Table of Content

Topics Page #
Summary
Introduction
Principles of corporate governance
Corporate governance models around the
world
Regulation
History
Parties to Corporate Governance
Objectives
Internal corporate governance controls
!ternal corporate governance controls
Systematic Problems in Corporate Governance
"ebates In Corporate Governance
Comment
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Corporate Governance
Summary
Corporate governance refers to the set of systems$ principles and processes by which a company
is governed% &hey 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 sta'eholders in the long term% Sta'eholders in this case would
include everyone ranging from the board of directors$ management$ shareholders to customers$
employees and society% &he management of the company hence assumes the role of a trustee for
all the others% It is based on principles such as conducting the business with all integrity and
fairness% &he 'ey to success for all the leading companies in the world is practice of good
Corporate Governance Codes% It is not a one day process but it is spontaneous combustion of
efforts and practice of the same code% &he other principles on which corporate Governance is
based are being transparent with regard to all transactions$ ma'ing all the necessary disclosures
and decisions$ complying with all the laws of the land$ accountability and responsibility towards
the sta'eholders and commitment to conducting business in an ethical manner%
(ltimately$ there is a level of confidence that is associated with a company that is 'nown to
have good corporate governance% &he presence of an active group of independent directors on
the board contributes a great deal towards ensuring confidence in the mar'et% Corporate
governance is 'nown 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 'nown to have a
positive influence on the share price of the company% Having a clean image on the corporate
governance front could also ma'e it easier for companies to source capital at more reasonable
costs% (nfortunately$ corporate governance often becomes the center of discussion only after the
e!posure of a large scam%
&he main characteristics and features of corporate governance are listed as% &ransparency of al
the matters$ protection of all the present shareholders rights$ giving more power and rights to the
CO$ accountability$ all the rule must be based upon ethics$ rules and procedure set in the
organi)ation are universally applicable or applied all over the world% It is given a legal
*
recognition in many countries% +ll companies must use corporate governance voluntarily and
systematic based upon law and procedures% Corporate governance is very systematic% It is based
on laws$ procedures$ practices$ rules$ etc% +ll these laws are made to increase the wealth of the
shareholders and to protect the rights of all the sta'eholders of the company%
Corporate Governance is practiced in two ways both internally and e!ternally% Internal corporate
governance controls monitor activities and then ta'e corrective action to accomplish
organi)ational goals% !amples include, -onitoring by the board of directors, &he board of
directors$ with its legal authority to hire$ fire and compensate top management$ safeguards
invested capital% !ternal corporate governance controls encompass the controls e!ternal
sta'eholders e!ercise over the organi)ation% !amples include, demand for and assessment
performance information .especially financial statements/$debt covenants government
regulations$ media pressure
0
Introduction
Corporate Governance may be defined as a set of systems$ processes and principles which
ensure that a company is governed in the best interest of all sta'eholders% It is the system by
which companies are directed and controlled% It is about promoting corporate fairness$
transparency and accountability% In other words$ 1good corporate governance1 is simply 1good
business1% It ensures,
+de2uate disclosures and effective decision ma'ing to achieve corporate objectives3
&ransparency in business transactions3
Statutory and legal compliances3
Protection of shareholder interests3
Commitment to values and ethical conduct of business%
Corporate governance also refers to the system by which corporations are directed and
controlled% &he governance structure specifies the distribution of rights and responsibilities
among different participants in the corporation .such as the board of directors$ managers$
shareholders$ creditors$ auditors$ regulators$ and other sta'eholders/ and specifies the rules and
procedures for ma'ing decisions in corporate affairs% Governance provides the structure through
which corporations set and pursue their objectives$ while reflecting the conte!t of the social$
regulatory and mar'et environment% Governance is a mechanism for monitoring the actions$
policies and decisions of corporations% Governance involves the alignment of interests among
the sta'eholders%
It is about commitment to values$ about ethical business conduct and about ma'ing a distinction
between personal and corporate funds in the management of a company% thical dilemmas arise
from conflicting interests of the parties involved% In this regard$ managers ma'e decisions based
on a set of principles influenced by the values$ conte!t and culture of the organi)ation% thical
leadership is good for business as the organi)ation is seen to conduct its business in line with the
e!pectations of all sta'eholders%
4
&here has been renewed interest in the corporate governance practices of modern corporations$
particularly in relation to accountability$ since the high5profile collIt is about commitment to
values$ about ethical business conduct and about ma'ing a distinction between personal and
corporate funds in the management of a company% thical dilemmas arise from conflicting
interests of the parties involved% In this regard$ managers ma'e decisions based on a set of
principles influenced by the values$ conte!t and culture of the organi)ation% thical leadership is
