Corporate governance is an area that has grown very rapidly in the last decade,

particularly since the collapse of Enron in 2001 and the subsequent financial
problems of other companies in various countries. As mentioned above, emerging
financial scandals will continue to ensure that there is a sharp focus on corporate
governance issues, especially relating to transparency and disclosure, control and
accountability, and to the most appropriate form of board structur5e that may be
capable of preventing such scandals occurring in future. Not surprisingly, there has
been a significant interest shown by governments in trying to ensure that such
collapses do not happen again because these lead to a lack of confidence in
financial markets. In order to realize why corporate governance in trying to ensure
that such collapses do not happen again because these lead to a lack of confidence
in financial markets. In order to realize why corporate governance has become so
important, it is essential to have an understanding of what corporate governance
actually is and how it may improve corporate accountability.

A fairly narrow definition of corporate governance is given by Shleifer and Vishny

(1977): Corporate governance deals with the ways in which suppliers of finance to
corporations assure themselves of getting a return on their investment. A broader
definition is provided by the Organisation for Economic Cooperation and
Development OECD (1999), which describes corporate governance as . A set of
relationships between a companys board, its shareholders and other stakeholders.
It also provides the structure through which the objectives of the company are set,
and the means of attaining those objectives, and monitoring performance, are
determined. Similarly Sir Adrian Cadbury (1999) said: Corporate governance is
concerned with holding the balance between economic and social goals and
between individual and communal goalsthe aim is to align as nearly as possible
the interests of individuals, corporations and society. These definitions serve to
illustrate that corporate governance is concerned with both the shareholders and
the internal aspects of the company, such as internal control, and the external
aspects, such as an organisations relationship with its shareholders and other
stakeholders. Corporate governance is also seen as an essential mechanism
helping the company to attain its corporate objectives and monitoring performance
is a key element in achieving these objectives.

It can be seen that corporate governance is important for a number of reasons, and
is fundamental to well managed companies and to ensuring that they operate at
optimum efficiency. Some of the important features of corporate governance are as
follows:

It helps to ensure that an adequate and appropriate system of controls

operates within a company and hence assets may be safeguarded;
It prevents any single individual having too powerful an influence;
It is concerned with the relationship between a companys management, the
board of directors, shareholders, and other stakeholders;
 It aims to ensure that the company is managed in the best interests of the
shareholders and the other stakeholders;
It tries to encourage both transparency and accountability, which investors
are increasingly looking for in both corporate management and corporate
performance.
The first point above refers to the internal control system of a company whereby
there are appropriate and adequate controls to ensure that transactions are
properly recorded and that assets cannot be misappropriated. Each year, a
company has an annual audit and a key part of the auditors job is to assess
whether the internal controls in a business are operating properly. Of course, the
auditor has to exercise a certain degree of judgment regarding the assurance given
by the directors, the directors being ultimately responsible for the implementation
of an appropriate internal control system in the company. The directors are also
responsible for ensuring that there are risk assessment procedures in place to
identify the risks that companies face in todays business environment, including ,
for example, exposures to movements in foreign exchange and risks associated with
business competition.

As well as being fundamental to investor confidence, good corporate governance is

essential to attracting new investment, particularly for developing countries where
good corporate governance is often seen as a means of attracting foreign direct
investment at more favourable rates. As the emphasis on corporate governance
has grown during the last decade, we have seen a sea change in many countries
around the world. Developed and developing countries alike have introduced
corporate governance codes by which companies are expected to abide. The codes
emphasise the importance of transparency, accountability, internal controls, board
composition and structure, independent directors, and performance related
executive pay. There is much emphasise on the rights of shareholders and an
expectation that shareholders, especially institutional investors, will take a more
proactive role in the companies in which they own shares and actually start to act
more as owners rather than playing a passive shareholder role. Corporate
governance is an exciting area, fast developing to accommodate the needs of a
changing business environment where investor expectations are higher than ever
before; the cost to companies that ignore the benefits of good corporate
governance can be high and, ultimately, can mean the collapse of the company.

