What Is Corporate Governance?
The tug of war between individual freedom and institutional power is a continuing theme of history. Early on, the focus was on the church; more recently, it is on the civil state. Today, the debate is about making corporate power compatible with the needs of a democratic society. The modern corporation has not only created untold wealth and given individuals the opportunity to express their genius and develop their talents but also has imposed costs on individuals and society. How to encourage the liberation of individual energy without inflicting unacceptable costs on individuals and society, therefore, has emerged as a key challenge.
Example 2.1 – Corporate Governance in Action
General Electric has ended its relationship with KPMG, the major accounting firm that GE has worked with for over a century. Deloitte will become the new CPA for GE. With a reshuffle in GE’s top executives, its new management team hopes to send new signals to the market that changes are coming. In 2018, about one-third of shareholders had expressed their desire to replace KPMG because the firm had failed to prevent accounting troubles at GE. In the same year, GE named a new CEO, Larry Culp, the first CEO from outside the company in GE’s 126-year history. Again in 2019, GE named a new chief financial officer, Carolina Dybeck Happe, from the outside.
Source: Forbes, GE Names New Auditor For The First Time In Over A Century, Yu Mu, 2020Fa
Corporate governance lies at the heart of this challenge. It deals with the systems, rules, and processes by which corporate activity is directed. Narrow definitions focus on the relationships between corporate managers, a company’s board of directors, and its shareholders. Broader descriptions encompass the relationship of the corporation to all of its stakeholders and society, and cover the sets of laws, regulations, listing rules, and voluntary private-sector practices that enable corporations to attract capital, perform efficiently, generate profit, and meet both legal obligations and general societal expectations. The wide variety of definitions and descriptions that have been advanced over the years also reflect their origin: lawyers tend to focus on the contractual and fiduciary aspects of the governance function; finance scholars and economists think about decision-making objectives, the potential for conflict of interest, and the alignment of incentives, while management consultants tend to adopt a more task-oriented or behavioral perspective.
Complicating matters, different definitions also reflect two fundamentally different views about a corporation’s purpose and responsibilities. Often referred to as the “shareholder versus stakeholder” perspectives, they define a debate about whether managers should run a corporation primarily or solely in the interests of its legal owners—the shareholders (the shareholder perspective)—or whether they should actively concern themselves with the needs of other constituencies (the stakeholder perspective).
This question is answered differently in different parts of the world. In Continental Europe and Asia, for example, managers and boards are expected to concern themselves with the interests of employees and the other stakeholders, such as suppliers, creditors, tax authorities, and the communities in which they operate. Reflecting this perspective, the Centre of European Policy Studies (CEPS) defines corporate governance as “the whole system of rights, processes and controls established internally and externally over the management of a business entity with the objective of protecting the interests of all stakeholders.”
In contrast, the Anglo-American approach to corporate governance emphasizes the primacy of ownership and property rights and is primarily focused on creating “shareholder” value. In this view, employees, suppliers, and other creditors have rights in the form of contractual claims on the company, but as owners with property rights, shareholders come first:
Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place.
Example 2.2 – Shareholder Value Creation
Enerflex, a Canadian-based energy services company that provides turnkey solutions for the global natural gas industry, announced a new president and Chief Executive Officer (CEO), Marc Rossiter, during the company’s annual shareholder meeting. The appointment was touted as a reflection of the firm’s commitment to executive succession planning. Mr. Rossiter had worked for more than 22 years in numerous operational and administrative roles, starting as a project engineer. Additionally, the smooth transition of power is expected to create shareholder value by ensuring continuity and continued growth as Mr. Rossiter takes over the reins of the company from Enerflex’s previous CEO of 15-years, J. Blair Goertzen.
Source: MarketWatch, Enerflex Announces President and Chief Executive Officer Succession (inactive link as of 05/28/2021), Tatog Sasono, 2019Wi
Perhaps the broadest, and most neutral, definition is provided by the Organization for Economic Cooperation and Development (OECD), an international organization that brings together the governments of countries committed to democracy and the market economy to support sustainable economic growth, boost employment, raise living standards, maintain financial stability, assist other countries’ economic development, and contribute to growth in world trade:
Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.