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Topic Corporate

Governance

LEARNING OUTCOMES
By the end of this topic, you should be able to: 1. 2. 3. 4. Explain corporate governance; Identify the three components in the definition of corporate governance; Explain the two perspectives of corporate governance; and Interpret good corporate practices based on the Code of Corporate Governance.

INTRODUCTION

Have you heard of the term corporate governance? What does it mean? Occasionally business organisations would use this term due to the importance placed on it. In the following sections, we will look into these aspects in order to learn more on corporate governance: Definition of corporate governance The components in the definition of corporate governance The perspective of corporate governance Corporate governance dealing with the top management The reason for studying corporate governance The code of corporate governance The future of corporate governance

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7.1

WHAT IS CORPORATE GOVERNANCE?

In responding to the dynamic world of business, corporations need to constantly be alert of their corporate practices. This is especially crucial in light of many instances where corporations ended up in controversial practices such as Enron, American International Group (AIG), Transmile and Sime Darby. As public listed companies need to be accountable to their stakeholders and shareholders in particular, top managements have to gear up to their best practices to uphold their social contract, which is to meet the societal expectations. Before we explore further into corporate governance, let us look at the definition of corporate governance. Corporate governance is a formal system of oversight, accountability and control of corporate decisions, operations, and actions has to be in place to earn the corporation's much-needed commodity: stakeholders' continuous trust. (Ferrell, 2011; Thorne, 2010) This phenomenon of greater governance is a direct consequence of societal progression, the availability of information, and shareholder activism.

7.1.1

Components of Corporate Governance

From the definition of corporate governance, we can identify three components as shown in Figure 7.1.

Figure 7.1: Three components of corporate governance

Let us look in detail at the components of corporate governance: (a) Oversight Oversight simply means check and balance. Hence, oversight allows management decisions to be questioned and challenged, thereby reducing

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the risk of mismanagement. For example, the practicality to invest in a new project abroad can be questioned and top management has to answer any issues raised related to the project. The main objective of oversight is to minimise top managements abuse of power. (b) Accountability Accountability means how the decisions taken by the management align with the firms stated strategic direction. In simple words, did the management act based on their stated mission or vision? As promises are made to the public, management has to be accountable to them or else they will lose the publics trust. For example, a corporation promises to reduce its carbon emissions. The question raised will be: Did the corporation commit or take any effort to fulfill its promises? If it did not, then the accountability of the corporation is at stake due to its undelivered promises. Control Control is a process of auditing and improving organisation decisions and actions. It is here that actual performance is compared with certain budget, standard or goal. Ultimately, corporate governance aims to balance power, address mistakes, reduce risks and avoid misconduct in order to achieve integrity. SELF-CHECK 7.1 1. 2. In your own words, define corporate governance. Explain briefly the components of corporate governance.

(c)

7.2

THE CORPORATE GOVERNANCE PERSPECTIVE

Do you know that corporate governance can be observed from two different perspectives? The two perspectives are as shown in Figure 7.2.

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Figure 7.2: Corporate governance perspectives

All discussions, decisions and actions are made based on these perspectives. Therefore, the top management needs to be extremely clear of the perspective of corporate governance that they hold on to. From the shareholder perspective, the spirit of practising good corporate governance is in the interest of the shareholders. Being the owners of companies, the purpose of corporate governance is at the interest of the shareholders. The rationale according to Friedman (1962, 1970) is that shareholders are owners of the corporation. Therefore, the corporation should be responsible and accountable to its shareholders. For example, if the shareholders are pleased with the top managements decision and action to clear a piece of land for development, top management will proceed with the process. All other stakeholders interests are of secondary importance. However, from the stakeholder perspective, the spirit of corporate governance is in the interest of the stakeholders. This is because other stakeholders also invest in the success of the firm. Another argument is that all corporate decisions and actions can affect its stakeholders and the stakeholders, in turn, can affect the corporations decisions and actions (Freeman, 1984). For example, if a corporation is involved in an insider trading, the following situations might happen: (a) (b) (c) Shareholders might suffer losses Employees might lose their jobs Customers might decline the customer service they deserve

Consequently, loyal employees will leave the corporation and loyal customers might discontinue purchasing and using the corporations products or services. This signifies the reflexive relationship between businesses and their stakeholders.

