MEANING AND DEFINITION OF CORPORATE GOVERNANCE

Corporate or a Corporation is derived from the Latin term “corpus”

which means a “body”. Governance means administering the processes
and systems placed for satisfying stakeholder expectation. The root
of the word Governance is from ‘gubernate’, which means to steer.
When combined, Corporate Governance means a set of systems,
procedures, policies, practices, standards put in place by a corporate
to ensure that relationship with various stakeholders is maintained in
transparent and honest manner. The phrase “corporate governance”
describes “the framework of rules, relationships, systems and
processes within and by which authority is exercised and controlled
within corporations. It encompasses the mechanisms by which
companies, and those in control, are held to account.”

Corporate Governance is a continuous process of applying the best

management practices, ensuring the law is followed the way intended,
and adhering to ethical standards by a firm for effective
management, meeting stakeholder responsibilities, and complying with
corporate social responsibilities.

It contains policies and rules to maintain a strong relationship

between the owners of the company (shareholders), the Board of
Directors, management, and various stakeholders like employees,
customers, Government, suppliers, and the general public. It applies
to all kinds of organizations-profit or not-for-profit.
DEFINITION “Corporate Governance is the application of best
management practices, compliance of law in true letter and spirit and
adherence to ethical standards for effective management and
distribution of wealth and discharge of social responsibility for
sustainable development of all stakeholders.”

NEED FOR CORPORATE GOVERNANCE Corporate Governance is

needed to create a corporate culture of transparency, accountability
and disclosure. IT refers to compliance with all moral and ethical
values, legal framework and voluntarily adopted practices.

ADVANTAGES OF GOVERNANCE

Some of the salient advantages of Corporate Governance are stated

hereunder:

1. Good corporate governance ensures corporate success and

economic growth.
2. Strong corporate governance maintains investors’ confidence, as
a result of which, company can raise capital efficiently and
effectively.

3. There is a positive impact on the share price.

4. It provides proper inducement to the owners as well as
managers to achieve objectives that are in interests of the
shareholders and the organization.
5. Good corporate governance also minimizes wastages,
corruption, risks and mismanagement.
6. It helps in brand formation and development.
7. Good corporate governance creates transparent rules and
controls, provides guidance to leadership, and aligns the
interests of shareholders, directors, management, and
employees.
8. It helps build trust with investors, the community, and public
officials.
9. Corporate governance can provide investors and stakeholders
with a clear idea of a company's direction and business
integrity.
10. It promotes long-term financial viability, opportunity, and
returns.
11. It can facilitate the raising of capital.
12. Good corporate governance can translate to rising share prices.
13. It can lessen the potential for financial loss, waste, risks, and
corruption.
14. It is a game plan for resilience and long-term success.
PRINCIPLES OF CORPORATE GOVERNANCE
The principles of Corporate Governance are:

1. Accountability
Accountability means to be answerable and be obligated to
take responsibility for one’s actions. By doing so, two things
can be ensured-

 That the management is accountable to the Board of

Directors.
 That the Board of Directors is accountable to the
shareholders of the company.
 This principle gives confidence to shareholders in the
business of the company that in case of any unfavorable
situation, the persons responsible will be held in charge.

2. Fairness
Fairness gives shareholders an opportunity to voice their
grievances and address any issues relating to the violation of
shareholder’s rights. This principle deals with the protection of
shareholders’ rights, treating all shareholders equally without
any personal favoritism, and granting redressal for any
violations of rights.

3.Transparency
Providing clear information about a company’s policies and
practices and the decisions that affect the rights of the
 shareholders represents transparency. This helps to build trust
and a sense of togetherness between the top management and
the stakeholders. It ensures accurate and full disclosure timely
on material matters like financial condition, performance,
ownership.

4.Independence
Independence means the ability to make decisions freely
without being unduly influenced. Decisions should be made
freely without having any personal interest in the company. It
ensures the reduction in conflict of interest. Corporate
governance suggests the appointment of independent directors
and advisors so that decisions are taken responsibly without
influence.

5. Social Responsibility
Apart from the 4 main principles, there is an additional
principle of corporate governance. Company social responsibility
obligates the company to be aware of social issues and take
action to address them. In this way, the company creates a
positive image in the industry. The first step towards
Corporate Social Responsibility is to practice good Corporate
Governance.

