What are the aspects of good corporate governance?

The effect of good corporate governance is analyzed through practical examples of corporate entities and different relevant literature reviews.
Estimated Reading Time: 8 minutes

Introduction

Good corporate governance is expected to increase corporate performance and value. Good corporate governance principles include honesty, openness, trust and integrity, responsibility and accountability, performance orientation, mutual respect, and commitment towards the company. The main idea behind implementing good corporate governance principles in the company is to optimize value for its shareholders and stakeholders in the long-run.

The importance of corporate governance started to recognise the aftermath of many major corporate scandals, so the regulators tightened the company’s regulations. The United States passed Sarbanes-Oxley Act, and President George W. Bush proclaimed that “the era of low standards and false profits is over.”[1]

Following that, India also brought some changes in the company regulations when the Security and Exchange Board of India (SEBI) introduced clause 40 to the listing agreement. The amendment was done to promote transparent disclosures and enhance transparency and integrity to financial statements.

Adequate disclosures then began to regard as one of the practices of good governance in India. However, the concept of corporate governance is more than a decade old in the country. After the chaos of the popular Satyam Scandal, Industry groups and regulators in India advocated many significant reforms that led the Ministry of Company Affairs to issue Corporate Governance Voluntary Guidelines 2009. The MCA issued the guidelines to encourage and guide corporate entities to adopt best practices such as the creation of whistleblowing mechanism, board committees’ appointment, and appointment and rotation of external auditors.  Later, with the new Companies Amendment Bill, the corporate governance disclosures were made even more stringent.

Fundamentals of corporate governance

It concerns relations between various corporation stakeholders and how the shareholders, the board, directors, managers, employees, clients, investors, and communities mutually interact. The formal and informal corporate governance rules are usually found in every company’s legal, institutional, and regulatory framework.

It is a crucial element in improving the company’s economic efficiency and growth and increasing investors’ trust. It ensures a defined structure through which the company objectives are set and effectively monitor the management and other personnel to achieve those objectives.

Good corporate governance should ensure adequate incentives are given to the directors, the management, and shareholders to act in the company’s best interest. It depends on a committed and functional institutional and legal system that helps smooth the company’s operations. However, such a system can be developed only through positive developments that prevent abuse of authority and resources.

General principles of good corporate governance

Good corporate governance’s general principles include the following four elements: primarily laid down in the Millstein Report, 1998.[2]

  1. Accountability: The accountability principle ensures that the company’s management is accountable to the board, and the board is accountable to the owners of the company, i.e. its shareholders.
  2. Fairness: A fair management ensures that the rights of shareholders are protected. Fairness in the systems ensures that all the shareholders, including minorities, are also treated equitably, and there is an effective redress mechanism to act against violations.
  3. Transparency: Transparency in the system ensures timely and accurate disclosure of information on all material matters, including performance improvement, ownership and corporate governance, and financial and non-financial situations.
  4. Responsibility: The corporate should be compliant with the laws and regulations reflecting the extant society’s values.

The additional evolved principle is Independence, which represents a proper implementation of procedures and structures to minimize or altogether avoid conflicts of interest. It is also pertinent that the independent directors and advisors are entirely free from the influence of others.

Core principles of good corporate governance-OECD

The OECD set up a task force, and in April 1999, it issued a set of corporate governance principles to operationalize the findings of Millstein Report, 1998. OECD expanded the core concepts of Transparency, Fairness, Accountability, and Responsibility and strengthened the foundational principles as given below:

Fairness

Fairness concept has two developed principles. The first principle says that ‘the corporate governance framework should protect the rights of shareholders’.[3] The rights include both proprietary and participatory rights. Good governance depends on the laws, regulations, and practices that protect the property right of shareholder by ensuring the security of their ownership and transferability of shares. Further, participatory rights will enable them to involve in critical corporate decisions.

The second principle is that the governance framework ensures equitable treatment of all shareholders, including the minority and foreign shareholders, ensures effective redress against any rights violation such as misappropriation of assets, or dealing by controlling shareholders, etc.

Responsibility

The responsibility principle says that the corporate must abide by the established laws and regulations and special recognition to protect the stakeholders’ rights, mainly employees. The CSR practice, as per the growing trend, should be established in the corporate governance framework. The corporate should also go beyond the legal requirement to provide additional incentives in remuneration like health care or retirement benefits, or other financial support.

Transparency

The transparency principle indicates the corporate to ensure timely and accurate disclosure of information and decision-making on material matters concerning stakeholders. The material matter includes performance, financial situation, and the company’s ownership and governance that must reach the stakeholders to have access to the risk exposures and corporate objectives. The critical component of transparency includes an independent audit in accordance with the internally acceptable accounting and audit standard. It would enhance comparability and help the analysts and investors in comparing corporate performance and accordingly taking decisions.

Accountability

The fifth principle of accountability states that the corporate governance mechanism should ensure the strategic guidance and effective monitoring of the company’s management by the board of directors. A key aspect of good corporate governance is the quality of directors. The board has a fiduciary relationship with the company and its shareholders and is accountable to them. So, essentially the principle lays down a legal duty on the board to fulfil their fiduciary relationship, which requires them to act diligently, avoid self-interest while decision-making, and make an informed decision in stakeholders’ interests.  The board should monitor the managerial conduct and require some of the directors to be independent with no financial or personal relationship, in the present or the past, with its members.