good for business as the organi)ation is seen to conduct its business in line with the e!pectations
of all sta'eholders% +pses of a number of large corporations during *66#7*66*$ most of which
involved accounting fraud% Corporate scandals of various forms have maintained public and
political interest in the regulation of corporate governance% In the (%S%$ these include nron
Corporation and -CI Inc% .formerly 8orldCom/% &heir demise is associated with the (%S%
federal government passing the Sarbanes5O!ley +ct in *66*$ intending to restore public
confidence in corporate governance%
Corporate governance has also been defined as 9a system of law and sound approaches by which
corporations are directed and controlled focusing on the internal and e!ternal corporate
structures with the intention of monitoring the actions of management and directors and thereby
mitigating agency ris's which may stem from the misdeeds of corporate officers%9
In contemporary business corporations$ the main e!ternal sta'eholder groups are shareholders$
debt holders$ trade creditors$ suppliers$ customers and communities affected by the corporation1s
activities% Internal sta'eholders are the board of directors$ e!ecutives$ and other employees%
-uch of the contemporary interest in corporate governance is concerned with mitigation of the
conflicts of interests between sta'eholders% 8ays of mitigating or preventing these conflicts of
interests include the processes$ customs$ policies$ laws$ and institutions which have an impact on
the way a company is controlled% +n important theme of governance is the nature and e!tent of
corporate accountability%
+ related but separate thread of discussions focuses on the impact of a corporate governance
system on economic efficiency$ with a strong emphasis on shareholders1 welfare% In large firms
where there is a separation of ownership and management and no controlling shareholder$ the
principal7agent issue arises between upper5management .the 9agent9/ which may have very
:
different interests$ and by definition considerably more information$ than shareholders .the
9principals9/% &he danger arises that rather than overseeing management on behalf of
shareholders$ the board of directors may become insulated from shareholders and beholden to
management% &his aspect is particularly present in contemporary public debates and
developments in regulatory policy%
conomic analysis has resulted in a literature on the subject% One source defines corporate
governance as 9the set of conditions that shapes the e! post bargaining over the 2uasi5rents
generated by a firm% &he firm itself is modelled as a governance structure acting through the
mechanisms of contract% Here corporate governance may include its relation to corporate
finance%
Principles of corporate governance
Contemporary discussions of corporate governance tend to refer to principles raised in three
documents released since #;;6, &he Cadbury Report .(<$ #;;*/$ the Principles of Corporate
Governance .OC"$ #;;= and *664/$ the Sarbanes5O!ley +ct of *66* .(S$ *66*/% &he
Cadbury and OC" reports present general principles around which businesses are e!pected to
operate to assure proper governance% &he Sarbanes5O!ley +ct$ informally referred to as Sarbo!
or So!$ is an attempt by the federal government in the (nited States to legislate several of the
principles recommended in the Cadbury and OC" reports%
Rights and e2uitable treatment of shareholders, Organi)ations should respect the rights of
shareholders and help shareholders to e!ercise those rights% &hey can help shareholders e!ercise
their rights by openly and effectively communicating information and by encouraging
shareholders to participate in general meetings%
Interests of other sta'eholders, Organi)ations should recogni)e that they have legal$ contractual$
social$ and mar'et driven obligations to non5shareholder sta'eholders$ including employees$
investors$ creditors$ suppliers$ local communities$ customers$ and policy ma'ers%
Role and responsibilities of the board, &he board needs sufficient relevant s'ills and
understanding to review and challenge management performance% It also needs ade2uate si)e
and appropriate levels of independence and commitment%
>
Integrity and ethical behavior, Integrity should be a fundamental re2uirement in choosing
corporate officers and board members% Organi)ations should develop a code of conduct for their
directors and e!ecutives that promotes ethical and responsible decision ma'ing%
"isclosure and transparency, Organi)ations should clarify and ma'e publicly 'nown the roles
and responsibilities of board and management to provide sta'eholders with a level of
accountability% &hey should also implement procedures to independently verify and safeguard
the integrity of the company1s financial reporting% "isclosure of material matters concerning the
organi)ation should be timely and balanced to ensure that all investors have access to clear$
factual information%
Corporate governance models around the world:
&here are many different models of corporate governance around the world% &hese differ
according to the variety of capitalism in which they are embedded% &he +nglo5+merican
9model9 tends to emphasi)e the interests of shareholders% &he coordinated or -ulti sta'eholder
-odel associated with Continental urope and ?apan also recogni)es the interests of wor'ers$
managers$ suppliers$ customers$ and the community% + related distinction is between mar'et5
orientated and networ'5orientated models of corporate governance%
Continental Europe
Some continental uropean countries$ including Germany and the @etherlands$ re2uire a two5
tiered Aoard of "irectors as a means of improving corporate governance% In the two5tiered
board$ the !ecutive Aoard$ made up of company e!ecutives$ generally runs day5to5day
operations while the supervisory board$ made up entirely of non5e!ecutive directors who
represent shareholders and employees$ hires and fires the members of the e!ecutive board$
