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What Is Corporate Governance

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Over the last 2 decades, we have heard and read about businesses that were touted as having the world’s smartest, innovative, best chief executive etc, in a twinkle of an eye only for these businesses to be in extinction. A few examples would include – ENRON, WORLD COM, OCEANIC BANK, INTERCONTINENTAL BANK, ARTHUR ANDERSON – just to mention but 5.

In order to understand the importance of Corporate Governance, it will be necessary to first get an explicit definition;

According to the institutional investor and activist Hermes; – Corporate Governance concept refers “to the corporate decision making and control, particularly the structure of the board and its working procedures”. However, this definition of the term Corporate Governance is sometimes used very widely embracing a company’s relations with a wide range of stakeholders or very narrowly referring to a company’s compliance with the provisions of best practice.

The Organization for Economic Cooperation and Development (OECD) defines it as “the procedures and processes through which an organization is directed and controlled. The Corporate Governance structure specifies the distribution of rights and responsibilities among the different participants in the organization, such as the board, managers, shareholders and other stakeholders – and lays down the rules and procedures for decision making”.

From the definitions, it is obvious that good Corporate Governance would lead businesses towards increasing shareholders values and wealth creation. This is evident from the statement of the International Finance Corporation (IFC), a lending arm of the World Bank Group argues that “good Corporate Governance won’t just keep a company out of trouble. It states that well governed companies often draw huge investments premiums, get access to cheaper debt and finance and out performs their peers”.

McKinsey’s Global Investors Opinion Survey in 2002, clearly shows the links between good governance and investors’ interests. It was found out that “80% of institutional investors would pay a premium for a well governed company”.

This premium varied from about 40% for companies in countries where they felt that business operations were dubious (e.g. Russia, Egypt, Nigeria) to approximately 12% for companies in countries where the felt that business operations were regarded on the high side (e.g. Canada, United Kingdom etc.)

The McKinsey line of thought is duly subscribed to by investors under the auspices of the Principles for Responsible Investments (PRI). Responsible investment has been described as an approach to investment that explicitly acknowledges the relevance to the investor of environmental, social and governance (ESG) factors, and the long-term health and stability of the market as a whole. It recognizes that the generation of long-term sustainable returns is dependent on stable, well-functioning and well governed social, environmental and economic systems.

The importance of the Corporate Governance practices cannot be underrated as it is becoming a key fundamental aspect in decision making for major investors that are signed up to these principles and hold over $34 trillion in investments in different countries of the world.

In order to understand the importance, it will be necessary to identify the principal issues of Corporate Governance. There are many broad issue areas, which include:

CEO/Chairman of the Board

  • What is the appropriate role of the CEO?
  • What is the appropriate role of the Chairman of the Board
  • If the roles are distinct, can they nonetheless be combined in one person?
  • If the roles are distinct, what are the necessary qualities in the CEO?
  • What are the necessary qualities in a Chairman?

The Board of Directors

  • What is the role of the Board of Directors?
  • Which of the executive officers of the company should serve on the board?
  • Why is it important for members of the Board of Directors to be nominated?
  • Why have independent non-executive directors come to be regarded as very critical?
  • What qualities should these non-executive directors have?
  • What does it mean to be truly independent?
  • What types of activities should disqualify a person from being considered as truly independent
  • How should the performance of the board be measured?
  • Should we assess the performance of board committees?

Shareholders and Stakeholders

  • What role if any should the shareholders play in the running of the company?
  • Why has there been being a clamor for institutional investors to be more active in corporate affairs of businesses?
  • Who are a company’s stakeholders?
  • Why are they important?
  • What various roles do they play?

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