Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company

) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, the board of directors, executives, employees, customers, creditors, suppliers, and the community at large. Corporate governance is a multi-faceted subject.[1] An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem. A related but separate thread of discussions focuses on the impact of a corporate governance system in economic efficiency, with a strong emphasis on shareholders' welfare. There are yet other aspects to the corporate governance subject, such as the stakeholder view and the corporate governance models around the world (see section 9 below). There has been renewed interest in the corporate governance practices of modern corporations since 2001, particularly due to the high-profile collapses of a number of large U.S. firms such as Enron Corporation and MCI Inc. (formerly WorldCom). In 2002, the U.S. federal government passed the Sarbanes-Oxley Act, intending to restore public confidence in corporate governance.

Contents
[hide]
y y y y y y y y

y y y

y y y y

1 Definition 2 Legal environment 3 History - United States 4 Impact of Corporate Governance 5 Role of institutional investors 6 Parties to corporate governance 7 Principles 8 Mechanisms and controls o 8.1 Internal corporate governance controls o 8.2 External corporate governance controls 9 Systemic problems of corporate governance 10 Role of the accountant 11 Regulation o 11.1 Rules versus principles o 11.2 Enforcement o 11.3 Action Beyond Obligation o 11.4 Proposals 12 Corporate governance models around the world o 12.1 Anglo-American Model 13 Codes and guidelines 14 Ownership structures 15 Corporate governance and firm performance o 15.1 Board composition

y y y y

o 15.2 Remuneration/Compensation 16 See also 17 References 18 Further reading 19 External links

[edit] Definition
This section relies largely or entirely upon a single source. Please help improve this article by introducing appropriate citations to additional sources. (July 2010) In A Board Culture of Corporate Governance, business author Gabrielle O'Donovan defines corporate governance as 'an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity, accountability and integrity. Sound corporate governance is reliant on external marketplace commitment and legislation, plus a healthy board culture which safeguards policies and processes. O'Donovan goes on to say that 'the perceived quality of a company's corporate governance can influence its share price as well as the cost of raising capital. Quality is determined by the financial markets, legislation and other external market forces plus how policies and processes are implemented and how people are led. External forces are, to a large extent, outside the circle of control of any board. The internal environment is quite a different matter, and offers companies the opportunity to differentiate from competitors through their board culture. To date, too much of corporate governance debate has centred on legislative policy, to deter fraudulent activities and transparency policy which misleads executives to treat the symptoms and not the cause.'[2] It is a system of structuring, operating and controlling a company with a view to achieve long term strategic goals to satisfy shareholders, creditors, employees, customers and suppliers, and complying with the legal and regulatory requirements, apart from meeting environmental and local community needs. Report of SEBI committee (India) on Corporate Governance defines corporate governance as the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.´ The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution. Corporate Governance is viewed as business ethics and a moral duty. See also Corporate Social Entrepreneurship regarding employees who are driven by their sense of integrity (moral conscience) and duty to society. This notion stems from traditional philosophical ideas of virtue (or self governance) [3]and represents a "bottom-up" approach to corporate governance (agency) which supports the more obvious "top-down" (systems and processes, i.e. structural) perspective.

[edit] Legal environment
In the United States, corporations are governed under common law, the Model Business Corporation Act, and Delaware law since Delaware, as of 2004, was the domicile for the majority of publicly-traded corporations.[4] Individual rules for corporations are based upon the corporate charter and, less authoritatively, the corporate bylaws.[4] In the United States, shareholders cannot initiate changes in the corporate charter although they can initiate changes to the corporate bylaws.[4] In the UK, however, the analogous corporate constitutional documents (the memorandum and articles of association) can be modified by a supermajority (75%) of shareholders.[4] Shareholders can initiate 'precatory proposals' on various initiatives, but the results are nonbinding. Precatory proposals which have received majority support from shareholders, even for several consecutive years, have historically been rejected by the board of directors.[4]

[edit] History - United States
In the 19th century, state corporation laws enhanced the rights of corporate boards to govern without unanimous consent of shareholders in exchange for statutory benefits like appraisal rights, to make corporate governance more efficient. Since that time, and because most large publicly traded corporations in the US are incorporated under corporate administration friendly Delaware law, and because the US's wealth has been increasingly securitized into various corporate entities and institutions, the rights of individual owners and shareholders have become increasingly derivative and dissipated. The concerns of shareholders over administration pay and stock losses periodically has led to more frequent calls for corporate governance reforms. In the 20th century in the immediate aftermath of the Wall Street Crash of 1929 legal scholars such as Adolf Augustus Berle, Edwin Dodd, and Gardiner C. Means pondered on the changing role of the modern corporation in society. Berle and Means' monograph "The Modern Corporation and Private Property" (1932, Macmillan) continues to have a profound influence on the conception of corporate governance in scholarly debates today. From the Chicago school of economics, Ronald Coase's "The Nature of the Firm" (1937) introduced the notion of transaction costs into the understanding of why firms are founded and how they continue to behave. Fifty years later, Eugene Fama and Michael Jensen's "The Separation of Ownership and Control" (1983, Journal of Law and Economics) firmly established agency theory as a way of understanding corporate governance: the firm is seen as a series of contracts. Agency theory's dominance was highlighted in a 1989 article by Kathleen Eisenhardt ("Agency theory: an assessement and review", Academy of Management Review). US expansion after World War II through the emergence of multinational corporations saw the establishment of the managerial class. Accordingly, the following Harvard Business School management professors published influential monographs studying their prominence: Myles Mace (entrepreneurship), Alfred D. Chandler, Jr. (business history), Jay Lorsch (organizational behavior) and Elizabeth MacIver (organizational behavior). According to Lorsch and MacIver

received considerable press attention due to the wave of CEO dismissals (e. "Representing Corporate Officers and Directors.g. AOL. the East Asian Financial Crisis saw the economies of Thailand. The California Public Employees' Retirement System (CalPERS) led a wave of institutional shareholder activism (something only very rarely seen before). and hence good corporate governance is a tool for socio-economic development.[6] Marc Lane's book on best corporate governance practices. Global Crossing. Indonesia. corporate governance has been the subject of significant debate in the U. The lack of corporate governance mechanisms in these countries highlighted the weaknesses of the institutions in their economies..[11][12] With the goal of promoting positive social change. broad efforts to reform corporate governance have been driven.[9][10] The new version is updated annually with the most recent supplement for the year 2010. Over the past three decades. therefore. personal and emotional interest . the massive bankruptcies (and criminal malfeasance) of Enron and Worldcom. Malaysia and The Philippines severely affected by the exit of foreign capital after property assets collapsed. such as Adelphia Communications. Honeywell) by their boards. worldwide.S. Bold. rules and responsibilities in response to the avalanche of corporate accounting scandals.[7][8] He revisited his treatise on corporate governance in 2005. as well as lesser corporate debacles.: IBM. In the early 2000s." Since the late 1970¶s. corporate directors¶ duties have expanded greatly beyond their traditional legal responsibility of duty of loyalty to the corporation and its shareowners. officers. Lane provides companies and their directors. in part."many large corporations have dominant control over business affairs without sufficient accountability or monitoring by their board of directors.S." was first published in 1987. Tyco. led to increased shareholder and governmental interest in corporate governance. as a way of ensuring that corporate value would not be destroyed by the now traditionally cozy relationships between the CEO and the board of directors (e. not infrequently back dated). Kodak. buyers and sellers of corporation stocks were individual investors. by the needs and desires of shareowners to exercise their rights of corporate ownership and to increase the value of their shares and.[13][14] [edit] Role of institutional investors Many years ago. auditors and shareholders with insights for the compliance of new legislation. wealth. South Korea. the issue of corporate governance in the U. by the unrestrained issuance of stock options. This is reflected in the passage of the Sarbanes-Oxley Act of 2002. In 1997. Arthur Andersen.who often had a vested.[3] [edit] Impact of Corporate Governance The positive effect of corporate governance on different stakeholders ultimately is a strengthened economy. and around the globe. such as wealthy businessmen or families.[5] In the first half of the 1990s.g.