This text seeks to chart the development of corporate governance over the last
decade and to illustrate the importance of corporate governance to the company
itself, to directors, shareholders and other stakeholders, and to the wider business
community. The text is structured in four major parts. Part one contains two
chapters that chart the development of corporate governance and look at the
various theoretical aspects, including the frameworks within which corporate
governance might be developed, and the development of corporate governance
codes in various countries. Part Two contain four chapters, the first of which,
Chapter 4, looks at the role of shareholders and stakeholders, identifies the various
stakeholder groups, and discusses their role in companies and in corporate
governance. The text recognizes that corporate ownership across the world varies
and that the family owned firm is the dominant form of business in many countries:
Chapter 5 is devoted solely to family owned firms and their governance. Chapter 6
looks at the role of institutional investors in corporate governance; institutional
investors are the predominant type of owner in the UK and the USA. Chapter 7 is
devoted to socially responsible investment, or ethical investment, because it is an
area that is attracting increasing interest in many countries and in which
institutional investors in particular are taking much more of an interest. Part three
concentrates on various aspects of directors and board structure: Chapter 8
examines the role of directors, their duties, their responsibilities, and looks at the
important areas of boards and board sub-committees. Non-executive directors
(outside), emphasised in many of the corporate governance codes as being a key
element of good corporate governance, are discussed in detail. Chapter 9 looks at
directors performance and remuneration. It reviews the background to the debate
on directors remuneration and looks at the ways in which directors performance
and remuneration may be effectively linked. The text is designed to appeal to a
global audience and Part Four is devoted to corporate governance development in
various continents around the world: Chapter 10 looks at corporate governance in
Continental Europe; Chapter 11, corporate governance in the central and Eastern
European countries; Chapter 12, corporate governance in South East Asia; Chapter
13, corporate governance in a number of other countries including South Africa,
India, and Brazil. Chapter 14 provides some concluding comments on these
developments in corporate governance, the evolution of the various shareholder
and stakeholder groups, and potential future developments in corporate
governance.

At the start of each chapter, there are learning objectives that identify the key
objectives of the chapter, and at the end of each chapter, there is a useful summary
of the key points raised. There are short discussion question and mini case studies
to illustrate the key issues raised in various chapters, and references to appropriate
publications and websites for each chapter.

An important new feature of the book is the accompanying online resource centre
(ORC) which contains additional useful material such as student learning tools
incorporating questions and web links, and lecturers material including power point
slides and updates (on an annual basis)of significant new material. Throughout
each chapter, links to the Online Resource Centre are indicated by an icon in the
margin.

References
Cadbury, Sir Adrian (199), Corporate Governance Overview, World Bank Report.
OECD (1999), principles of corporate governance, OECD, Paris
Shleifer, A. and Vishny, R. (1997), A Survey of Corporate Governance, journal of
Finance, Vol. LII, No.2.

Theoretical Aspects of Corporate Governance

Learning Objectives
To understand the various main theories that underlie the development of
corporate governance
To be aware of the impact of the form of legal system, capital market, and
ownership structure on the development of corporate governance
Introduction

Corporate governance has only relatively recently come to prominence in the

business world; the term corporate governance and its everyday usage in the
financial press is a new phenomenon of the last fifteen years or so. However, the
theories underlying the development of corporate governance, and the areas it
encompasses, date from much earlier and are drawn from a variety of disciplines
including finance, economics, accounting, law, management, and organizational
behavior.

It must be remembered that the development of corporate governance is a global

occurrence and, as such, is a complex area including legal, cultural, ownership, and
other structural differences. Therefore some theories may be more appropriate and
relevant to some countries than others, or more relevant at different times
depending on what stage an individual country, or group of countries, is at. The
stage of development may refer to the evolution of the economy, corporate
structure, or ownership groups, all of which affect how corporate governance will
develop and be accommodated within its own country setting. An aspect of
particular importance is whether the company itself operates within a shareholder
framework, focusing primarily on the maintenance or enhancement of shareholder
value as its main objective, or whether it takes a broader stakeholder approach,
emphasizing the interests of diverse groups such as employees, providers of credit,
suppliers, customers, and the local community.