ELEMENTS AND SCOPE OF CORPORATE GOVERNANCE

1. Role and powers of Board
Good governance is decisively the manifestation of
personal beliefs and values which configure the organizational
 values, beliefs and actions of its Board. The board is the
primary direct stakeholder influencing corporate governance.
The Board as a main functionary is primary responsible to
ensure value creation for its stakeholders. The absence of
clearly designated role and powers of Board weakens
accountability mechanism and threatens the achievement of
organizational goals. Therefore, the foremost requirement of
good governance is the clear identification of powers, roles,
responsibilities and accountability of the Board, CEO, and
the Chairman of the Board. The role of the Board should
be clearly documented in a Board Charter.
2. Legislation
Clear and unambiguous legislation and regulations are
fundamental to effective corporate governance. Legislation
that requires continuing legal interpretation or is difficult
to interpret on a day-to-day basis can be subject to
deliberate manipulation or inadvertent misinterpretation.
3. Management environment
Management environment includes setting-up of clear
objectives and appropriate ethical framework, establishing due
processes, providing for transparency and clear enunciation of
responsibility and accountability, implementing sound business
planning, encouraging business risk assessment, having right
people and right skill for the jobs, establishing clear boundaries
for acceptable behaviour, establishing performance evaluation
measures and evaluating performance and sufficiently
 recognizing individual and group contribution.
4. Board skills
To be able to undertake its functions efficiently and
effectively, the Board must possess the necessary blend of
qualities, skills, knowledge and experience. Each of the
directors should make quality contribution. A Board should
have a mix of the following skills, knowledge and experience:
– Operational or technical expertise, commitment to establish leadership;
– Financial skills;
– Legal skills; and
5. Code of conduct
It is essential that the organization’s explicitly prescribed
norms of ethical practices and code of conduct are
communicated to all stakeholders and are clearly understood
and followed by each member of the organization. Systems
should be in place to periodically measure, evaluate and if
possible recognize the adherence to code of conduct.
6. Strategy setting
The objectives of the company must be clearly documented in
a long- term corporate strategy including an annual business
plan together with achievable and measurable performance
targets and milestones.
7. Business and community obligations

Though basic activity of a business entity is inherently

commercial yet it must also take care of community’s
obligations. Commercial objectives and community service
 obligations should be clearly documented after approval by
the Board. The stakeholders must be informed about the
proposed and ongoing initiatives taken to meet the
community obligations.

8. Audit Committees
The Audit Committee is inter alia responsible for liaison
with the management; internal and statutory auditors,
reviewing the adequacy of internal control and compliance
with significant policies and procedures, reporting to the
Board on the key issues. The quality of Audit Committee
significantly contributes to the governance of the company.
9. Risk management
Risk is an important element of corporate functioning
and governance. There should be a clearly established process
of identifying, analyzing and treating risks, which could
prevent the company from effectively achieving its
objectives. It also involves establishing a link between risk-
return and resourcing priorities. Appropriate control
procedures in the form of a risk management plan must be
put in place to manage risk throughout the organization.
The plan should cover activities as diverse as review of
operating performance, effective use of information
technology, contracting out and outsourcing.
 EVOLUTION OF GOVERNANCE THEORIES
a) Agency Theory

According to this theory, managers act as ‘Agents’ of the

corporation. The owners set the central objectives of the
corporation. Managers are responsible for carrying out these
objectives in day-to-day work of the company. Corporate Governance
is control of management through designing the structures and
processes.

The principals who are widely scattered may not be able to

counter this in the absence of proper systems in place as
regards timely disclosures, monitoring and oversight. Corporate
Governance puts in place such systems of oversight.
b ) Stockholder/shareholder Theory
According to this theory, it is the corporation which is
considered as the property of shareholders/ stockholders. They
can dispose off this property, as they like. They want to get
maximum return from this property.
The owners seek a return on their investment and that is
why they invest in a corporation. But this narrow role has
been expanded into overseeing the operations of the
corporations and its mangers to ensure that the corporation is
in compliance with ethical and legal standards set by the
government. So the directors are responsible for any damage or
harm done to their property i.e., the corporation.
C) Stakeholder Theory
According to this theory, the company is seen as an input-
output model and all the interest groups which include
creditors, employees, customers, suppliers, local-community and
the government are to be considered. From their point of
view, a corporation exists for them and not the shareholders
alone.

The different stakeholders also have a self- interest. The

interests of these different stakeholders are at times
conflicting. The managers and the corporation are responsible
 to mediate between these different stakeholder’s interest.
The stake holders have solidarity with each other. This theory
assumes that stakeholders are capable and willing to negotiate
and bargain with one another. This results in long term self-
interest.

d) Stewardship Theory
The word ‘steward’ means a person who manages
another’s property or estate. Here, the word is used in
the sense of guardian in relation to a corporation, this
theory is value based. The managers and employees are to
safeguard the resources of corporation and its property and
interest when the owner is absent. They are like a
caretaker. They have to take utmost care of the
corporation. They should not use the property for their
selfish ends. This theory thus makes use of the social
approach to human nature.