determines their compensation$ and reviews major business decisions%
India
B
India1s SAI Committee on Corporate Governance defines corporate governance as the
9acceptance by management of the inalienable rights of shareholders as the true owners of the
corporation and of their own role as trustees on behalf of the shareholders% It is about
commitment to values$ about ethical business conduct and about ma'ing a distinction between
personal C corporate funds in the management of a company%9 It has been suggested that the
Indian approach is drawn from the Gandhian principle of trusteeship and the "irective
Principles of the Indian Constitution$ but this conceptuali)ation of corporate objectives is also
prevalent in +nglo5+merican and most other jurisdictions%
nited States! nited "ingdom
&he so5called 9+nglo5+merican model9 of corporate governance emphasi)es the interests of
shareholders% It relies on a single5tiered Aoard of "irectors that is normally dominated by non5
e!ecutive directors elected by shareholders% Aecause of this$ it is also 'nown as 9the unitary
system9% 8ithin this system$ many boards include some e!ecutives from the company .who are
e! officio members of the board/% @on5e!ecutive directors are e!pected to outnumber e!ecutive
directors and hold 'ey posts$ including audit and compensation committees% &he (nited States
and the (nited <ingdom differ in one critical respect with regard to corporate governance, In
the (nited <ingdom$ the CO generally does not also serve as Chairman of the Aoard$ whereas
in the (S having the dual role is the norm$ despite major misgivings regarding the impact on
corporate governance%
In the (nited States$ corporations are directly governed by state laws$ while the e!change
.offering and trading/ of securities in corporations .including shares/ is governed by federal
legislation% -any (S states have adopted the -odel Ausiness Corporation +ct$ but the
dominant state law for publicly traded corporations is "elaware$ which continues to be the place
of incorporation for the majority of publicly traded corporations% Individual rules for
corporations are based upon the corporate charter and$ less authoritatively$ the corporate bylaws%
Shareholders cannot initiate changes in the corporate charter although they can initiate changes
to the corporate by laws%
#egulation:
=
$egal environment % General
Corporations are created as legal persons by the laws and regulations of a particular jurisdiction%
&hese may vary in many respects between countries$ but a corporation1s legal person status is
fundamental to all jurisdictions and is conferred by statute% &his allows the entity to hold
property in its own right without reference to any particular real person% It also results in the
perpetual e!istence that characteri)es the modern corporation% &he statutory granting of
corporate e!istence may arise from general purpose legislation .which is the general case/ or
from a statute to create a specific corporation$ which was the only method prior to the #;th
century%
In addition to the statutory laws of the relevant jurisdiction$ corporations are subject to common
law in some countries$ and various laws and regulations affecting business practices% In most
jurisdictions$ corporations also have a constitution that provides individual rules that govern the
corporation and authori)e or constrain its decision5ma'ers% &his constitution is identified by a
variety of terms3 in nglish5spea'ing jurisdictions$ it is usually 'nown as the Corporate Charter
or the and +rticles of +ssociation% &he capacity of shareholders to modify the constitution of
their corporation can vary substantially%
&he (%S% passed the Doreign Corrupt Practices +ct .DCP+/ in #;BB$ with subse2uent
modifications% &his law made it illegal to bribe government officials and re2uired corporations
to maintain ade2uate accounting controls% It is enforced by the (%S% "epartment of ?ustice and
the Securities and !change Commission .SC/% Substantial civil and criminal penalties have
been levied on corporations and e!ecutives convicted of bribery%
&he (< passed the Aribery +ct in *6#6% &his law made it illegal to bribe either government or
private citi)ens or ma'e facilitating payments .i%e%$ payment to a government official to perform
their routine duties more 2uic'ly/% It also re2uired corporations to establish controls to prevent
bribery%
Sarbanes&'(ley )ct of *++*
-ain article, Sarbanes5O!ley +ct
;
&he Sarbanes5O!ley +ct of *66* was enacted in the wa'e of a series of high profile corporate
scandals% It established a series of re2uirements that affect corporate governance in the (%S% and
influenced similar laws in many other countries% &he law re2uired$ along with many other
elements$ that,
&he Public Company +ccounting Oversight Aoard .PC+OA/ be established to regulate the
auditing profession$ which had been self5regulated prior to the law% +uditors are responsible for
reviewing the financial statements of corporations and issuing an opinion as to their reliability%
&he Chief !ecutive Officer .CO/ and Chief Dinancial Officer .CDO/ attest to the financial
statements% Prior to the law$ CO1s had claimed in court they hadn1t reviewed the information as
part of their defense%
Aoard audit committees have members that are independent and disclose whether or not at least
one is a financial e!pert$ or reasons why no such e!pert is on the audit committee%
!ternal audit firms cannot provide certain types of consulting services and must rotate their
lead partner every : years% Durther$ an audit firm cannot audit a company if those in specified
senior management roles wor'ed for the auditor in the past year% Prior to the law$ there was the
real or perceived conflict of interest between providing an independent opinion on the accuracy
and reliability of financial statements when the same firm was also providing lucrative
consulting services%
Codes and guidelines
Corporate governance principles and codes have been developed in different countries and
issued from stoc' e!changes$ corporations$ institutional investors$ or associations .institutes/ of