Summary of theories affecting corporate governance development

Theory name Summary
Agency Agency theory identifies the agency relationship where one
party, the principal, delegates work to another party, the
agent. In the context of a corporation, the owners are the
principal and the directors are the agent
Transaction cost Transaction cost economics views the firm itself as a
economics governance structure. The choice of an appropriate
governance structure can help align the interests of directors
 and shareholders
Stakeholder Stakeholder theory takes account of a wider group of
constituents rather than focusing on shareholders. Where
there is an emphasis on stakeholders, then the governance
structure of the company may provide for some direct
representation of the stakeholder groups
Stewardship Directors are regarded as the stewards of the companys
assets and will be predisposed to act in the best interest of
the shareholders
Class hegemony Directors view themselves as an elite t the top of the
company and will recruit/promote to new director
appointments taking into account how well new
appointments might fit into that elite
Managerial Management of a company, with its knowledge of day to day
hegemony operations, may effectively dominate the directors and
hence weaken the influence of directors

What is corporate governance?

Seeking a tidy definition of any subject presents difficulties, but few are less tidy
than corporate governance. Corporations create employment for many if not most
people in the advanced economies around the world. Their profits fuel wealth
creation, through the payment of dividends they pay to their shareholdes or the
money they invest in research and development to create new products or to
reduce the costs of creating the goods and services that people around the world
want to buy. Much of the improvement we have seen in living standards in the last
200 years can be attributed to corporate activity, since the industrial revolution
made mass production possible and with it made products available to the masses.
Governing such entities involves overseeing strategy, human resources, financial
accounting, marketing, external communications, factories and organizational
structures and deciding how they all fit together.

Corporations the large businesses operating on a scale that one individual person
could easily control and only a few could ever dream of owning also operate in ways
unlike other entities, other economic actors. Unlike individual people, corporations
are difficult to hold to account. You cannot imprison a corporation. Their owners
claim property rights over them, but in a very peculiar way. Owners rights over the
corporation scarcely justify using the term ownership at all.

Corporations occupy an odd place in the political system in which they reside. Even
the word reside is odd: to create the structures we know of as corporations,
nineteenth-century political and legal theorists decided to treat them as though
they were people. Companies groups of people working as an economic unit were
allowed to incorporate and in so doing become legal persons, entitled in law to
enter into contracts with people and other corporations, and given the protection of
law as though they were people. But unlike people or, until the past few decades,
partnerships between people corporations, received in law the recognition that
their members, that is, their shareholders or owners, were not personally liable for
their debts or if something went wrong. This protection in law allowed corporations
to amass the large amounts of capital needed to build large enterprises using large
machinery and employing large numbers of people. Through that protection, they
grew throughout the twentieth century into the enterprises we know today (for
background, see McCraw, 1997).

Many large corporations, the ones we sometimes call multinational enterprises or

transnational companies, have more income and produce more wealth than many
countries. Their employees may well be citizens of a country or of more than one
but their expatriate managers may have a greater sense of allegiance to the
corporation than to any single nation state. Their actions if nothing else through
threatening to move their legal seat from one political jurisdiction to another can
prompt governments to change policy. A few conspired to overthrow governments,
so great is the potential of their power (for the case of ITT and Chile, see Sampson,
1973)

Most corporations, of course, do not enjoy such power let alone use it. But neither
are they easy to subsume under law in any one jurisdiction. Particularly in the
liberal democracies that fostered the growth of corporations and the economic
welfare they allowed, governments claim legitimacy through their right to govern
the people who live under their jurisdiction. Corporations cannot claim such
legitimacy, yet they can govern, in many ways , the lives and activities of the
workforces and the companies and individuals who supply them or buy the products
and services they create. The scope of this power sits ultimately but uncomfortably
under the jurisdiction of law and society. But the power they possess puts them and
the managers who lead them in a position to do much damage as well as much
good.