e) Resource Dependency Theory

 The Resource Dependency Theory focuses on the role of
board directors in providing access to resources needed by
the firm. It states that directors play an important role in
providing or securing essential resources to an organization
through their linkages to the external environment. The
provision of resources enhances organizational functioning,
firm’s performance and its survival. The directors bring
resources to the firm, such as information, skills, access to
key constituents such as suppliers, buyers, public policy
makers, social groups as well as legitimacy. Directors can be
classified into four categories of insiders, business experts,
support specialists and community influentials.

f) Transaction Cost Theory

Transaction cost theory states that a company has

number of contracts within the company itself or with
market through which it creates value for the company.
There is cost associated with each contract with external
party; such cost is called transaction cost. If transaction
cost of using the market is higher, the company would
undertake that transaction itself.

g) Political Theory

Political theory brings the approach of developing voting

support from shareholders, rather by purchasing voting
power. It highlights the allocation of corporate power,
 profits and privileges are determined via the governments’
favor

Corporate Governance Models

The Anglo-American Model

This model can take various forms, such as the Shareholder Model,
the Stewardship Model, and the Political Model. However, the
Shareholder Model is the principal model.

The Shareholder Model is designed so that the board of directors

and shareholders are in control. Stakeholders such as vendors and
employees, though acknowledged, lack control.

Management is tasked with running the company in a way that

maximizes shareholder interest. Importantly, proper incentives
should be made available to align management behavior with the
goals of shareholders/owners.

The model accounts for the fact that shareholders provide the
company with funds and may withdraw that support if
dissatisfied. This can keep management working efficiently and
effectively.

The board should consist of both insiders and independent

members. Although traditionally, the board chairman and the CEO
can be the same person, this model seeks to have two different
people hold those roles.

The success of this corporate governance model depends on ongoing

communications between the board, company management, and
the shareholders. Important issues are brought to shareholders'
attention. Important decisions to be made are put to shareholders
for a vote.

U.S. regulatory authorities tend to support shareholders over

boards and executive management.

The Continental Model

Two groups represent the controlling authority under the

Continental Model. They are the supervisory board and the
management board.

In this two-tiered system, the management board is comprised of

company insiders, such as its executives. The supervisory board is
made up of outsiders, such as shareholders and union
representatives. Banks with stakes in a company also could have
representatives on the supervisory board.

The two boards remain completely separate. The size of the

supervisory board is determined by a country's law. It can't be
changed by shareholders.

National interests have a strong influence on corporations with

this model of corporate governance. Companies can be expected to
align with government objectives.

This model also considers stakeholder engagement of great value, as

they can support and  strengthen a company’s continued
operations.

The Japanese Model

The key players in the Japanese Model of corporate governance

are banks, affiliated entities, major shareholders
called Keiretsu (who may be invested in common companies or
have trading relationships), management, and the government.
Smaller, independent, individual shareholders have no role or voice.

Together, these key players establish and control corporate

governance.

The board of directors is usually comprised of insiders, including

company executives. Keiretsu may remove directors from the
board if profits wane.

The government affects the activities of corporate management via

its regulations and policies.

In this model, corporate transparency is less likely due to the

concentration of power and the focus on interests of those with
that power.

How to Assess Corporate Governance

As an investor, you want to select companies that practice good

corporate governance in the hope of avoiding losses and other
negative consequences such as bankruptcy.

You can research certain areas of a company to determine whether

or not it's practicing good corporate governance. These areas
include:

 Disclosure practices

 Executive compensation structure (whether it's tied only to

performance or also to other metrics)

 Risk management (the checks and balances on decision-

making)

 Policies and procedures for reconciling conflicts of interest

(how the company approaches business decisions that might
conflict with its mission statement)

 The members of the board of the directors (their stake in

profits or conflicting interests)

 Contractual and social obligations (how a company approaches

areas such as climate change)

 Relationships with vendors

 Complaints received from shareholders and how they were

addressed

 Audits (the frequency of internal and external audits and

how issues have been handled)

Types of bad governance practices include:

 Companies that do not cooperate sufficiently with auditors

or do not select auditors with the appropriate scale,
resulting in the publication of spurious or noncompliant
 financial documents

 Bad executive compensation packages that fail to create an

optimal incentive for corporate officers

 Poorly structured boards that make it too difficult for

shareholders to oust ineffective incumbents

Be sure to include corporate governance in your due diligence

before making an investment decision.

TOP 5 CORPORATE GOVERNANCE BEST PRACTICES

Right-sized governance practices will positively impact long-term

corporate performance – but companies must design and
implement those that both comply with legal requirements and
meet their particular needs. Here are the top 5 corporate
governance best practices that every Board of Directors can engage
– and that will benefit every company.