directors and managers with the support of governments and international organi)ations% +s a
rule$ compliance with these governance recommendations is not mandated by law$ although the
codes lin'ed to stoc' e!change listing re2uirements may have a coercive effect%
#6
'EC, principles
One of the most influential guidelines has been the OC" Principles of Corporate Governance
Epublished in #;;; and revised in *664% &he OC" guidelines are often referenced by
countries developing local codes or guidelines% Auilding on the wor' of the OC"$ other
international organi)ations$ private sector associations and more than *6 national corporate
governance codes formed the (nited @ations Intergovernmental 8or'ing Group of !perts on
International Standards of +ccounting and Reporting .IS+R/ to produce their Guidance on
Good Practices in Corporate Governance "isclosure% &his internationally agreed benchmar'
consists of more than fifty distinct disclosure items across five broad categories,
+uditing
Aoard and management structure and process
Corporate responsibility and compliance
Dinancial transparency and information disclosure
Ownership structure and e!ercise of control rights
Stoc' e!change listing standards
Companies listed on the @ew For' Stoc' !change .@FS/ and other stoc' e!changes are
re2uired to meet certain governance standards% Dor e!ample$ the @FS Gisted Company
-anual re2uires$ among many other elements,
Independent directors, 9Gisted companies must have a majority of independent
directors%%%ffective boards of directors e!ercise independent judgment in carrying out their
responsibilities% Re2uiring a majority of independent directors will increase the 2uality of board
oversight and lessen the possibility of damaging conflicts of interest%9 .Section 060+%6#/ +n
independent director is not part of management and has no 9material financial relationship9 with
the company%
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Aoard meetings that e!clude management, 9&o empower non5management directors to serve as
a more effective chec' on management$ the non5management directors of each listed company
must meet at regularly scheduled e!ecutive sessions without management%9
Aoards organi)e their members into committees with specific responsibilities per defined
charters% 9Gisted companies must have a nominatingHcorporate governance committee composed
entirely of independent directors%9 &his committee is responsible for nominating new members
for the board of directors% Compensation and +udit Committees are also specified$ with the
latter subject to a variety of listing standards as well as outside regulations%
'ther guidelines
&he investor5led organi)ation International Corporate Governance @etwor' .ICG@/ was set up
by individuals centered around the ten largest pension funds in the world #;;:% &he aim is to
promote global corporate governance standards% &he networ' is led by investors that manage #=
trillion dollars and members are located in fifty different countries% ICG@ has developed a suite
of global guidelines ranging from shareholder rights to business ethics%
&he 8orld Ausiness Council for Sustainable "evelopment .8ACS"/ has done wor' on
corporate governance$ particularly on accountability and reporting$ and in *664 released Issue
-anagement &ool, Strategic challenges for business in the use of corporate responsibility codes$
standards$ and framewor's% &his document offers general information and a perspective from a
business associationHthin'5tan' on a few 'ey codes$ standards and framewor's relevant to the
sustainability agenda%
In *66;$ the International Dinance Corporation and the (@ Global Compact released a report$
Corporate Governance 5 the Doundation for Corporate Citi)enship and Sustainable Ausiness$
lin'ing the environmental$ social and governance responsibilities of a company to its financial
performance and long5term sustainability%
-ost codes are largely voluntary% +n issue raised in the (%S% since the *66: "isney decision is
the degree to which companies manage their governance responsibilities3 in other words$ do
they merely try to supersede the legal threshold$ or should they create governance guidelines
that ascend to the level of best practice% Dor e!ample$ the guidelines issued by associations of
#*
directors$ corporate managers and individual companies tend to be wholly voluntary but such
documents may have a wider effect by prompting other companies to adopt similar practices%
-istory
In the *6th century in the immediate aftermath of the 8all Street Crash of #;*; legal scholars
such as +dolf +ugustus Aerle$ dwin "odd$ and Gardiner C% -eans pondered on the changing
role of the modern corporation in society% Drom the Chicago school of economics$ Ronald Coase
introduced the notion of transaction costs into the understanding of why firms are founded and
how they continue to behave%
(S e!pansion after 8orld 8ar II through the emergence of multinational corporations saw the
establishment of the managerial class% Studying and writing about the new class were several
Harvard Ausiness School management professors, -yles -ace .entrepreneurship/$ +lfred "%
Chandler$ ?r% .business history/$ ?ay Gorsch .organi)ational behavior/ and li)abeth -acIver
.organi)ational behavior/% +ccording to Gorsch and -acIver 9many large corporations have
dominant control over business affairs without sufficient accountability or monitoring by their
board of directors%9
In the #;=6s$ ugene Dama and -ichael ?ensen established the principal7agent problem as a
way of understanding corporate governance, the firm is seen as a series of contracts%
Over the past three decades$ corporate directorsI duties in the (%S% have e!panded beyond their
traditional legal responsibility of duty of loyalty to the corporation and its shareholders%
In the first half of the #;;6s$ the issue of corporate governance in the (%S% received considerable
press attention due to the wave of CO dismissals .e%g%, IA-$ <oda'$ Honeywell/ by their