How, then, do we govern these corporate entities? In the narrow sense, corporate
governance looks at the mechanisms put in place inside companies to guide their
actions and monitor their performance. Most writing and thinking about corporate
governance focuses on the role of the board of directors, the group of people who
sit at the top of the enterprise, deciding what direction it should take, what
strategies it should adopt, hiring a team of managers and then holding them to
account for the performance they deliver. Another aspect of corporate governance
looks at how those boards of directors relate to their owners, the investors who
bought shares in the corporation and claim, through the legitimacy of their property
rights, to have some sort of say over the affairs of the corporation. These two areas
the relationship between boards and managers and the relationship between
investors and boards form what we will call the classical agenda of corporate
governance, which has dominated the thinking and writing about corporate
governance (Cadbury & Millstein, 2005; Charkham, 1994; MacAvoy & Millstein,
2003; Millstein & MacAvoy, 1998; Monks & Minow, 2003). Despite the difficulties
associated with looking into the private and often highly confidential affairs of
private entities, scholars have attempted to describe how these processes work, in
part so that other directors on other boards can see, if only through a glass darkly,
how they might conduct their business. Even more scholars have attempted to
prescribe how boards ought to conduct their relationships with managers and
investors even in absence of definitive information about how the complex
interaction of all the factors that come together at the board really works.

There is, however, another range of issues that have increasingly come to be seen
as forming new agenda incorporate governance: how corporations relate to their
broader society. Whether we call it corporate social responsibility, sustainability,
ethics or just corporate responsibility with the social this stream of thinking (Benn
& Dunphy, 2007; Crowther & Rayman Bacchus, 2004; DesJardins, 2007; Elkington,
1999) involves a consideration of how boards and the top management teams they
employ relate to their employees, suppliers, customers, and even their competitors
and those who might seek to compete against them. It seeks to take into account
as well how the corporation relates to the community in which it operates, the
people who live near the factories and office buildings the corporation operates
local governments, and even national governments and supranational
organizations. It seeks as well to examine how and even whether corporations have
a responsibility to non governmental organizations, even those that are not
particularly part of a local community in which the global corporation just happens
to work. It seeks to identify the role of the corporation and its board in preserving
the environment in which we all live, a larger and more prominent part of the
agenda as the consensus of scientific opinion has built around the impact of global
warming and the role corporations play in it. This second agenda has been widely
studied in descriptive ways as well, often with even less access to definitive
information that would lead to conclusions we might consider robust. It too, has
developed a large academic literature of a prescriptive nature, and one with
perhaps even more vigour of opinion than we see in the literature of the classical
corporate governance agenda:

Both streams of thinking seek to address simultaneously two issues:

How are corporations directed and monitored, and what mechanism can we
use to make them perform better?
What mechanism can we put in place to ensure that corporations, their
managers and directors do not destroy the value that the corporation was
meant to create and destroy the value of others with whom it conducts its
affairs?
Inside corporations, however, corporate governance has another aspect: How can
we create value? That was, after all, why the corporation was formed; indeed, why
society created the institution of the corporation in the first place.

In that sense, running a corporation is a bit like sailing a ship or driving a car. The
term governance traces its roots to the Latin word gubernare to seer- as in directing
a ship towards its destination, overcoming whatever vagaries the wind and tides
might inflict on the crews inflict on the crews intended course of action.
Governance is, therefore, the job of setting the direction. When kings were truly
sovereign, governance referred to the instructions that the leader had set out for his
subjects to follow, come what may. But over the centuries other definitions have
come into play. Democracies govern not by edict, but rather by systems of checks
and balances, by negotiating a settlement between competing interests. The role of
governance is not merely to set direction, but rather to mediate between the
various parties contesting for control of resources.