corporate governance


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Corporate Governance

The manner in which the stakeholders in a corporation relate to one another. Corporate governance has a positive connotation and a company with "good" corporate governance is said to be a company in which all stakeholders relate to each other in a positive way. Good corporate governance is considered an important quality of sustainable growth for a company; that is, if the shareholders, management, and employees all fulfill their fiduciary responsibilities to one another, the corporation is thought to have a greater likelihood of success. Corporate governance is laid out in the corporation's charter and other applicable documents.

corporate governance

the duties and responsibilities of a company's BOARD OF DIRECTORS in managing the company and their relationship with the SHAREHOLDERS of the company Typically salaried professional managers have acquired substantial powers in respect of the affairs of the company they are paid to run on behalf of their shareholders. However, directors have not always had the best interests of shareholders in mind when performing their managerial functions (see PRINCIPAL-AGENT THEORY) and this has led to attempts to make directors more accountable for their policies and actions.

A number of reports have been published in the UK in the 1990s prompted by the public's concern at cases of gross mismanagement (for example, the collapse of the BCCI bank and Polly Peck and the misappropriation of employees' pension monies at the Mirror Group) and ‘fat cat’ pay increases secured by executive directors. The Cadbury Committee Report (1992), recommended a ‘Code of Best Practice’ relating to the appointment and responsibilities of executive directors, the independence of non-executive directors and tighter internal financial controls and reporting procedures. The Greenbury Committee Report (1995) specifically addressed the issue of directors' pay recommending that executive directors' pay packages should be determined by the company's Remuneration Committee consisting solely of non-executive directors and that share awards under EXECUTIVE SHARE OPTION SCHEMES and LONG-TERM INCENTIVE PLANS (LTIPs) should be linked to the company's financial performance. The Hempel Committee Report (1998) covered many of the same issues raised by these two earlier reports recommending (‘Principles of Good Governance’) checks on the power of any one individual executive director (by, for example, separating the roles of Chairman and Chief Executive), a more independent and stronger voice for non-executives (including the appointment of a ‘senior’ non-executive to offer guidance to, and check ‘empire building’ tendencies on the part of, executive directors, and in liaising with shareholder interests), and more accountability to shareholders at the AGM (including the approval of options and LTIP schemes).

In 1998 the ‘Code of Best Practice’ and ‘Principles of Good Governance’ were combined and ‘the combined code’ was formally incorporated into the listing rules of the London STOCK EXCHANGE.

Increased concern with financial irregularities and malpractice resulted in two reports (Turnbull, 1999 and Smith 2003) proposing guidelines to tighten internal financial control and auditing practices. A similar stricter regime of financial monitoring has been implemented in the USA (the Sarbanes-Oxley Act, 2002) in the wake of ‘scandals’ such as Enron.

More recently, the Higgs Report (2003) on the role of non-executive directors recommended that they be given a more prominent position including: the company's Chairman should be a non-executive and that at least half of the Board's directors should be non-executive. See BUSINESS OBJECTIVES, SOCIAL RESPONSIBILITY, STAKEHOLDER.

corporate governance

The duties and responsibilities of a company's BOARD OF DIRECTORS in managing the company and their relationship with the SHAREHOLDERS of the company. With the DIVORCE OF OWNERSHIP FROM CONTROL, salaried professional managers have acquired substantial powers in respect of the affairs of the company they are paid to run on behalf of their shareholders. However, directors have not always had the best interests of shareholders in mind when performing their managerial functions (see PRINCIPAL-AGENT THEORY), and this has led to attempts to make directors more accountable for their policies and actions.

A number of reports were published in the UK in the 1990s, prompted by the public's concern at cases of gross mismanagement (for example, the collapse of the BCCI bank and Polly Peck and the misappropriation of employee's pension monies at the Mirror Group) and ‘fat cat’ pay increases secured by executive directors. The Cadbury Committee Report (1992) recommended a ‘Code of Best Practice’ relating to the appointment and responsibilities of executive directors, the independence of nonexecutive directors and tighter internal financial controls and reporting procedures. The Greenbury Committee Report (1995) specifically addressed the issue of directors’ pay, recommending that executive directors’ pay packages should be determined by companies’ remuneration committees, consisting

solely of nonexecutive directors, and that share awards under EXECUTIVE SHARE OPTION SCHEMES and LONG-TERM INCENTIVE PLANS ( LTIPs) should be linked to companies’ financial performance. The Hempel Committee Report (1998) covered many of the same issues raised by these two earlier reports, recommending (‘Principles of Good Governance’) checks on the power of any one individual executive director (by, for example, separating the roles of chairman and chief executive), a more independent and stronger voice for nonexecutives (including the appointment of a ‘senior’ nonexecutive to offer guidance to, and check ‘empire building’ tendencies on the part of, executive directors and in liaising with shareholder interests) and more accountability to shareholders at the AGM (including the approval of options and LTIP schemes).

In 1998 the ‘Code of Best Practice’ and ‘Principles of Good Governance’ were combined and formally incorporated into the listing rules of the London STOCK EXCHANGE.

In 1999 the Turnbull Committee Report on ‘Internal Control’ proposed guidelines for regular internal controls not only on financial procedures but also on business and operational matters with a greater emphasis on ‘risk’ management and evaluation to ensure that these are compatible with the company's business objectives.

More recently, the Higgs Committee Report (2003) envisaged a more prominent role for nonexecutives, including the following recommendations: the chairman should be a nonexecutive; the senior independent nonexecutive director should be given additional responsibilities, particularly in regard to liaising between the board and the companies’ shareholders; nomination committees should consist entirely of nonexecutives; at least half the board's directors should be nonexecutive; no full-time executive director should take on more than one additional non-executive position in another company.

For UK and other MULTINATIONAL COMPANIES operating in the USA the Sarbanes-Oxley Act (2002) requires them to follow strict financial accounting procedures, audits and reporting to increase financial transparency and to prevent fraud. The Act was introduced following a number of financial scandals, notably those at Enron and World Com., and the failure of nonexecutives and major accountancy firms such as Arthur Anderson (now broken up) to detect malpractices. In the UK itself, financial reporting has been tightenend up following the recommendations of the Smith Committee Report (2003) on internal auditing practices.

While traditionally the issue of corporate governance has tended to focus on director-shareholder relationships, the stakeholder approach emphasizes that directors have wider responsibilities to other groups with an interest or ‘stake’ in the business: their employees, consumers, suppliers and the community at large.

See FIRM OBJECTIVES, MANAGERIAL THEORIES OF THE FIRM, SOCIAL RESPONSIBILITY.

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