boards% &he California Public mployees1 Retirement System .CalPRS/ led a wave of
institutional shareholder activism .something only very rarely seen before/$ as a way of ensuring
that corporate value would not be destroyed by the now traditionally co)y relationships between
the CO and the board of directors .e%g%$ by the unrestrained issuance of stoc' options$ not
infre2uently bac' dated/%
#0
In the early *666s$ the massive ban'ruptcies .and criminal malfeasance/ of nron and
8orldcom$ as well as lesser corporate scandals$ such as +delphia Communications$ +OG$
+rthur +ndersen$ Global Crossing$ &yco$ led to increased political interest in corporate
governance% &his is reflected in the passage of the Sarbanes5O!ley +ct of *66*% Other triggers
for continued interest in the corporate governance of organi)ations included the financial crisis
of *66=H; and the level of CO pay%
East )sia
In #;;B$ the ast +sian Dinancial Crisis severely affected the economies of &hailand$ Indonesia$
South <orea$ -alaysia$ and the Philippines through the e!it of foreign capital after property
assets collapsed% &he lac' of corporate governance mechanisms in these countries highlighted
the wea'nesses of the institutions in their economies%
Parties to corporate governance:
<ey parties involved in corporate governance include sta'eholders such as the board of
directors$ management and shareholders% !ternal sta'eholders such as creditors$ auditors$
customers$ suppliers$ government agencies$ and the community at large also e!ert influence% &he
agency view of the corporation posits that the shareholder forgoes decision rights .control/ and
entrusts the manager to act in the shareholders1 best .joint/ interests% Partly as a result of this
separation between the two investors and managers$ corporate governance mechanisms include
a system of controls intended to help align managers1 incentives with those of shareholders%
+gency concerns .ris'/ are necessarily lower for a controlling shareholder%
#esponsibilities of the board of directors
Dormer Chairman of the Aoard of General -otors ?ohn G% Smale wrote in #;;:, 9&he board is
responsible for the successful perpetuation of the corporation% &hat responsibility cannot be
relegated to management% 9+ board of directors is e!pected to play a 'ey role in corporate
governance% &he board has responsibility for, CO selection and succession3 providing
feedbac' to management on the organi)ation1s strategy3 compensating senior e!ecutives3
monitoring financial health$ performance and ris'3 and ensuring accountability of the
#4
organi)ation to its investors and authorities% Aoards typically have several committees .e%g%$
Compensation$ @ominating and +udit/ to perform their wor'%
&he OC" Principles of Corporate Governance .*664/ describe the responsibilities of the
board3 some of these are summari)ed below,
Aoard members should be informed and act ethically and in good faith$ with due
diligence and care$ in the best interest of the company and the shareholders%
Review and guide corporate strategy$ objective setting$ major plans of action$ ris'
policy$ capital plans$ and annual budgets%
Oversee major ac2uisitions and divestitures%
Select$ compensate$ monitor and replace 'ey e!ecutives and oversee succession
planning%
+lign 'ey e!ecutive and board remuneration .pay/ with the longer5term interests of the
company and its shareholders%
nsure a formal and transparent board member nomination and election process%
nsure the integrity of the corporations accounting and financial reporting systems$
including their independent audit%
nsure appropriate systems of internal control are established%
Oversee the process of disclosure and communications%
8here committees of the board are established$ their mandate$ composition and wor'ing
procedures should be well5defined and disclosed%
Sta.eholder interests
+ll parties to corporate governance have an interest$ whether direct or indirect$ in the financial
performance of the corporation% "irectors$ wor'ers and management receive salaries$ benefits
#:
and reputation$ while investors e!pect to receive financial returns% Dor lenders$ it is specified
interest payments$ while returns to e2uity investors arise from dividend distributions or capital
gains on their stoc'% Customers are concerned with the certainty of the provision of goods and
services of an appropriate 2uality3 suppliers are concerned with compensation for their goods or
services$ and possible continued trading relationships% &hese parties provide value to the
corporation in the form of financial$ physical$ human and other forms of capital% -any parties
may also be concerned with corporate social performance%
+ 'ey factor in a party1s decision to participate in or engage with a corporation is their
confidence that the corporation will deliver the party1s e!pected outcomes% 8hen categories of
parties .sta'eholders/ do not have sufficient confidence that a corporation is being controlled
and directed in a manner consistent with their desired outcomes$ they are less li'ely to engage
with the corporation% 8hen this becomes an endemic system feature$ the loss of confidence and
participation in mar'ets may affect many other sta'eholders$ and increases the li'elihood of
political action% &here is substantial interest in how e!ternal systems and institutions$ including
mar'ets$ influence corporate governance%
Control and ownership structures:
Control and ownership structure refers to the types and composition of shareholders in a
corporation% In some countries such as most of Continental urope$ ownership is not necessarily
e2uivalent to control due to the e!istence of e%g% dual5class shares$ ownership pyramids$ voting
coalitions$ pro!y votes and clauses in the articles of association that confer additional voting
rights to long5term shareholders% Ownership is typically defined as the ownership of cash flow
rights whereas control refers to ownership of control or voting rights% Researchers often
9measure9 control and ownership structures by using some observable measures of control and
