Corporate governance is the combination of rules, processes, or laws by which businesses are operated, regulated, or controlled. The term encompasses the internal and external factors that affect the interests of a company’s stakeholders, including shareholders, customers, suppliers, government regulators, and management. The board of directors is responsible for creating the framework for corporate governance that best aligns business conduct with objectives.
Specific processes that can be outlined in corporate governance include action plans, performance measurement, disclosure practices, executive compensation decisions, dividend policies, procedures for reconciling conflicts of interest, and explicit or implicit contracts between the company and stakeholders.
An example of good corporate governance is a well-defined and enforced structure that works for the benefit of everyone concerned by ensuring that the enterprise adheres to accepted ethical standards, best practices, and formal laws. Alternatively, bad corporate governance is seen as poorly structured, ambiguous, and non-compliant, which could damage the image or financial health of a business.
Principles of corporate governance
While corporate governance structure may vary, most organizations incorporate the following key elements:
- All shareholders should be treated equally and fairly. Part of this is making sure shareholders are aware of their rights and how to exercise them.
- Legal, contractual, and social obligations to non-shareholder stakeholders must be upheld. This includes always communicating pertinent information to employees, investors, vendors, and members of the community.
- The board of directors must maintain a commitment to ensure accountability, fairness, diversity, and transparency within corporate governance. Board members must also possess the adequate skills necessary to review management practices.
- Organizations should define a code of conduct for board members and executives, only appointing new individuals if they meet that standard.
- All corporate governance policies and procedures should be transparent or disclosed to relevant stakeholders.
Conflict management in corporate governance
One purpose of corporate governance is to implement a checks and balances system that minimizes conflicts of interest. Conflicts typically arise when two involved parties have opposing opinions on the way the business should be conducted. Since a board of directors is typically a mix of internally and externally involved members, corporate governance is a non-biased way to approach conflict.
Conflicts could occur when executives disagree with shareholders. For example, the shareholders will typically want to solely pursue interests that generate profit while the chief executive officer might want to invest in better employee engagement efforts. Another type of conflict could arise if multiple shareholders disagree with each other. It would be the role of corporate governance to define how these matters are settled.
Regulation of corporate governance
Corporate governance has received increased attention because of high-profile scandals involving abuse of corporate power or alleged criminal activity by corporate officers. Therefore, laws and regulations have been passed to address the components of corporate governance.
- Sarbanes-Oxley Act: This act was passed after it was found that high-profile companies and their executives were committing fraud. As a result, emphasis was placed on corporate governance as a way to restore faith in public companies.
- Gramm-Leach-Bliley Act: This act regulated the ways that financial institutions handled privation information, making it crucial for corporate governance to include how to oversee financial organizations and stakeholders.
- Basel II: This is a business standard that minimizes the financial effect of risky operational decisions. The rights of shareholders are covered under this standard, thus affecting corporate governance.