Corporate Governance - Definitions / Overview

Question 1

What are the key corporate governance definitions?

Answer 1

1. System by which companies are directed and controlled (Cadbury Committee - 1992).
2. Set of relationships between a company’s management, its board, its shareholders and other stakeholders… also provides the structure through which objectives… are set, and the means of attaining those objectives and monitoring performance (OECD - 2004).
3. Corporate governance is… about what the… company does and how it sets the values of the company (UK Corporate Governance Code - 2016).

Question 2

Theories of Corporate Governance: Why is Corporate Governance Necessary?

Answer 2

1. Conflicts and issues may arise from separation of ownership (shareholders) and management (directors) of a company.
2. ‘Agency conflict’: Management’s interest is in receiving position benefits, being higher where they have no ownership interest. Four key issues:
   - Moral hazard: Non-owning managers may take great risks.
   - Level of effort: Non-owning managers may be less incentivised.
   - Earnings retention: Non-owning managers may grow the business for remuneration, without releasing excess profit to shareholders.
   - Time horizon: Non-owning managers may be less interested in the company’s long-term, sustainable success.

Question 3

Theories of Corporate Governance: What are the Four Key Governance Theories?

Answer 3

1. Shareholder value: Board should act in the best interests of shareholders.
2. Stakeholder approach: Board should consider and balance all stakeholder interests when decision-making.
3. Inclusive stakeholder approach: Board should consider legitimate interests and expectations of key stakeholders as this in the company’s best interests.
4. Enlightened shareholder approach (s.172, CA ‘06): To maximise shareholder value, board should consider the short- and long-term, and consider the views and impacts upon other company stakeholders (insofar as in the shareholders’ interests).

Question 4

Theories of Corporate Governance: What does s.172, CA ‘06 say about the Enlightened Shareholder Theory?

Answer 4

Directors must promote the company’s success for the benefit of its members as a whole, having regard to:
- Likely long-term consequences of any decision;
- Interests of the company’s employees;
- Need to foster business relationships with company suppliers, customers and others, and the company’s impact on the community and environment;
- Desirability of maintaining a reputation for high business conduct standards; and
- Need to act fairly as between company members.

Question 5

What is Stakeholder Capitalism?

Answer 5

Stakeholder capitalism creates shareholder returns by creating value for society as a whole (i.e. customers, employees, suppliers, communities and the environment). Frequently centres on intangible sources of value - IP, talent, property, reputation.

Question 6

What are the Four Principles of Good Corporate Governance?

Answer 6

1. Responsibility: Those with authority accept full responsibility for their powers and authority, exercising them ethically and with honesty, probity and integrity.
2. Accountability: Person or group of responsible stakeholders are held to account for (non-)exercise of granted authority, providing honest and unmanipulated information.
3. Transparency: Ease with which an outside may make a meaningful analysis of an organisation and its actions.
4. Fairness: All key stakeholders should be treated fairly when decisions or actions are taken by a company.

Question 7

What are Six Benefits of Good Reputational Management?

Answer 7

1. Improved shareholder relations.
2. More favourable environment for investment and capital access.
3. Recruitment and retention of best employees.
4. Securing premium prices for products and services.
5. Minimisation of litigation risk and more stringent regulation.
6. Reduction of crisis potential.

Question 8

What are the Principal Standing-setting Approaches to Corporate Governance?

Answer 8

1. Rules-based approach: Predicated on mandatory compliance with legal or regulatory requirements, subject to sanction (‘comply-or-else’).
2. Principles-based approach: May entail adherence with prescribed governance standards, with provision for deviation from the same on appropriate explanation (‘comply-or-explain’ - UK CGC; ‘apply-or-explain’ - King IV / Wates, minimises tickbox compliance).
3. Hybrid approach of rules and principles (prevalent in UK).

Question 9

What are Six Reasons for adopting Good Corporate Governance Practices?

Answer 9

1. Long(er)-term sustainability.
2. Improved access to external financing.
3. Enhanced operational performance.
4. Reduced risk of corporate scandals.
5. Effective decision-making.
6. Succession planning.

Question 10

What are the Two Chief Consequences of Weak Governance Practices for a Company?

Answer 10

1. Corporate failure: Accounting fraud, dominant board personalities, risk management failures, inadequacy of board skills and experience.
2. Reputational problems: Unethical business practices (e.g. VW Dieselgate), lack of transparency/disclosure (e.g. Olympus), poor board-shareholder relations (e.g. Sports Direct), inappropriate remuneration mechanisms (e.g. Carillion).

Question 11

What are the Chief Consequences of Weak Governance Practices for Industry?

Answer 11

1. Establishment of powerful regulators.
2. Excess regulation.
3. Development of shareholder representative bodies.
4. Emphasis on executive pay regulation and disclosure.
5. Diminished investment in capital markets.