process transparent to the stakeholders.
- All the stakeholders should be entitled to fair treatment from the management.
- The management should exhibit accountability, transparency, and fairness in all its business activities.
- An auditor should be assigned for reviewing the management decisions, and the auditor directly reports to the BoD.
There have been several instances in the past where the management had breached corporate governance and misused the power given to them by the shareholders. Hence, the following strict regulations have been introduced to ensure that these companies take corporate governance seriously.
- Sarbanes-Oxley Act: It was ordained in 2002 by the US Federal Law to improve it by raising management’s accountability for internal controls and boosting investor confidence in financial reporting. It came into force to protect the investors from scandals like that of Enron, WorldCom, and Tyco International.
- Gramm-Leach-Bliley Act: It was enacted in the year 1999 by the US Federal Law mandating financial institutions to disclose how they ensure the protection of private customer information. The Safeguards Rule outlines the primary data protection propositions, while the additional privacy requirements are covered under the Financial Privacy Rule. This act helped restore public faith in the financial systems.
Conflict Management in Corporate Governance
In order to manage conflicts within the organization, companies must adhere to a strict corporate governance system, which covers different spheres of management rights, from corporate disclosure to internal control mechanisms. It is important to make the employees realize that ignoring any conflict situation only aggravates the problem, and so the best strategy is to resolve the conflict by dealing with it. One of the most effective conflict management practices is the promotion of a positive culture within the organization that can only be achieved by applying uncomplicated and transparent management policies. The best working culture can only mature out of trust, collaboration, mutual respect, and accountability, which clearly communicates to the employees what is expected of them. In other words, the management practices should help in establishing a collaborative relationship between the managers and the employees.
It is an important aspect of any business as it helps develop a system of rules and regulations that govern company operations while keeping it aligned with the interest of its stakeholders. Good corporate governance is a reflection of ethical and fair business practices, which results in stakeholders’ satisfaction and better financial viability. On the other hand, bad corporate governance often leads to scandals and frauds that eventually result in the downfall of the overall business.
Some of the key takeaways of the article are:
- It refers to the set of guidelines, principles, and practices that governs the day-to-day working of an organization.
- A company’s BoD plays a pivotal role in establishing good corporate governance.
- The underlying principles that lay the foundation of corporate governance include accountability, fairness, and transparency.
- Sarbanes-Oxley Act and Gramm-Leach-Bliley Act are two regulations that help in boosting investors’ confidence in the financial system and protecting them against any corporate scandals.
- While good corporate governance can enhance the financial viability of a business, bad corporate governance can deteriorate a company’s reputation along with the business.
So, it can be seen that it is a set of guiding principles that leads a company’s operations, ensuring fair treatment and transparent business activities. A company with strong corporate governance invariably makes decisions that are favorable to all the stakeholders, which makes it an attractive option for investors. On the other hand, a company with bad corporate governance often finds itself involved in scandals that ultimately lead to its downfall.
This is a guide to Corporate Governance. Here we also discuss the definition, examples, principles, and regulations along with their importance. You may also have a look at the following articles to learn more –