This article provides a practical explanation of Corporate Governance. After reading, you’ll understand the basics of this powerful strategy tool.
What is Corporate Governance?
Corporate Governance is about managing a system using rules, processes, and other practices that allow for the proper management of a company. In addition, Corporate Governance means the interest of many different stakeholders within a company are represented and balanced. This refers to stakeholders, such as shareholders, suppliers, customers, investors, governments, management, and the community. Corporate Governance also provides a framework for achieving objectives.
Corporate Governance facilitates contacts between the company and stakeholders for sharing responsibilities, rights, and rewards. This also involves procedures for reconciling potential conflicts of interest. These interests must be realigned with tasks, privileges, roles, and procedures for supervision and control.
Corporate Governance is therefore mainly about managing the organisation, especially internally. Interest in this aspect of business operations increased after a significant number of organisations collapsed in the period right after the turn of the century, and again during the financial crisis of 2008. Various business scandals have also contributed to this.
Many important parties are involved in Corporate Governance. Take for instance stakeholders such as the board of directors, management, and shareholders. External, smaller stakeholders also exert influence. External stakeholders include creditors, customers, suppliers, and accountants.
In profit-making organisations, the owners (or shareholders) choose to have their interest represented by the board of directors. This is a responsible task, and the interests of the shareholders are clear. These interests are maximising operating profit. However, every shareholder has a different time horizon and risk appetite, so compromises often have to be made.
According to the Stakeholder Theory of Corporate Governance, managers and directors must consider the interest of each shareholder in business operations. This also means investing energy in actively preventing conflict between shareholders and their interests.
Corporate Governance at Enron
Enron, a major supplier of natural gas, was founded in July 1985. Later Enron also started selling natural gas products, and in the second half of the 1990s the company started trading in electricity. The company introduced several revolutionary changes in the energy sector, propelled by powerful changes in the nature of energy markets that were deregulated during this period. This opened the door for new traders and suppliers. In 1999, Enron launched Enron Online. In 2001, it conducted online transactions worth around 2 billion euros per day.
It thus became one of the most successful companies in the world, with a sales increase of more than 50% in just four years. However, it turned out Enron’s Corporate Governance was not entirely sound. According to many analysts, the company’s balance sheet and financial reports made little sense. For instance, many of Enron’s debts were transferred to partnerships abroad. Many of these partnerships were discovered to be created by CFO Andrew Fastow. The company also committed fraud with contract trading, and used partnerships to sell contracts back and forth to itself.
In February 2001, Jeffrey Skilling, former president, took over from CEO Kenneth Lay. He remained as chairman, but when Skilling suddenly resigned later in the year, Kenneth Lay resumed the role of CEO. From this moment, rumours started to spread of Enron’s poor Corporate Governance. The company suffered major losses and appeared to destroy documents on a large scale. Eventually, the company came under the supervision of various committees. At the end of 2001, Enron applied for bankruptcy protection. However, this initiated a criminal investigation by the Justice Department.
At this point, the once powerful Enron was completely in ruin. Enron’s energy branch was sold to a European bank, and several Enron officials were taken to court during spring. Most were now unemployed, and their shares in the company were worth very little.
Following the Enron scandal, measures were taken in various parts of the world against the disorderly practices of board members. For example, the United States saw the introduction of the Sarbanes-Oxley Act. This law made directors personally liable in the event of mismanagement.
Responsibilities and Characteristics of Board Members
The board of directors is given the legal responsibility to manage an organisation. In order to manage an organisation, many different individual roles and responsibilities are required. Just like in a team, every board member has different strengths, talents, and skills. Effective board members have strong character traits and personal integrity. Furthermore, board members must be receptive and patient.
The board is also responsible for selecting and checking the director by finding a suitably qualified candidate. Moreover, the board is in charge of evaluating the performance of the director. Members of the board of directors are regularly asked to participate in a performance review with the director. However, most of the time, board members are busy with organisational planning. They check an organisation’s activities with regards to products, services, and processes. They also keep abreast of competitors and developments in the industry.
Corporate Governance is primarily about effectively preventing conflicts of interest. For this purpose, the board of directors draws up a policy. Because there is a lot of voting on important matters, conflicts will occasionally arise within the board of directors. However, the board members will individually remain faithful to the vision and mission of the company. For this reason, compromises will often be made.
Corporate Governance and Sustainability
Stakeholders attach great importance to the effort that companies make to produce and operate in a sustainable way. For example, a company’s external environment likes to read about how the company reduces emissions, introduces technological solutions for reducing paper usage, and how today’s issues of sustainability can be addressed. The interests for a sustainable policy are to the advantage of both the climate and the organisation itself. In addition to cost savings that yield many measures, investors are also interested in this.
The principles of Corporate Governance are based on transparency, responsibility, and justice. These principles are also directly related to the social responsibility of an organisation. Good Corporate Governance takes this into account and helps companies maintain a good balance. It also provides a control mechanism and benchmark tool, which will ultimately promote the satisfaction of shareholders and other stakeholders.
Now it’s your turn
What do you think? Are you familiar with the explanation of Corporate Governance? Do you recognise the importance of coordinating different interests between stakeholders? What do you believe are crucial elements for creating a good relationship in the management of an organisation? Do you have any tips or additional comments?
Share your experience and knowledge in the comments box below.
- Council, A. C. G. (2007). Corporate governance principles and recommendations.
- La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (2000). Investor protection and corporate governance. Journal of financial economics, 58(1-2), 3-27.
- Weston, J. F., Mitchell, M., Mulherin, J. H., Siu, J. A., & Johnson, B. A. (2004). Takeovers, restructuring, and corporate governance.
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