ownership concentration or the e!tent of inside control and ownership% Some features or types
of control and ownership structure involving corporate groups include pyramids$ cross5
shareholdings$ rings$ and webs% German 9concerns9 .<on)ern/ are legally recogni)ed corporate
groups with comple! structures% ?apanese 'eiretsu and South <orean chaebol .which tend to be
family5controlled/ are corporate groups which consist of comple! interloc'ing business
relationships and shareholdings% Cross5shareholding are an essential feature of 'eiretsu and
#>
chaebol groups % Corporate engagement with shareholders and other sta'eholders can differ
substantially across different control and ownership structures%
/amily control
Damily interests dominate ownership and control structures of some corporations$ and it has
been suggested the oversight of family controlled corporation is superior to that of corporations
9controlled9 by institutional investors .or with such diverse share ownership that they are
controlled by management/% + recent study by Credit Suisse found that companies in which
9founding families retain a sta'e of more than #6J of the company1s capital enjoyed a superior
performance over their respective sectorial peers%9 Since #;;>$ this superior performance
amounts to =J per year% Dorget the celebrity CO% 9Goo' beyond Si! Sigma and the latest
technology fad% One of the biggest strategic advantages a company can have is blood ties$9
according to a Ausiness 8ee' study%
,iffuse shareholders
&he significance of institutional investors varies substantially across countries% In developed
+nglo5+merican countries .+ustralia$ Canada$ @ew Kealand$ (%<%$ (%S%/$ institutional investors
dominate the mar'et for stoc's in larger corporations% 8hile the majority of the shares in the
?apanese mar'et are held by financial companies and industrial corporations$ these are not
institutional investors if their holdings are largely with5on group%
&he largest pools of invested money .such as the mutual fund 1Languard :661$ or the largest
investment management firm for corporations$ State Street Corp%/ are designed to ma!imi)e the
benefits of diversified investment by investing in a very large number of different corporations
with sufficient li2uidity% &he idea is this strategy will largely eliminate individual firm financial
or other ris' and% + conse2uence of this approach is that these investors have relatively little
interest in the governance of a particular corporation% It is often assumed that$ if institutional
investors pressing for will li'ely be costly because of 9golden handsha'es9 or the effort
re2uired$ they will simply sell out their interest%
0echanisms and controls
#B
Corporate governance mechanisms and controls are designed to reduce the inefficiencies that
arise from moral ha)ard and adverse selection% &here are both internal monitoring systems and
e!ternal monitoring systems% Internal monitoring can be done$ for e!ample$ by one .or a few/
large shareholder.s/ in the case of privately held companies or a firm belonging to a business
group% Durthermore$ the various board mechanisms provide for internal monitoring% !ternal
monitoring of managers1 behavior$ occurs when an independent third party .e%g% the e!ternal
auditor/ attests the accuracy of information provided by management to investors% Stoc'
analysts and debt holders may also conduct such e!ternal monitoring% +n ideal monitoring and
control system should regulate both motivation and ability$ while providing incentive alignment
toward corporate goals and objectives% Care should be ta'en that incentives are not so strong
that some individuals are tempted to cross lines of ethical behavior$ for e!ample by
manipulating revenue and profit figures to drive the share price of the company up%
'b1ective of Corporate Governance:
The aim of 9Good Corporate Governance9 is to ensure commitment of the board in managing
the company in a transparent manner for ma!imi)ing long5term value of the company for its
shareholders and all other partners% It integrates all the participants involved in a process$ which
is economic$ and at the same time social%
&he fundamental objective of corporate governance is to enhance shareholders1 value and
protect the interests of other sta'eholders by improving the corporate performance and
accountability% Hence it harmoni)es the need for a company to stri'e a balance at all times
between the need to enhance shareholders1 wealth whilst not in any way being detrimental to the
interests of the other sta'eholders in the company% Durther$ its objective is to generate an
environment of trust and confidence amongst those having competing and conflicting interests%
It is integral to the very e!istence of a company and strengthens investor1s confidence by
ensuring company1s commitment to higher growth and profits% Aroadly$ it see's to achieve the
following objectives, + properly structured board capable of ta'ing independent and objective
decisions is in place at the helm of affairs3
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&he board is balance as regards the representation of ade2uate number of non5e!ecutive and
independent directors who will ta'e care of their interests and well5being of all the sta'eholders3
&he board adopts transparent procedures and practices and arrives at decisions on the strength
of ade2uate information3
&he board has an effective machinery to sub serve the concerns of sta'eholders3
&he board 'eeps the shareholders informed of relevant developments impacting the company3
&he board effectively and regularly monitors the functioning of the management team3
&he board remains in effective control of the affairs of the company at all times%
&he overall endeavor of the board should be to ta'e the organi)ation forward so as to ma!imi)e
long term value and shareholders1 wealth%
Internal corporate governance controls
Internal corporate governance controls monitor activities and then ta'e corrective action to
accomplish organi)ational goals% !amples include,