1. Build a strong, qualified board of directors and evaluate

performance. Boards should be comprised of directors who are
knowledgeable and have expertise relevant to the business and
are qualified and competent, and have strong ethics and
integrity, diverse backgrounds and skill sets, and sufficient
time to commit to their duties. How do you build – and
keep – such a Board?

o Identify gaps in the current director complement and

the ideal qualities and characteristics, and keep an
“ever-green” list of suitable candidates to fill Board
 vacancies.

o The majority of directors should be independent: not a

member of management and without any direct or
indirect material relationship that could interfere with
their judgment.

o Develop an engaged Board where directors ask questions

and challenge management and don’t just “rubber-
stamp” management’s recommendations.

o Educate them. Give new directors an orientation to

familiarize them with the business, their duties and the
Board’s expectations; reserve time in Board meetings
for on-going education about the business and
governance matters.

o Regularly review Board mandates to assess whether

Directors are fulfilling their duties, and undertake
meaningful evaluations of their performance. 
 

2. Define roles and responsibilities. Establish clear lines of

accountability among the Board, Chair, CEO, Executive
Officers and management: 

o Create written mandates for the Board and each

committee setting out their duties and accountabilities.

o Delegate certain responsibilities to a sub-group of

directors. Typical committees include: audit, nominating,
 compensation and corporate governance committees and
“special committees” formed to evaluate proposed
transactions or opportunities.

o Develop written position descriptions for the Board

Chair, Board committees, the CEO and executive
officers.

o Separate the roles of the Board Chair and the CEO:

the Chair leads the Board and ensures it’s acting in the
company’s long-term best interests; the CEO leads
management, develops and implements business strategy
and reports to the Board.
  

3. Emphasize integrity and ethical dealing. Not only must

directors declare conflicts of interest and refrain from voting
on matters in which they have an interest, but a general
culture of integrity in business dealing and of respect and
compliance with laws and policies without fear of
recrimination is critical.  To create and cultivate this culture:

o  Adopt a conflict of interest policy, a code of business

conduct setting out the company’s requirements and
process to report and deal with non-compliance, and a
Whistleblower policy.

o Make someone responsible for oversight and management

of these policies and procedures.
   

4. Evaluate performance and make principled compensation

decisions. The Board should:

o Set directors’ fees that will attract suitable candidates,

but won’t create an appearance of conflict in a
director’s independence or discharge of her duties.

o Establish measurable performance targets for executive

officers (including the CEO), regularly assess and
evaluate their performance against them and tie
compensation to performance.

o Establish a Compensation Committee comprised of

independent directors to develop and oversee executive
compensation plans (including equity-based ones like
stock option plans).
  

5. Engage in effective risk management. Companies should

regularly identify and assess the risks they face, including
financial, operational, reputational, environmental, industry-
related, and legal risks:

o The Board is responsible for strategic leadership in

establishing the company’s risk tolerance and developing
a framework and clear accountabilities for managing risk.
It should regularly review the adequacy of the systems
 and controls management puts in place to identify,
assess, mitigate and monitor risk and the sufficiency of
its reporting.

o Directors are responsible to understand the current and

emerging short and long-term risks the company faces
and the performance implications. They should challenge
management’s assumptions and the adequacy of the
company’s risk management processes and procedures.

Why is corporate governance important?

Corporate governance is important to improve the integrity and

performance of a company. It gives it a sustainable approach to
the affairs of the organisation. This provides an upper ground to
the company and increases its competitive advantage.

What are the elements of Corporate Governance?

The elements of corporate governance are:

1. Transparent disclosure

2. Well-defined rights of shareholders

3. Internal control environment

4. Structured Board practices

 5. Board commitment

What are the four ‘P’s (Philosophies) of corporate governance?

The four Ps are People, Purpose, Process, and Performance.

FOUR P’S OF CORPORATE GOVERNANCE • Experts break

corporate governance into four simple words: People, Purpose,
Process and Performance.

People :

People come first in the Four Ps because people exist on every

side of the business equation. • They are the founders, the board,
the stakeholder and consumer and impartial observer. • People are
the organisers who determine a purpose to work towards, develop
a consistent process to achieve it, evaluate their performance
outcomes, and use those outcomes to grow themselves and others
as people.

Purpose :

Purpose is the next step. Every piece of governance exists for a

purpose and to achieve a purpose. • The ‘for’ is the guiding
principles of the organisation. Their mission statements. • Every
one of their policies and projects should exist to further this
agenda.

Process :

Governance is the process by which people achieve their company’s

purpose, and that process is developed by analysing performance. •
Processes are refined over time in order to consistently achieve
their purpose, and it’s always smart to take a critical eye to your
governance processes.

Performance :

Performance analysis is a key skill in any industry. • The ability to

look at the results of a process and determine whether it was
successful (or successful enough), and then apply those findings to
the rest of your organization, is one of the primary functions of
the governance process.