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ACTIVITY 7.1
From the stakeholder perspective, if an organisation decided to limit its budget, what will happen to its stakeholders? Discuss with your coursemates.

7.3

CORPORATE GOVERNANCE DEALING WITH THE TOP MANAGEMENT

In an organisation, corporate decisions, actions and operations are mainly the responsibility of the top management. Corporate governance deals mostly with the top management, specifically the board of directors (refer below). Board of directors and top management are fiduciaries to shareholders. They are the persons placed in a position of trust who use due care and loyalty in acting on behalf of the organisations best interest. When top management practices due care, they make informed and prudent decisions. These decisions range from merger, acquisition, investment to divesting. Top management and the board of directors are expected to be loyal. It is only when they are loyal that all decisions are made in the interests of the corporation and its stakeholders. For example, when executive (the top management) compensation is decided, is that decision beneficial only to a group of people or will it benefit the corporation? A corporation with good corporate governance practice will make decision based on the best outcome for the corporation.

7.4

WHY STUDY CORPORATE GOVERNANCE?

After knowing what corporate governance is and what corporate governance is made up of, the question lies in why it is so important to study it. It is part of a corporations corporate responsibility to observe some practices that are regarded as appropriate. As owners of the corporations, top managements are responsible and accountable to their stockholders. In addition, the incidences of recent malpractices placed companies under greater scrutiny by all parties which include not only the stockholders but also the future investors, the government, the media and the industry. Corporations

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cannot afford to jeopardise their much needed reputation for support when facing stiff competition.

SELF-CHECK 7.2
1. 2. Elaborate briefly on the two perspectives of corporate governance. Explain why one needs to learn on corporate governance.

7.6

THE CODE OF CORPORATE GOVERNANCE

The Malaysian Code of Corporate Governance (also known as the Code) is formulated and governed by the Securities Commission (Securities Commission, 2010). The Securities Commission, established on 1 March 1993 under the Securities Commission Act 1993, is a self-funding statutory body with investigative and enforcement powers. It reports to the Minister of Finance and its accounts are tabled in Parliament annually. The Securities Commission, which is a government agency, protects the stockholders rights by making sure that the stock markets are conducted fairly and that investment information is fully disclosed. The objective is to give the stockholders more and better company information as disclosure is one of the best ways to safeguard the investors interests. Figure 7.3 show us the regulatory fuction of the Securities Commission.

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Figure 7.3: Regulatory functions of the Securities Commission

Now, let us move on to the Code. First issued in 2000, it covers the following three main areas: (a) Directors The Code covers director appointments, formality and transparency. (b) Shareholders The Code emphasises on information for investment decisions and annual general meetings. Accountability and Audit Accountability and audit refers to internal control and auditor relations.

(c)

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The Code, which aims to achieve optimum governance framework, is divided into two parts: The principles of corporate governance The best practices of corporate governance

The revised 2007 version of the Code mainly concentrates on strengthening the Board of Directors and the audit committee. It focuses on the eligibility criteria of board members on ensuring the effectiveness of the boards in carrying out its responsibility. For further information on the revised 2007 version of the Code, you may refer to this website: http://www.sc.com.my/eng/html/cg/cg2007.pdf However, it is worth to note that compliance with the Code is NOT mandatory. The compliance is not regulated as to reduce the ticking-the-box exercise. The flexibility is to promote self-regulation in responding to the markets best practices. Under the Listing Requirements of Bursa Malaysia, companies have to include a narrative account of how they have applied the principles and best practices set out in the Code. In other words, a corporation has to disclose how it has complied with the Code. Failure to do so will result in the corporation having to provide a narrative explanation of the reasons. The goal is to give investors information of the corporations performance, both financially and its governance, in which they can make informed and sound decisions. Two other organisations supporting the best practices of corporate governance in Malaysia are: (a) The Malaysian Institute of Corporate Governance The Malaysian Institute of Corporate Governance (MICG), which is established in 1998, is a non-profit public company. One of the objectives of MICG is to be a leading establishment for promotion of best practices and corporate governance development through continuous education programmes for major corporate figures such as company directors, chief executive officers (CEOs), company secretaries, company advisers, company auditors, accountants, lawyers, members of audit committees and investors (Malaysia Institute of Corporate Governance, 2007-2008). The mission of MICG is as stated in Figure 7.4.