-onitoring by the board of directors, &he board of directors$ with its legal authority to hire$ fire
and compensate top management$ safeguards invested capital% Regular board meetings allow
potential problems to be identified$ discussed and avoided% 8hilst non5e!ecutive directors are
thought to be more independent$ they may not always result in more effective corporate
governance and may not increase performance% "ifferent board structures are optimal for
different firms% -oreover$ the ability of the board to monitor the firm1s e!ecutives is a function
of its access to information% !ecutive directors possess superior 'nowledge of the decision5
ma'ing process and therefore evaluate top management on the basis of the 2uality of its
decisions that lead to financial performance outcomes$ e! ante% It could be argued$ therefore$
that e!ecutive directors loo' beyond the financial criteria%
Internal control procedures and internal auditors, Internal control procedures are policies
implemented by an entity1s board of directors$ audit committee$ management$ and other
#;
personnel to provide reasonable assurance of the entity achieving its objectives related to
reliable financial reporting$ operating efficiency$ and compliance with laws and regulations%
Internal auditors are personnel within an organi)ation who test the design and implementation of
the entity1s internal control procedures and the reliability of its financial reporting%
Aalance of power, &he simplest balance of power is very common3 re2uire that the President be
a different person from the &reasurer% &his application of separation of power is further
developed in companies where separate divisions chec' and balance each other1s actions% One
group may propose company5wide administrative changes$ another group review and can veto
the changes$ and a third group chec' that the interests of people .customers$ shareholders$
employees/ outside the three groups are being met%
Remuneration, Performance5based remuneration is designed to relate some proportion of salary
to individual performance% It may be in the form of cash or non5cash payments such as shares
and share options$ superannuation or other benefits% Such incentive schemes$ however$ are
reactive in the sense that they provide no mechanism for preventing mista'es or opportunistic
behavior$ and can elicit myopic behavior%
-onitoring by large shareholders andHor monitoring by ban's and other large creditors, Given
their large investment in the firm$ these sta'eholders have the incentives$ combined with the
right degree of control and power$ to monitor the management%
In publicly traded (%S% corporations$ boards of directors are largely chosen by the
PresidentHCO and the PresidentHCO often ta'es the Chair of the Aoard position for hisHherself
.which ma'es it much more difficult for the institutional owners to 9fire9 himHher/% &he practice
of the CO also being the Chair of the Aoard is fairly common in large +merican corporations%
8hile this practice is common in the (%S%$ it is relatively rare elsewhere% In the (%<%$ successive
codes of best practice have recommended against duality%
E(ternal corporate governance controls
!ternal corporate governance controls encompass the controls e!ternal sta'eholders e!ercise
over the organi)ation% !amples include,
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competition
debt covenants
demand for and assessment of performance information .especially financial statements/
government regulations
managerial labour mar'et
media pressure
ta'eovers
/inancial reporting and the independent auditor
&he board of directors has primary responsibility for the corporation1s e!ternal financial
reporting functions% &he Chief !ecutive Officer and Chief Dinancial Officer are crucial
participants and boards usually have a high degree of reliance on them for the integrity and
supply of accounting information% &hey oversee the internal accounting systems$ and are
dependent on the corporation1s accountants and internal auditors%
Current accounting rules under International +ccounting Standards and (%S% G++P allow
managers some choice in determining the methods of measurement and criteria for recognition
of various financial reporting elements% &he potential e!ercise of this choice to improve
apparent performance .see creative accounting and earnings management/ increases the
information ris' for users% Dinancial reporting fraud$ including non5disclosure and deliberate
falsification of values also contributes to users1 information ris'% &o reduce this ris' and to
enhance the perceived integrity of financial reports$ corporation financial reports must be
audited by an independent e!ternal auditor who issues a report that accompanies the financial
statements .see financial audit/%
One area of concern is whether the auditing firm acts as both the independent auditor
and management consultant to the firm they are auditing% &his may result in a conflict of
interest which places the integrity of financial reports in doubt due to client pressure to
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appease management% &he power of the corporate client to initiate and terminate
management consulting services and$ more fundamentally$ to select and dismiss
accounting firms contradicts the concept of an independent auditor% Changes enacted in
the (nited States in the form of the Sarbanes5O!ley +ct .following numerous corporate
scandals$ culminating with the nron scandal/ prohibit accounting firms from providing
both auditing and management consulting services% Similar provisions are in place under
clause 4; of Standard Gisting +greement in India%
Systemic problems of corporate governance
"emand for information, In order to influence the directors$ the shareholders must combine with
others to form a voting group which can pose a real threat of carrying resolutions or appointing
directors at a general meeting%
-onitoring costs, + barrier to shareholders using good information is the cost of processing it$