So, as per the Organization for Economic Cooperation and Development, the brief overview of principles of good corporate governance is as follow:[4]

  1. Recognition of rights of shareholder and the equitable treatment.
  2. It is imperative to protect the interests of other stakeholders, and hereby the corporation should recognize their legal and other responsibility to all legitimate stakeholders.
  3. A well-defined role and responsibilities of the board because they are legally the primary responsibility for the company and management performance.
  4. The transparency in disclosing all relevant information and material matters concerning the corporation in a timely and balanced method must ensure that all the investors have full access to clear factual information.
  5. Lastly, the inculcation of integrity and ethical behaviour in the company’s value is very important.

Corporate governance and Corporate Social Responsibility

One of the significant aspects of good corporate governance is its intertwined CSR agenda, corporate social responsibility. Over recent years, there has been an increasing emphasis on governing corporation in accordance with social and environmental norms. The aim is to ensure that the negative externalities associated with social and environmental norms are minimized to a greater extent. The negative externalities here, us referred to all social and environmental costs a corporation imposes on society and is not factored into the total costs incurred by them.

And suppose when this happens on a significant level by all corporations because these reckless actions of corporations affect the society without paying for it. That is why we need companies to be socially and environmentally conscious and responsible so that the inconvenience society is suffering gets lowered at all cost. This is CSR’s concept, the corporate social responsibility, which guides the corporations to follow sustainable business practices.

In the context of good corporate governance, CSR indicates that “corporations have to take into account the society and the environment as stakeholders, and cater to their needs instead of just pursuing profits at the expense of everything else.”[5]Meaning, good corporate governance must encompass aspects of social and environmental responsibility, and this is why the corporations need to incorporate CSR elements within the ambit of corporate governance. It is hoped that through CSR, the corporations would govern themselves sustainably and be accountable for their social and environmental costs and responsible towards society and the environment.

How CSR positively impact corporate governance?

With the evolving concept of CSR and its application by many corporate in their management system, it has been seen that CSR positively impact the governing rules of corporate governance. To name a few corporate-like Hyundai, Samsung, Unilever, and P&G, they publish their CSR reports and the company’s annual reports. This is an immediate consequence of the push to broaden the agenda of good corporate governance by including CSR within its ambit. Additionally, many other corporates now publish a routine report of how much cost they are imposing on society (negative externalities) and the efforts done by them towards minimizing it.

So, corporate governance principles are no longer restricted to transparency and accountability within the business regulatory framework; it has been broadened to consolidate the whole gamut of social and environmental concerns within the corporate governance agenda. Talking about multilateral bodies such as the United Nations and the WTO, they have also established normative rules of conduct under classifications like the Corporate Sustainability- UN Global Compact[6]. The UN Global Compact has guidelines for the corporations to follow that bind them to social and environmental responsibility. There are many corporate signatories to the compact who are expected to follow the guidelines, though voluntarily, as part of their sustainability drives.

However, looking at the current global climate situation, it is necessarily required to combine both voluntary and enforced rules of conduct and behaviour that corporate must follow as part of their CSR related to corporate governance.

Conclusion

As many corporate scandals have surfaced in the recent past, we need to have a proper effective regulatory mechanism to reduce and eliminate such corporate scams’ possibilities for arising such corporate scams in the future. This is why we need good corporate governance in an organization that will monitor the organization’s performance and prevent them from falling prey to any scam.

Moreover, whether good corporate governance facilitates improving corporate performance or not is still a valid question of thought for reasons like ambiguity regarding the directions of casualty. However, the present article had listed good corporate governance aspects, which causes higher corporate performance when applied efficiently. To conclude, corporate governance is no longer just about the ethical practices concerning business activities. Instead, the agenda has broadened to include the social and environmental norms that are social responsibility practices.


[1] Kandukuri, R.L., Memdani, L. and Raja Babu, P. (2015), “Effect of Corporate Governance on Firm Performance – A Study of Selected Indian Listed Companies”, Overlaps of Private Sector with Public Sector around the Globe (Research in Finance, Vol. 31), Emerald Group Publishing Limited, pp. 47-64. https://doi.org/10.1108/S0196-382120150000031010.

[2] Jerab, Daoud Abdellatef, The Effect of Internal Corporate Governance Mechanisms on Corporate Performance (2011) last assessed Jan 9th 2021, Available at SSRN: https://ssrn.com/abstract=1846628 or http://dx.doi.org/10.2139/ssrn.1846628.

[3] Mohamad, Shafi. (2004). The Importance of Effective Corporate Governance. SSRN Electronic Journal. 10.2139/ssrn.617101.

[4] Organization for Economic Cooperation and Development (OECD) 2004.

[5] Broadening the Corporate Governance Agenda: The Corporate Social Responsibility, last assessed Jan 10th 2021, at https://www.managementstudyguide.com/broadening-the-corporate-governance-agenda.htm.

[6] https://d306pr3pise04h.cloudfront.net/docs/news_events%2F8.1%2FGC_brochure_FINAL.pdf.

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