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Figure 7.4: The mission of the Malaysian Institute of Corporate Governance

(b)

The Malaysian Institute of Chartered Secretaries and Administrators Established in 1958, Malaysian Institute of Chartered Secretaries and Administrators (MAICSA) sets out to produce qualified company secretaries and at the same time ensuring the professionalism of its members (Malaysian Institute of Chartered Secretaries and Administrators, 200). MAICSA seeks to maintain the highest standard of integrity and ethics among its members within the profession. It also aims to act as a change catalyst by involving actively in enhancing corporate governance in the corporate field. In addition, it sets out to champion the best practices in corporate governance and its importance by educating the Malaysian corporate sectors. Figure 7.5 shows the mission of MAICSA.

Figure 7.5: Mission of MAICSA

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ACTIVITY 7.2
Discuss how MICG and MAICSA help to instill good corporate governance practices.

EXERCISE 7.1
Visit the Securities Commission website at www.sc.com.my and the Malaysian Institute of Corporate Governance (MICG) at http://www.micg.net/history.htm. Find out how they encourage good corporate governance practice.

7.7

THE FUTURE OF CORPORATE GOVERNANCE

Do you know that corporate governance will be a significant part of corporate management in times to come? For management to manage the corporation effectively and efficiently, it must take corporate governance guided by its principles and best practices seriously. Thus, in its effort to create good corporate governance, the management should look into the following aspects which show the benefits of practicing good corporate governance: (a) Involvement of Board of Directors Board of directors will be held responsible for developing the corporations mission and vision, which take stakeholders interest into careful consideration. In the business arena, the board of directors need to be alert that corporations do not operate in isolation. Perform Self-Assessments Apart from that, board members are required to perform self-assessments. This is set out to reflect on how effective the boards are in governing the corporation. By conducting self-assessments, they are also able to realise how relevant they are in the corporate decision-making process. Increasingly, board member selection will be more formalised.

(b)

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(c)

Enhanced Role of Nomination Committee As spelled out in the 2007 revision of the Code, the role of the nomination committee is enhanced. The committee is expected to play a more active role in nominating qualified board members. Based on the fact that board members operate in committees, they tend to work independently which affects the corporate governances function of oversight. Consequently, boards are expected to perform more effectively as a team. Well-elaborated Explanation It is expected that more narrative information will appear in the annual report. Corporations are expected to explain more of their decisions and justify their actions and to report not only of their accomplishments but also of their weaknesses and failures. Shift of the Model A shift to the stakeholder model as opposed to the shareholder model will be more apparent. Conduct Training and Seminar A series of training and seminar are organised for corporations to realise the importance of having a broader view of those whom they should be accountable for. Greater Management Support There will be greater management support for corporate governance as they begin to realise the importance of good corporate governance practices. Well-informed Shareholders and Stakeholders Shareholders and other stakeholders are now more well-informed and educated. They are more sensitive towards current happenings in the business world. Greater Government Involvement Besides corporations, there will also be greater government involvement and presence in promoting good corporate governance practice in light of economic reform efforts. Good corporate governance practice will ensure continuous support for businesses, which in turn will strengthen the nations economy.

(d)

(e)

(f)

(g)

(h)

(i)

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EXERCISE 7.2
Visit Bursa Malaysias website at www.klse.com.my in order to find out its role in promoting good corporate governance practice in Malaysia.

Corporate governance is a formal system of oversight, accountability and control of corporate decisions, operations and actions. There are three components in the definition of corporate governance: oversight, control and accountability. There are two perspectives of corporate governance and they are: The shareholder perspective; and The stakeholder perspective. Board of directors and top management are fiduciaries to shareholders. They are persons placed in positions of trust who use due care and loyalty in acting on behalf of the organisations best interest. In Malaysia, besides Securities Commission, there are other organisations which support the best practices of corporate governance such as the Malaysian Institute of Corporate Governance (MICG) and the Malaysian Institute of Chartered Secretaries and Administrators (MAICSA).

Accountability Board of directors Code of Corporate Governance Corporate governance Directors Institute of Corporate Governance

Institute of Secretaries and Administrators Securities commission Shareholder Stakeholder Top management