especially to a small shareholder% &he traditional answer to this problem is the efficient mar'et
hypothesis .in finance$ the efficient mar'et hypothesis .-H/ asserts that financial mar'ets are
efficient/$ which suggests that the small shareholder will free ride on the judgments of larger
professional investors%
Supply of accounting information, Dinancial accounts form a crucial lin' in enabling providers
of finance to monitor directors% Imperfections in the financial reporting process will cause
imperfections in the effectiveness of corporate governance% &his should$ ideally$ be corrected by
the wor'ing of the e!ternal auditing process%
,ebates in corporate governance
E(ecutive pay
-ain article, Say on pay Increasing attention and regulation .as under the Swiss referendum
9against corporate Rip5offs9 of *6#0/ has been brought to e!ecutive pay levels since the
financial crisis of *66B7*66=% Research on the relationship between firm performance and
**
e!ecutive compensation does not identify consistent and significant relationships between
e!ecutives1 remuneration and firm performance% @ot all firms e!perience the same levels of
agency conflict$ and e!ternal and internal monitoring devices may be more effective for some
than for others% Some researchers have found that the largest CO performance incentives came
from ownership of the firm1s shares$ while other researchers found that the relationship between
share ownership and firm performance was dependent on the level of ownership% &he results
suggest that increases in ownership above *6J cause management to become more entrenched$
and less interested in the welfare of their shareholders%
Some argue that firm performance is positively associated with share option plans and that these
plans direct managers1 energies and e!tend their decision hori)ons toward the long5term$ rather
than the short5term$ performance of the company% However$ that point of view came under
substantial criticism circa in the wa'e of various security scandals including mutual fund timing
episodes and$ in particular$ the bac'dating of option grants as documented by (niversity of
Iowa academic ri' Gie and reported by ?ames Alander and Charles Dorelle of the 8all Street
?ournal%
ven before the negative influence on public opinion caused by the *66> bac'dating scandal$
use of options faced various criticisms% + particularly forceful and long running argument
concerned the interaction of e!ecutive options with corporate stoc' repurchase programs%
@umerous authorities .including (%S% Dederal Reserve Aoard economist 8eisbenner/
determined options may be employed in concert with stoc' buybac's in a manner contrary to
shareholder interests% &hese authors argued that$ in part$ corporate stoc' buybac's for (%S%
Standard C Poors :66 companies surged to a M:66 billion annual rate in late *66> because of
the impact of options% + compendium of academic wor's on the optionHbuybac' issue is
included in the study Scandal by author -% Gumport issued in *66>%
+ combination of accounting changes and governance issues led options to become a less
popular means of remuneration as *66> progressed$ and various alternative implementations of
buybac's surfaced to challenge the dominance of 9open mar'et9 cash buybac's as the preferred
means of implementing a share repurchase plan%
Separation of Chief E(ecutive 'fficer and Chairman of the 2oard roles
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Shareholders elect a board of directors$ who in turn hire a Chief !ecutive Officer .CO/ to
lead management% &he primary responsibility of the board relates to the selection and retention
of the CO% However$ in many (%S% corporations the CO and Chairman of the Aoard roles are
held by the same person% &his creates an inherent conflict of interest between management and
the board%
Critics of combined roles argue the two roles should be separated to avoid the conflict of
interest% +dvocates argue that empirical studies do not indicate that separation of the roles
improves stoc' mar'et performance and that it should be up to shareholders to determine what
corporate governance model is appropriate for the firm%
In *664$ B0%4J of (%S% companies had combined roles3 this fell to :B%*J by -ay *6#*% -any
(%S% companies with combined roles have appointed a 9Gead "irector9 to improve
independence of the board from management% German and (< companies have generally split
the roles in nearly #66J of listed companies% mpirical evidence does not indicate one model is
superior to the other in terms of performance% However$ one study indicated that poorly
performing firms tend to remove separate CO1s more fre2uently than when the COHChair
roles are combined%
Comments:
+s discussed in the report Corporate Governance is set of systems$ principles and processes by
which a company is governed% &hey 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 sta'eholders in the long term% It is very
essential for the Corporate Public or private companies to have and practice good codes of
Corporate Governance in order to become successful in the business% It not only protects the
rights of all the sta'es holder whether internal or e!ternal but also help them ma!imi)e their
profits% It emphasi)es on being transparent with regard to all transactions$ ma'ing all the
necessary disclosures and decisions$ complying with all the laws of the land$ accountability and
responsibility towards the sta'eholders and commitment to conducting business in an ethical
manner% It does not support the personnel interests of the owner instead it demands to give all
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rights to the CO of the company% &he CO is powerful enough to ta'e any decision which is
good for the business%
&he companies which are practicing these good principals are now at the height of success% +nd
the one which deny these code only succeed to the certain level then they have two options
either to stic' with the same position for whole time period or 2uite that business%
*: