What is the purpose of corporate governance?
According to the Financial Reporting Council’s 2016 Corporate Governance Code, the purpose of corporate governance is, ‘to facilitate effective, entrepreneurial and prudent management that can deliver the long term success of the company.’ Corporate Governance utilises a set of principles that determines what a board of directors does. The core principles of corporate governance are
Accountability – not only acting in the best interests of shareholders but also other affected stakeholders through activities such as corporate social responsibility (CSR) and environmental policies.
Transparency – the extent to which an organisation’s activities are observable by outsiders.
Probity – ‘the quality of having strong moral principles, honesty and decency.’
Focus – on the long-term sustainability of the organisation.
The concept of corporate governance is based around a theory called the ‘principal-agent problem.’ Jensen and Meckling (1976) define this as, ‘a contract under which one or more persons (shareholders) engage other persons (directors) to perform on their behalf which includes delegating some decision-making authority to the agent.’ The agency problem therefore recognises that directors can often seek to act in ways beneficial to themselves, at a detriment to the shareholder. Shakespeare recognised the agency problem in his play ‘The Merchant of Venice,’ when he describes Antonio’s anguish and uncertainty as he watched his worldly fortune set sail from the harbour, now entrusted to other people.
Well-publicised corporate scandals such as Enron, Worldcom, Lehman Brothers and Satyam remind are examples of directors acting in their own best interests and how shareholders lose out. The BP Deepwater Horizon disaster was not only catastrophic for shareholders and BP – who were forced to pay out over $40billion in compensation – but also the environment, the local eco-system, the local community, the local economy and of course the lives of the eleven men who died in the explosion. Corporate governance principles therefore seek to protect shareholder, stakeholder and corporate interests.
Rather than being perceived as ‘yet another set of rules’ that restricts actions, potential performance and financial gains and competitiveness, good corporate governance helps to strengthen a company and help to ensure its long-term sustainability and should therefore be viewed more positively.
The benefits of good corporate governance
An organisation built upon the foundation of a sound corporate governance framework experiences:
- A reduction in risk
- Protection against loss of reputational capital
- Greater competitiveness and credibility
- Greater trust from shareholders and other investors through improved transparency
- Greater protection from criminal and civil prosecution
- Greater protection from scandal and fraud
- Greater positioning for long-term success and sustainability of the organisation
- Better relationships with shareholders
- Better financial performance and profitability
- Protection from the negative effects of unethical people on the whole organisation, as through the principle of accountability, each person is aware of his or her responsibility
- Enhanced relationships with non-shareholder stakeholders such as employees, customers, investors, communities, regulatory and trade bodies, analysts, unions, NGO’s, environmental groups, suppliers, debtors and the media
- The knowledge that the environment is protected for the benefit of future generations through corporate social responsibility (CSR), sustainability and environmental protection programmes
- The knowledge that the integrity and efficiency of financial markets is protected
- A firm base from which to develop corporate strategies and make decisions
- A clear hierarchy and communication structure
- The ability to self-police and identify potentially harmful issues as soon as they arise
- A clear set of principles tailored to the organisation from which each individual can operate
How can Snowstar Consulting help your organisation?
Snowstar Consulting can assist your organisation by carrying out full governance risk assessments; design bespoke corporate governance frameworks and help develop strategies and action plans to mitigate governance and business risk. We can also advise on sustainable development and assist in the development of corporate social responsibility policies.
Please feel free to contact us and let us know how we can help you or your organisation.
It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.