such as officers of the corporation or business colleagues.." Since 1996. such as in mutual funds.1 A recent study by Credit Suisse found that companies in which "founding families retain a stake of more than 10% of the company's capital enjoyed a superior performance over their respective sectorial peers." See also. The rise of the institutional investor has brought with it some increase of professional diligence which has tended to improve regulation of the stock market (but not necessarily in the interest of the small investor or even of the naïve institutions. and the Board diligently kept an eye on the company and its principal executives (they usually hired and fired the President. there has been a concurrent lapse in the oversight of large corporations. aka. mutual funds. Program trading. Over time. exchange-traded funds.g." by Alan Murray. [4] (Moreover. insurance companies. However this growth occurred primarily by way of individuals turning over their funds to 'professionals' to manage. brokers. banks. hedge funds. "BW identified five key ingredients that contribute to superior performance. In this way. Occasionally. these statistics do not reveal the full extent of the practice.in the corporations whose shares they owned. if the owning institutions don't like what the President/CEO is doing and they feel that firing them will likely be costly (think "golden handshake") and/or time consuming. the hallmark of institutional trading. Nowadays. "Revolt in the Boardroom. markets have become largely institutionalized: buyers and sellers are largely institutions (e. because of so-called 'iceberg' orders. See Quantity and display instructions under last reference. But they do go far to explain why it helps to have someone at the helm² or active behind the scenes² who has more than a mere paycheck and the prospect of a cozy retirement at stake. The Board of Directors of large corporations used to be chosen by the principal shareholders. [BusinessWeek has found]. Since the (institutional) shareholders rarely object. or Chief Executive Officer² CEO). the majority of investment now is described as "institutional investment" even though the vast majority of the funds are for the benefit of individual investors. the President/CEO generally takes the Chair of the Board position for his/herself (which makes it much more difficult for the institutional owners to "fire" him/her). they will simply sell out their interest. Not all are qualities unique to enterprises with retained family interests. . this superior performance amounts to 8% per year. of which there are many). Note that this process occurred simultaneously with the direct growth of individuals investing indirectly in the market (for example individuals have twice as much money in mutual funds as they do in bank accounts). One of the biggest strategic advantages a company can have. averaged over 80% of NYSE trades in some months of 2007. "Look beyond Six Sigma and the latest technology fad. but rarely. pension funds. other investor groups.[5] Forget the celebrity CEO. which are now almost all owned by large institutions. institutional investors support shareholder resolutions on such matters as executive pay and anti-takeover. and may be made up primarily of their friends and associates. and other financial institutions). The Board is now mostly chosen by the President/CEO. is blood lines. who usually had an emotional as well as monetary investment in the company (think Ford). "poison pill" measures." [6] In that last study.) Unfortunately.

therefore.) has soared. The Company Secretary. benefits and reputation. based on the idea that this strategy will largely eliminate individual company financial or other risk and. effective operations. workers and management receive salaries. a system of corporate governance controls is implemented to assist in aligning the incentives of managers with those of shareholders. Korean chaebol 'groups') [8]. the Chief Executive Officer. compliance and administration. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. the board of directors. the largest pools of invested money (such as the mutual fund 'Vanguard 500'. the ownership of stocks in markets around the world varies. or the largest investment management firm for corporations. It is their responsibility to endorse the organization's strategy.. Customers receive goods and services. develop directional policy. both individual and professional stock investors around the world have emerged as a potential new kind of major (short term) force in the direct or indirect ownership of corporations and in the markets: the casual participant. is a high ranking professional who is trained to uphold the highest standards of corporate governance. management. Since the marked rise in the use of Internet transactions from the 1990s. All parties to corporate governance have an interest. [edit] Parties to corporate governance Parties involved in corporate governance include the regulatory body (e. So. supervise and remunerate senior executives and to ensure accountability of the organization to its owners and authorities. the sale of derivatives (e. customers and the community at large. whether direct or indirect. State Street Corp. Even as the purchase of individual shares in any one corporation by individual investors diminishes. the majority of the shares in the Japanese market are held by financial companies and industrial corporations (there is a large and deliberate amount of cross-holding among Japanese keiretsu corporations and within S.g. Partly as a result of this separation between the two parties. etc. often still by large individual investors. for example. there has been an opportunity for a reversal of the separation of ownership and control problems because ownership is not so diffuse. The shareholder delegates decision rights to the manager to act in the principal's best interests. appoint. while shareholders receive capital return. exchange-traded funds (ETFs).) are designed simply to invest in a very large number of different companies with sufficient liquidity. creditors. But. shareholders and Auditors).Finally. employees.g. Directors. these investors have even less interest in a particular company's governance. . whereas stock in the USA or the UK and Europe are much more broadly owned. Other stakeholders who take part include suppliers. the interests of most investors are now increasingly rarely tied to the fortunes of individual corporations. Stock market index options [7]. A board of directors often plays a key role in corporate governance. known as a Corporate Secretary in the US and often referred to as a Chartered Secretary if qualified by the Institute of Chartered Secretaries and Administrators (ICSA). in the effective performance of the organization. With the significant increase in equity holdings of investors.

senior executives should conduct themselves honestly and ethically. social and other forms of capital. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. Because of this. Of importance is how directors and management develop a model of governance that aligns the values of the corporate participants and then evaluate this model periodically for its effectiveness. Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. In particular. though. performance orientation. It is important to understand. but it is also a necessary element in risk management and avoiding lawsuits. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. In return these individuals provide value in the form of natural. especially concerning actual or apparent conflicts of interest. that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Integrity and ethical behaviour: Ethical and responsible decision making is not only important for public relations. human. [edit] Principles Key elements of good corporate governance principles include honesty. A key factor is an individual's decision to participate in an organization e.g. and commitment to the organization. through providing financial capital and trust that they will receive a fair share of the organizational returns.suppliers receive compensation for their goods or services. Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. If some parties are receiving more than their fair return then participants may choose to not continue participating leading to organizational collapse. many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries. Disclosure of material . They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings. There are issues about the appropriate mix of executive and non-executive directors. mutual respect. openness. and disclosure in financial reports. Commonly accepted principles of corporate governance include: y y y y y Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. trust and integrity. responsibility and accountability.

For quite some time it was confined only to corporate management. Regular board meetings allow potential problems to be identified. [edit] Internal corporate governance controls Internal corporate governance controls monitor activities and then take corrective action to accomplish organisational goals. That is not so. efficient and transparent administration and strive to meet certain well defined. John G." despite some feeble attempts from various quarters. Smale.these should be constantly evolving due to interplay of many factors and the roles played by the more progressive/responsible elements within the corporate sector. Perpetuation for its own sake may be counterproductive. It is something much broader.matters concerning the organization should be timely and balanced to ensure that all investors have access to clear. Issues involving corporate governance principles include: y y y y y y y y internal controls and internal auditors the independence of the entity's external auditors and the quality of their audits oversight and management of risk oversight of the preparation of the entity's financial statements review of the compensation arrangements for the chief executive officer and other senior executives the resources made available to directors in carrying out their duties the way in which individuals are nominated for positions on the board dividend policy Nevertheless "corporate governance."[15] However it should be noted that a corporation should cease to exist if that is in the best interests of its stakeholders. and the commitment to run a transparent organization. remains an ambiguous and often misunderstood phrase. For example. for it must include a fair. with its legal authority to hire. fire and compensate top management. wrote: "The Board is responsible for the successful perpetuation of the corporation. The quantity. discussed and avoided. the degree and extent to which the board of Director (BOD) exercise their trustee responsibilities (largely an ethical commitment). factual information. Corporate governance must go well beyond law. safeguards invested capital. a former member of the General Motors board of directors. an independent third party (the external auditor) attests the accuracy of information provided by management to investors. quality and frequency of financial and managerial disclosure. Whilst non- . That responsibility cannot be relegated to management. written objectives. Examples include: y Monitoring by the board of directors: The board of directors. [edit] Mechanisms and controls Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. to monitor managers' behaviour. An ideal control system should regulate both motivation and ability.

Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance. and a third group check that the interests of people (customers. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes. shareholders. . require that the President be a different person from the Treasurer. Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity's board of directors. Moreover. that executive directors look beyond the financial criteria. It could be argued. however.y y y executive directors are thought to be more independent. It may be in the form of cash or non-cash payments such as shares and share options. they may not always result in more effective corporate governance and may not increase performance. ex ante. and other personnel to provide reasonable assurance of the entity achieving its objectives related to reliable financial reporting. Such incentive schemes. Examples include: y y y y y y y competition debt covenants demand for and assessment of performance information (especially financial statements) government regulations managerial labour market media pressure takeovers [edit] Systemic problems of corporate governance y Demand for information: In order to influence the directors. and can elicit myopic behaviour. management. therefore. and compliance with laws and regulations. This application of separation of power is further developed in companies where separate divisions check and balance each other's actions. another group review and can veto the changes.[16] Different board structures are optimal for different firms. employees) outside the three groups are being met. the ability of the board to monitor the firm's executives is a function of its access to information. One group may propose company-wide administrative changes. superannuation or other benefits. Internal auditors are personnel within an organization who test the design and implementation of the entity's internal control procedures and the reliability of its financial reporting Balance of power: The simplest balance of power is very common. operating efficiency. are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behaviour. the shareholders must combine with others to form a voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting. audit committee. [edit] External corporate governance controls External corporate governance controls encompass the controls external stakeholders exercise over the organisation.

Enron concealed huge losses by creating illusions that a third party was contractually obliged to pay the amount of any losses. and rely on auditors' competence. good financial reporting is not a sufficient condition for the effectiveness of corporate governance if users don't process it. Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. However. ideally. The directors of the company should be entitled to expect that management prepare the financial information in compliance with statutory and ethical obligations. [edit] Role of the accountant Financial reporting is a crucial element necessary for the corporate governance system to function effectively. The Enron collapse is an example of misleading financial reporting. the partner in charge of auditing. views inevitably led to the client prevailing. the third party was an entity in which Enron had a substantial economic stake.[17] Accountants and auditors are the primary providers of information to capital market participants. In the extreme. The exercise of this choice to improve apparent performance (popularly known as creative accounting) imposes extra information costs on users.y y Monitoring costs: A barrier to shareholders using good information is the cost of processing it. especially to a small shareholder. Current accounting practice allows a degree of choice of method in determining the method of measurement. criteria for recognition. be corrected by the working of the external auditing process. Changes enacted in the United States in the form of the SarbanesOxley Act (in response to the Enron situation as noted below) prohibit accounting firms from providing both auditing and management consulting services. the efficient market hypothesis (EMH) asserts that financial markets are efficient). which suggests that the small shareholder will free ride on the judgements of larger professional investors. The power of the corporate client to initiate and terminate management consulting services and. or if the informed user is unable to exercise a monitoring role due to high costs (see Systemic problems of corporate governance above). more fundamentally. it can involve nondisclosure of information. This should. In discussions of accounting practices with Arthur Andersen. The traditional answer to this problem is the efficient market hypothesis (in finance. Similar provisions are in place under clause 49 of SEBI Act in India. However.[citation needed] [edit] Regulation . This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management. Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. to select and dismiss accounting firms contradicts the concept of an independent auditor. and even the definition of the accounting entity. One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing.

Companies law Company · Business Company forms Sole proprietorship Partnership (General · Limited · LLP) Corporation Cooperative United States S corporation · C corporation LLC · LLLP · Series LLC Delaware corporation Nevada corporation Massachusetts business trust Delaware statutory trust UK / Ireland / Commonwealth Limited company (by shares · by guarantee Public · Proprietary) Unlimited company Community interest company European Union / EEA .

In practice rules can be more complex than principles. demarcating a clear line between acceptable and unacceptable behaviour.K.this is harder to achieve if one is bound by a broader principle. one can still find a way to circumvent their underlying purpose . Rules also reduce discretion on the part of individual managers or auditors.V. .A. They may be ill-equipped to deal with new types of transactions not covered by the code. · more Doctrines Corporate governance Limited liability · Ultra vires Business judgment rule Internal affairs doctrine De facto corporation and corporation by estoppel Piercing the corporate veil Rochdale Principles Related areas Contract · Civil procedure v·d·e [edit] Rules versus principles Rules are typically thought to be simpler to follow than principles. even if clear rules are followed.SE · SCE · SPE · EEIG Elsewhere AB · AG · ANS · A/S · AS · GmbH K. · Oy · S. · N. Moreover.

as well as smaller companies. At the same time. It allows the sector to determine what standards are acceptable or unacceptable. since after a filing. Overall. risk. risk and compliance solutions available to capture information in order to evaluate risk and to identify gaps in the organization¶s principles and processes. directors have to cover more of their own legal bills and are frequently sued by bankruptcy trustees as well as investors. for taken too far it can dampen valuable risk-taking. greater enforcement is not always better. They do not need Sarbanes-Oxley to mandate that they protect values and ethics or monitor CEO performance. enlightened boards regard compliance with regulations as merely a baseline for board performance. Unlike traditional boards. enlightened directors recognize that it is not their role to be involved in the day-to-day operations of the corporation. complex companies. Because enlightened directors strongly believe that it is their duty to involve themselves in an intellectual analysis of how the company should move forward into the future. Enlightened boards can be found in very large. They both deter bad actors and level the competitive playing field. as opposed to a real. most of the time. this is largely a theoretical.[18] [edit] Proposals The book Money for Nothing suggests importing from England the concept of term limits to prevent independent directors from becoming too close to management and demanding that directors invest a meaningful amount of their own money (not grants of stock or options that they receive free) to ensure that the directors' interests align with those of average investors. They are more likely to be supportive of the senior management team. Nevertheless.Principles on the other hand is a form of self regulation. [edit] Enforcement Enforcement can affect the overall credibility of a regulatory system. however. There are various integrated governance. They lead by example. enlightened boards do not feel hampered by the rules and regulations of the Sarbanes-Oxley Act.[19] Another proposal is for the government to allow poorly-managed businesses to go bankrupt. Enlightened directors go far beyond merely meeting the requirements on a checklist. Unlike standard boards that aim to comply with regulations. In practice. This type of software is based on project management style methodologies such as the ABACUS methodology which attempts to unify the management of these areas. what most distinguishes enlightened directors from traditional and standard directors is the passionate obligation they feel to engage in the day-to-day challenges and strategizing of the company. the enlightened board is aligned on the critically important issues facing the company.[20] . It also pre-empts over zealous legislations that might not be practical. rather than treat them as separate entities. [edit] Action Beyond Obligation Enlightened boards regard their mission as helping management lead the company.

This can lead to "self-dealing".S. the main problem is the conflict of interest between widely-dispersed shareholders and powerful managers. but are merely asked to rubberstamp the nominees of the sitting board. The board of directors is nominally selected by and responsible to the shareholders. The liberal model that is common in Anglo-American countries tends to give priority to the interests of shareholders. The liberal model of corporate governance encourages radical innovation and cost competition. and the community. Other duties of the board may include policy setting. but needs to get board approval for certain major actions. where the controlling families favor subsidiaries for which they have higher cash flow rights. recent approach to governance issues and what has happened in the UK. a corporation is governed by a board of directors. there are important differences between the U. The coordinated model that one finds in Continental Europe and Japan also recognizes the interests of workers. Perverse incentives have pervaded many corporate boards in the developed world. such as hiring his/her immediate subordinates. usually known as the chief executive officer. there is a considerable variation in corporate governance models around the world. customers. The CEO has broad power to manage the corporation on a daily basis. individual shareholders are not offered a choice of board nominees among which to choose. the chaebols in South Korea and many others are examples of arrangements which try to respond to the same corporate governance challenges as in the US. decision making. Frequently. However.[edit] Corporate governance models around the world Although the US model of corporate governance is the most notorious. acquiring another company. whereas the coordinated model of corporate governance facilitates incremental innovation and quality competition. major capital expansions. In the United States. or corporate control. with board members beholden to the chief executive whose actions they are intended to oversee. the main problem is that the voting ownership is tightly-held by families through pyramidal ownership and dual shares (voting and nonvoting). which has the power to choose an executive officer. suppliers. Each model has its own distinct competitive advantage. The intricated shareholding structures of keiretsus in Japan.[21] [edit] Anglo-American Model There are many different models of corporate governance around the world. but the bylaws of many companies make it difficult for all but the largest shareholders to have any influence over the makeup of the board. managers. the heavy presence of banks in the equity of German firms [9]. members of the boards of directors are CEOs of other corporations. normally. raising money. These differ according to the variety of capitalism in which they are embedded. In Europe. or other expensive projects. which some[22] see as a conflict of interest. [edit] Codes and guidelines . monitoring management's performance. In the United States.

companies quoted on the London and Toronto Stock Exchanges formally need not follow the recommendations of their respective national codes. including former Delaware Supreme Court Chief Justice E. This internationally agreed[24] benchmark consists of more than fifty distinct disclosure items across five broad categories:[25] y y Auditing Board and management structure and process . In the United States. Norman Veasey. it still considers its provisions and several prominent Delaware justices. This is due to Delaware's generally management-friendly corporate legal environment and the existence of a state court dedicated solely to business issues (Delaware Court of Chancery). including more than half of the Fortune 500. For example. However. One issue that has been raised since the Disney decision[23] in 2005 is the degree to which companies manage their governance responsibilities.Corporate governance principles and codes have been developed in different countries and issued from stock exchanges. do they merely try to supersede the legal threshold. corporate managers and individual companies tend to be wholly voluntary. Such documents. private sector associations and more than 20 national corporate governance codes. or should they create governance guidelines that ascend to the level of best practice. This was revised in 2004. they should provide explanations concerning divergent practices. corporations. For example. if they are public. Most states' corporate law generally follow the American Bar Association's Model Business Corporation Act. Building on the work of the OECD. The OECD remains a proponent of corporate governance principles throughout the world. institutional investors. although the codes linked to stock exchange listing requirements may have a coercive effect. companies are primarily regulated by the state in which they incorporate though they are also regulated by the federal government and. they must disclose whether they follow the recommendations in those documents and. the guidelines issued by associations of directors (see Section 3 above). While Delaware does not follow the Act. As a rule. One of the most influential guidelines has been the 1999 OECD Principles of Corporate Governance. The highest number of companies are incorporated in Delaware. however. where not. For example. compliance with these governance recommendations is not mandated by law. the United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) has produced voluntary Guidance on Good Practices in Corporate Governance Disclosure. Such disclosure requirements exert a significant pressure on listed companies for compliance. other international organisations. by their stock exchange. or associations (institutes) of directors and managers with the support of governments and international organizations. may have a wider multiplying effect prompting other companies to adopt similar documents and standards of best practice. in other words. The GM Board Guidelines reflect the company¶s efforts to improve its own governance capacity. participate on ABA committees.

McKinsey found that 80% of the respondents would pay a premium for well-governed companies. found that those "most admired" had an average return of 125%. Other studies have linked broad perceptions of the quality of companies to superior share price performance. . concentration ratios) and then making a sketch showing its visual representation. In a separate study Business Week enlisted institutional investors and 'experts' to assist in differentiating between boards with good and bad governance and found that companies with the highest rankings had the highest financial returns. whilst the 'least admired' firms returned 80%. Egypt and Russia). [edit] Ownership structures Ownership structures refers to the various patterns in which shareholders seem to set up with respect to a certain group of firms. to locate the ultimate owner of a particular group of firms. particularly on accountability and reporting. undertook formal evaluation of its directors. standards. research into the relationship between specific corporate governance controls and some definitions of firm performance has been mixed and often weak. It is a tool frequently employed by policy-makers and researchers in their analyses of corporate governance within a country or business group.And ownership can be changed by the stakeholders of the company. On the other hand. and was responsive to investors' requests for information on governance issues. rings. The following examples are illustrative.This document aims to provide general information.y y y Corporate responsibility and compliance Financial transparency and information disclosure Ownership structure and exercise of control rights The World Business Council for Sustainable Development WBCSD has done work on corporate governance. The idea behind the concept of ownership structures is to be able to understand the way in which shareholders interact with firms and. The size of the premium varied by market. and frameworks. whenever possible. cross-share holdings. Generally. from 11% for Canadian companies to around 40% for companies where the regulatory backdrop was least certain (those in Morocco. standards and frameworks relevant to the sustainability agenda. a "snap-shot" of the landscape and a perspective from a think-tank/professional association on a few key codes. and webs. [edit] Corporate governance and firm performance In its 'Global Investor Opinion Survey' of over 200 institutional investors first undertaken in 2000 and updated in 2002. ownership structures are identified by using some observable measures of ownership concentration (i. who had no management ties. Some examples of ownership structures include pyramids. In a study of five year cumulative returns of Fortune Magazine's survey of 'most admired firms'. and in 2004 created an Issue Management Tool: Strategic challenges for business in the use of corporate responsibility codes. Antunovich et al.e. They defined a well-governed company as one that had mostly out-side directors.

[edit] Board composition Some researchers have found support for the relationship between frequency of meetings and profitability. corporate stock buybacks for U. Others have found a negative relationship between the proportion of external directors and profitability.S. Some argue that firm performance is positively associated with share option plans and that these plans direct managers' energies and extend their decision horizons toward the long-term. A particularly forceful and long running argument concerned the interaction of executive options with corporate stock repurchase programs. [edit] Remuneration/Compensation The results of previous research on the relationship between firm performance and executive compensation have failed to find consistent and significant relationships between executives' remuneration and firm performance. It is unlikely that board composition has a direct impact on profitability. one measure of firm performance. These authors argued that. Numerous authorities (including U. while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. in particular. A combination of accounting changes and governance issues led options to become a less popular means of remuneration as 2006 progressed. and external and internal monitoring devices may be more effective for some than for others. and less interested in the welfare of their shareholders. in part. the backdating of option grants as documented by University of Iowa academic Erik Lie and reported by James Blander and Charles Forelle of the Wall Street Journal. rather than the short-term. and various alternative implementations of buybacks surfaced to challenge the dominance of "open market" cash buybacks as the preferred means of implementing a share repurchase plan. Federal Reserve Board economist Weisbenner) determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests. that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and. Low average levels of pay-performance alignment do not necessarily imply that this form of governance control is inefficient. Some researchers have found that the largest CEO performance incentives came from ownership of the firm's shares.S. Gumport issued in 2006. . In a recent paper Bhagat and Black found that companies with more independent boards are not more profitable than other companies. Even before the negative influence on public opinion caused by the 2006 backdating scandal. use of options faced various criticisms. Standard & Poors 500 companies surged to a $500 billion annual rate in late 2006 because of the impact of options. Not all firms experience the same levels of agency conflict. The results suggest that increases in ownership above 20% cause management to become more entrenched. performance of the company. while others found no relationship between external board membership and profitability. A compendium of academic works on the option/buyback issue is included in the study Scandal by author M. However.

corporations are governed under common law. Report of SEBI committee (India) on Corporate Governance defines corporate governance as the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. accountability and integrity. To date. however. Sound corporate governance is reliant on external marketplace commitment and legislation. processes and people.Definition In A Board Culture of Corporate Governance. about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company. i. Corporate Governance is viewed as business ethics and a moral duty. and offers companies the opportunity to differentiate from competitors through their board culture.' [2] It is a system of structuring. shareholders cannot initiate changes in the corporate charter although they can initiate changes to the corporate bylaws. O'Donovan goes on to say that 'the perceived quality of a company's corporate governance can influence its share price as well as the cost of raising capital. Quality is determined by the financial markets. but the . [4] In the United States. It is about commitment to values. apart from meeting environmental and local community needs. which serves the needs of shareholders and other stakeholders. The internal environment is quite a different matter. too much of corporate governance debate has centred on legislative policy. See also Corporate Social Entrepreneurship regarding employees who are driven by their sense of integrity (moral conscience) and duty to society. operating and controlling a company with a view to achieve long term strategic goals to satisfy shareholders. creditors. the corporate bylaws. outside the circle of control of any board. customers and suppliers.e. objectivity. business author Gabrielle O'Donovan defines corporate governance as 'an internal system encompassing policies. Legal environment In the United States.´ The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution. [4] Shareholders can initiate 'precatory proposals' on various initiatives. to a large extent. employees. the Model Business Corporation Act. and Delaware law since Delaware. less authoritatively. This notion stems from traditional philosophical ideas of virtue (or self governance) [3] and represents a "bottom-up" approach to corporate governance (agency) which supports the more obvious "top-down" (systems and processes. External forces are. and complying with the legal and regulatory requirements. to deter fraudulent activities and transparency policy which misleads executives to treat the symptoms and not the cause. legislation and other external market forces plus how policies and processes are implemented and how people are led. as of 2004. was the domicile for the majority of publicly-traded corporations. [4] Individual rules for corporations are based upon the corporate charter and. by directing and controlling management activities with good business savvy. 2. structural) perspective. plus a healthy board culture which safeguards policies and processes. [4] In the UK. the analogous corporate constitutional documents (the memorandum and articles of association) can be modified by a supermajority (75%) of shareholders.

corporate directors¶ duties have expanded greatly beyond their traditional legal responsibility of duty of loyalty to the corporation and its shareowners. Precatory proposals which have received majority support from shareholders. Bold. Since that time. and Gardiner C. Kodak.United States In the 19th century. (business history). to make corporate governance more efficient. broad efforts to reform corporate governance have been driven. Means pondered on the changing role of the modern corporation in society. Macmillan) continues to have a profound influence on the conception of corporate governance in scholarly debates today. [4] 3. According to Lorsch and MacIver "many large corporations have dominant control over business affairs without sufficient accountability or monitoring by their board of directors. the following Harvard Business School management professors published influential monographs studying their prominence: Myles Mace (entrepreneurship). and because the US's wealth has been increasingly securitized into various corporate entities and institutions. and around the globe. Over the past three decades. Journal of Law and Economics) firmly established agency theory as a way of understanding corporate governance: the firm is seen as a series of contracts. state corporation laws enhanced the rights of corporate boards to govern without unanimous consent of shareholders in exchange for statutory benefits like appraisal rights. Alfred D.S. corporate governance has been the subject of significant debate in the U. the issue of corporate governance in the U. by the needs and desires of shareowners to exercise their rights of corporate ownership and to increase the value of their shares and. The concerns of shareholders over administration pay and stock losses periodically has led to more frequent calls for corporate governance reforms. Academy of Management Review). even for several consecutive years. Eugene Fama and Michael Jensen's "The Separation of Ownership and Control" (1983. US expansion after World War II through the emergence of multinational corporations saw the establishment of the managerial class. Chandler. received considerable press attention due to the wave of CEO dismissals (e. wealth. in part. Fifty years later.S.results are nonbinding. Berle and Means' monograph "The Modern Corporation and Private Property" (1932. the rights of individual owners and shareholders have become increasingly derivative and dissipated. Accordingly." Since the late 1970¶s.: IBM.g. History . Jr. and because most large publicly traded corporations in the US are incorporated under corporate administration friendly Delaware law. In the 20th century in the immediate aftermath of the Wall Street Crash of 1929 legal scholars such as Adolf Augustus Berle. Jay Lorsch (organizational behavior) and Elizabeth MacIver (organizational behavior). Ronald Coase's "The Nature of the Firm" (1937) introduced the notion of transaction costs into the understanding of why firms are founded and how they continue to behave. Agency theory's dominance was highlighted in a 1989 article by Kathleen Eisenhardt ("Agency theory: an assessement and review". From the Chicago school of economics. Honeywell) by their . [5] In the first half of the 1990s. Edwin Dodd. have historically been rejected by the board of directors. therefore.

such as in mutual funds. by the unrestrained issuance of stock options. AOL. and hence good corporate governance is a tool for socio-economic development. This is reflected in the passage of the Sarbanes-Oxley Act of 2002. auditors and shareholders with insights for the compliance of new legislation.g. Malaysia and The Philippines severely affected by the exit of foreign capital after property assets collapsed. mutual funds. Arthur Andersen. South Korea. as well as lesser corporate debacles. buyers and sellers of corporation stocks were individual investors. the East Asian Financial Crisis saw the economies of Thailand. exchange-traded funds. not infrequently back dated). such as wealthy businessmen or families. In the early 2000s. personal and emotional interest in the corporations whose shares they owned. In this way. such as Adelphia Communications. The lack of corporate governance mechanisms in these countries highlighted the weaknesses of the institutions in their economies.who often had a vested. Global Crossing. Over time. hedge funds. markets have become largely institutionalized: buyers and sellers are largely institutions (e. Role of institutional investors Many years ago. of which there are many).g. banks. [13] [14] 5. The rise of the institutional investor has brought with it some increase of professional diligence which has tended to improve regulation of the stock market (but not necessarily in the interest of the small investor or even of the naïve institutions. worldwide. Tyco. as a way of ensuring that corporate value would not be destroyed by the now traditionally cozy relationships between the CEO and the board of directors (e. and other financial institutions). the majority of . Indonesia. pension funds. Impact of Corporate Governance The positive effect of corporate governance on different stakeholders ultimately is a strengthened economy. "Representing Corporate Officers and Directors.[3] 4. officers. other investor groups. Lane provides companies and their directors." was first published in 1987. [6] Marc Lane's book on best corporate governance practices. brokers.. The California Public Employees' Retirement System (CalPERS) led a wave of institutional shareholder activism (something only very rarely seen before). [11] [12] With the goal of promoting positive social change.boards. [9] [10] The new version is updated annually with the most recent supplement for the year 2010. Note that this process occurred simultaneously with the direct growth of individuals investing indirectly in the market (for example individuals have twice as much money in mutual funds as they do in bank accounts). In 1997. led to increased shareholder and governmental interest in corporate governance. However this growth occurred primarily by way of individuals turning over their funds to 'professionals' to manage. rules and responsibilities in response to the avalanche of corporate accounting scandals. the massive bankruptcies (and criminal malfeasance) of Enron and Worldcom. insurance companies.. [7] [8] He revisited his treatise on corporate governance in 2005.

and may be made up primarily of their friends and associates. the hallmark of institutional trading. both individual and professional stock investors around the world have emerged as a potential new kind of major (short term) force in the direct or indirect ownership of corporations and in the markets: the casual participant. is blood lines.) are designed simply to invest in a very large number of different companies with sufficient liquidity. exchange-traded funds (ETFs). State Street Corp.. Since the (institutional) shareholders rarely object." [6] In that last study." Since 1996. Finally. The Board is now mostly chosen by the President/CEO. the largest pools of invested money (such as the mutual fund 'Vanguard 500'. because of so-called 'iceberg' orders. [4] (Moreover. Stock market . Since the marked rise in the use of Internet transactions from the 1990s. the President/CEO generally takes the Chair of the Board position for his/herself (which makes it much more difficult for the institutional owners to "fire" him/her).[5] Forget the celebrity CEO. if the owning institutions don't like what the President/CEO is doing and they feel that firing them will likely be costly (think "golden handshake") and/or time consuming.1 A recent study by Credit Suisse found that companies in which "founding families retain a stake of more than 10% of the company's capital enjoyed a superior performance over their respective sectorial peers.investment now is described as "institutional investment" even though the vast majority of the funds are for the benefit of individual investors. Occasionally. which are now almost all owned by large institutions.) Unfortunately." See also. but rarely. this superior performance amounts to 8% per year. Even as the purchase of individual shares in any one corporation by individual investors diminishes. One of the biggest strategic advantages a company can have. Program trading." by Alan Murray. who usually had an emotional as well as monetary investment in the company (think Ford). averaged over 80% of NYSE trades in some months of 2007. [BusinessWeek has found]. Not all are qualities unique to enterprises with retained family interests. the sale of derivatives (e. these investors have even less interest in a particular company's governance. Nowadays. But they do go far to explain why it helps to have someone at the helm² or active behind the scenes² who has more than a mere paycheck and the prospect of a cozy retirement at stake. or Chief Executive Officer² CEO). these statistics do not reveal the full extent of the practice. therefore. they will simply sell out their interest. "BW identified five key ingredients that contribute to superior performance. such as officers of the corporation or business colleagues. there has been a concurrent lapse in the oversight of large corporations. The Board of Directors of large corporations used to be chosen by the principal shareholders. institutional investors support shareholder resolutions on such matters as executive pay and anti-takeover.g. and the Board diligently kept an eye on the company and its principal executives (they usually hired and fired the President. "poison pill" measures. See Quantity and display instructions under last reference. "Revolt in the Boardroom. or the largest investment management firm for corporations. "Look beyond Six Sigma and the latest technology fad. aka. based on the idea that this strategy will largely eliminate individual company financial or other risk and.

Directors. the Chief Executive Officer. there has been an opportunity for a reversal of the separation of ownership and control problems because ownership is not so diffuse. A board of directors often plays a key role in corporate governance. customers and the community at large. effective operations. If some parties are receiving more than their fair return then participants may choose to not continue participating leading to organizational collapse. etc. management. A key factor is an individual's decision to participate in an organization e. Customers receive goods and services.) has soared. through providing financial capital and trust that they will receive a fair share of the organizational returns.index options [7]. 7. With the significant increase in equity holdings of investors. whether direct or indirect. appoint. Parties to corporate governance Parties involved in corporate governance include the regulatory body (e. compliance and administration. It is their responsibility to endorse the organization's strategy. Korean chaebol 'groups') [8]. employees. a system of corporate governance controls is implemented to assist in aligning the incentives of managers with those of shareholders. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. human. The Company Secretary. social and other forms of capital. the ownership of stocks in markets around the world varies. The shareholder delegates decision rights to the manager to act in the principal's best interests. supervise and remunerate senior executives and to ensure accountability of the organization to its owners and authorities. But. Principles . in the effective performance of the organization. Partly as a result of this separation between the two parties.g. shareholders and Auditors). is a high ranking professional who is trained to uphold the highest standards of corporate governance. creditors. known as a Corporate Secretary in the US and often referred to as a Chartered Secretary if qualified by the Institute of Chartered Secretaries and Administrators (ICSA). develop directional policy. the interests of most investors are now increasingly rarely tied to the fortunes of individual corporations. benefits and reputation. All parties to corporate governance have an interest. whereas stock in the USA or the UK and Europe are much more broadly owned. for example. So. workers and management receive salaries. In return these individuals provide value in the form of natural. Other stakeholders who take part include suppliers. the board of directors. often still by large individual investors. the majority of the shares in the Japanese market are held by financial companies and industrial corporations (there is a large and deliberate amount of cross-holding among Japanese keiretsu corporations and within S.g. suppliers receive compensation for their goods or services. while shareholders receive capital return.

It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. openness. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. performance orientation. Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability.Key elements of good corporate governance principles include honesty. responsibility and accountability. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear. but it is also a necessary element in risk management and avoiding lawsuits. that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. In particular. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings. Because of this. mutual respect. factual information. There are issues about the appropriate mix of executive and non-executive directors. especially concerning actual or apparent conflicts of interest. trust and integrity. and disclosure in financial reports. senior executives should conduct themselves honestly and ethically. many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries. and commitment to the organization. Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. Commonly accepted principles of corporate governance include: y y y y y Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. Integrity and ethical behaviour: Ethical and responsible decision making is not only important for public relations. Issues involving corporate governance principles include: y y y y y internal controls and internal auditors the independence of the entity's external auditors and the quality of their audits oversight and management of risk oversight of the preparation of the entity's financial statements review of the compensation arrangements for the chief executive officer and other senior executives . Of importance is how directors and management develop a model of governance that aligns the values of the corporate participants and then evaluate this model periodically for its effectiveness. Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders. though. It is important to understand.

quality and frequency of financial and managerial disclosure. The quantity. written objectives. Regular board meetings allow potential problems to be identified. That responsibility cannot be relegated to management. remains an ambiguous and often misunderstood phrase. Perpetuation for its own sake may be counterproductive. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes. Moreover. that executive directors look beyond the financial criteria. Smale. wrote: "The Board is responsible for the successful perpetuation of the corporation. Corporate governance must go well beyond law. therefore." despite some feeble attempts from various quarters. Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity's board of directors. 8. and the commitment to run a transparent organization. the ability of the board to monitor the firm's executives is a function of its access to information.these should be constantly evolving due to interplay of many factors and the roles played by the more progressive/responsible elements within the corporate sector. with its legal authority to hire. Whilst nonexecutive directors are thought to be more independent. management. John G. to monitor managers' behaviour. a former member of the General Motors board of directors. ex ante. Mechanisms and controls Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection.y y y the resources made available to directors in carrying out their duties the way in which individuals are nominated for positions on the board dividend policy Nevertheless "corporate governance. safeguards invested capital. for it must include a fair. an independent third party (the external auditor) attests the accuracy of information provided by management to investors. It is something much broader. the degree and extent to which the board of Director (BOD) exercise their trustee responsibilities (largely an ethical commitment)." [15] However it should be noted that a corporation should cease to exist if that is in the best interests of its stakeholders. For quite some time it was confined only to corporate management. 8. Examples include: y y Monitoring by the board of directors: The board of directors. they may not always result in more effective corporate governance and may not increase performance. audit committee. and other personnel to provide reasonable assurance of the entity achieving its objectives . It could be argued. [16] Different board structures are optimal for different firms. An ideal control system should regulate both motivation and ability. For example. efficient and transparent administration and strive to meet certain well defined. 1. That is not so. Internal corporate governance controls Internal corporate governance controls monitor activities and then take corrective action to accomplish organisational goals. discussed and avoided. fire and compensate top management.

2. Role of the accountant . Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. employees) outside the three groups are being met.y y related to reliable financial reporting. This should. which suggests that the small shareholder will free ride on the judgements of larger professional investors. and compliance with laws and regulations. The traditional answer to this problem is the efficient market hypothesis (in finance. 10. Examples include: y y y y y y y competition debt covenants demand for and assessment of performance information (especially financial statements) government regulations managerial labour market media pressure takeovers 9. require that the President be a different person from the Treasurer. One group may propose company-wide administrative changes. be corrected by the working of the external auditing process. Internal auditors are personnel within an organization who test the design and implementation of the entity's internal control procedures and the reliability of its financial reporting Balance of power: The simplest balance of power is very common. Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. especially to a small shareholder. and a third group check that the interests of people (customers. shareholders. however. 8. Systemic problems of corporate governance y y y Demand for information: In order to influence the directors. are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behaviour. Monitoring costs: A barrier to shareholders using good information is the cost of processing it. another group review and can veto the changes. ideally. operating efficiency. This application of separation of power is further developed in companies where separate divisions check and balance each other's actions. External corporate governance controls External corporate governance controls encompass the controls external stakeholders exercise over the organisation. and can elicit myopic behaviour. Such incentive schemes. superannuation or other benefits. the efficient market hypothesis (EMH) asserts that financial markets are efficient). It may be in the form of cash or non-cash payments such as shares and share options. the shareholders must combine with others to form a voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting. Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance.

to select and dismiss accounting firms contradicts the concept of an independent auditor. or if the informed user is unable to exercise a monitoring role due to high costs (see Systemic problems of corporate governance above). However. The Enron collapse is an example of misleading financial reporting. One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing. Regulation Companies law Company · Business Company forms Sole proprietorship Partnership (General · Limited · LLP) Corporation Cooperative United States . it can involve nondisclosure of information. the partner in charge of auditing. In the extreme. and even the definition of the accounting entity. the third party was an entity in which Enron had a substantial economic stake. Changes enacted in the United States in the form of the SarbanesOxley Act (in response to the Enron situation as noted below) prohibit accounting firms from providing both auditing and management consulting services. In discussions of accounting practices with Arthur Andersen. Similar provisions are in place under clause 49 of SEBI Act in India. The power of the corporate client to initiate and terminate management consulting services and. The exercise of this choice to improve apparent performance (popularly known as creative accounting) imposes extra information costs on users. However. The directors of the company should be entitled to expect that management prepare the financial information in compliance with statutory and ethical obligations. criteria for recognition. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management.Financial reporting is a crucial element necessary for the corporate governance system to function effectively. [17] Accountants and auditors are the primary providers of information to capital market participants. Enron concealed huge losses by creating illusions that a third party was contractually obliged to pay the amount of any losses. Current accounting practice allows a degree of choice of method in determining the method of measurement. views inevitably led to the client prevailing.[citation needed] 11. and rely on auditors' competence. more fundamentally. good financial reporting is not a sufficient condition for the effectiveness of corporate governance if users don't process it.

for taken too far it can dampen valuable risk-taking.S corporation · C corporation LLC · LLLP · Series LLC Delaware corporation Nevada corporation Massachusetts business trust Delaware statutory trust UK / Ireland / Commonwealth Limited company (by shares · by guarantee Public · Proprietary) Unlimited company Community interest company European Union / EEA SE · SCE · SPE · EEIG Elsewhere AB · AG · ANS · A/S · AS · GmbH K. Enforcement Enforcement can affect the overall credibility of a regulatory system. Moreover.A. · Oy · S. 2.this is harder to achieve if one is bound by a broader principle. They may be ill-equipped to deal with new types of transactions not covered by the code. Nevertheless. · more Doctrines Corporate governance Limited liability · Ultra vires Business judgment rule Internal affairs doctrine De facto corporation and corporation by estoppel Piercing the corporate veil Rochdale Principles Related areas Contract · Civil procedure 11. Rules also reduce discretion on the part of individual managers or auditors. one can still find a way to circumvent their underlying purpose . · N. In practice. It also pre-empts over zealous legislations that might not be practical. demarcating a clear line between acceptable and unacceptable behaviour. even if clear rules are followed. In practice rules can be more complex than principles. They both deter bad actors and level the competitive playing field. this is largely a . Rules versus principles Rules are typically thought to be simpler to follow than principles. 1. however. Principles on the other hand is a form of self regulation. 11. It allows the sector to determine what standards are acceptable or unacceptable.K. greater enforcement is not always better.V.

This type of software is based on project management style methodologies such as the ABACUS methodology which attempts to unify the management of these areas. Because enlightened directors strongly believe that it is their duty to involve themselves in an intellectual analysis of how the company should move forward into the future. Unlike traditional boards. since after a filing. 11. enlightened boards regard compliance with regulations as merely a baseline for board performance. what most distinguishes enlightened directors from traditional and standard directors is the passionate obligation they feel to engage in the day-to-day challenges and strategizing of the company. risk.theoretical. as opposed to a real. [18] 11. They are more likely to be supportive of the senior management team. Enlightened boards can be found in very large. risk and compliance solutions available to capture information in order to evaluate risk and to identify gaps in the organization¶s principles and processes. Proposals The book Money for Nothing suggests importing from England the concept of term limits to prevent independent directors from becoming too close to management and demanding that directors invest a meaningful amount of their own money (not grants of stock or options that they receive free) to ensure that the directors' interests align with those of average investors. the heavy presence of banks in the equity of German firms [9]. the enlightened board is aligned on the critically important issues facing the company. Enlightened directors go far beyond merely meeting the requirements on a checklist. They do not need Sarbanes-Oxley to mandate that they protect values and ethics or monitor CEO performance. most of the time. complex companies. 3. there is a considerable variation in corporate governance models around the world. Unlike standard boards that aim to comply with regulations. enlightened boards do not feel hampered by the rules and regulations of the Sarbanes-Oxley Act. enlightened directors recognize that it is not their role to be involved in the day-to-day operations of the corporation. the chaebols in South Korea and many others are examples of arrangements which try to respond to the same corporate governance challenges as in the US. [19] Another proposal is for the government to allow poorly-managed businesses to go bankrupt. Overall. Corporate governance models around the world Although the US model of corporate governance is the most notorious. directors have to cover more of their own legal bills and are frequently sued by bankruptcy trustees as well as investors. 4. . as well as smaller companies. They lead by example. Action Beyond Obligation Enlightened boards regard their mission as helping management lead the company. rather than treat them as separate entities. At the same time. There are various integrated governance. The intricated shareholding structures of keiretsus in Japan. [20] 12.

As a rule. However. normally. a corporation is governed by a board of directors.In the United States. Perverse incentives have pervaded many corporate boards in the developed world. The liberal model of corporate governance encourages radical innovation and cost competition. although the codes linked to stock exchange listing requirements may have a coercive effect. [21] 12. usually known as the chief executive officer. The coordinated model that one finds in Continental Europe and Japan also recognizes the interests of workers. but needs to get board approval for certain major actions. However. raising money. corporations. there are important differences between the U. institutional investors. customers. but are merely asked to rubberstamp the nominees of the sitting board. 1. These differ according to the variety of capitalism in which they are embedded. whereas the coordinated model of corporate governance facilitates incremental innovation and quality competition. where the controlling families favor subsidiaries for which they have higher cash flow rights. companies quoted on the London and Toronto Stock Exchanges formally need not follow the recommendations of their respective national codes. The liberal model that is common in Anglo-American countries tends to give priority to the interests of shareholders. Frequently. compliance with these governance recommendations is not mandated by law.S. the main problem is that the voting ownership is tightly-held by families through pyramidal ownership and dual shares (voting and nonvoting). Anglo-American Model There are many different models of corporate governance around the world. or associations (institutes) of directors and managers with the support of governments and international organizations. which some [22] see as a conflict of interest. individual shareholders are not offered a choice of board nominees among which to choose. 13. Codes and guidelines Corporate governance principles and codes have been developed in different countries and issued from stock exchanges. In the United States. and the community. acquiring another company. they should . The CEO has broad power to manage the corporation on a daily basis. Each model has its own distinct competitive advantage. major capital expansions. or other expensive projects. The board of directors is nominally selected by and responsible to the shareholders. monitoring management's performance. suppliers. Other duties of the board may include policy setting. such as hiring his/her immediate subordinates. recent approach to governance issues and what has happened in the UK. This can lead to "self-dealing". with board members beholden to the chief executive whose actions they are intended to oversee. where not. For example. managers. members of the boards of directors are CEOs of other corporations. the main problem is the conflict of interest between widely-dispersed shareholders and powerful managers. decision making. but the bylaws of many companies make it difficult for all but the largest shareholders to have any influence over the makeup of the board. which has the power to choose an executive officer. they must disclose whether they follow the recommendations in those documents and. In Europe. or corporate control.

by their stock exchange. The OECD remains a proponent of corporate governance principles throughout the world.This document aims to provide general information.provide explanations concerning divergent practices. Such documents. The highest number of companies are incorporated in Delaware. however. Such disclosure requirements exert a significant pressure on listed companies for compliance. and frameworks. This is due to Delaware's generally management-friendly corporate legal environment and the existence of a state court dedicated solely to business issues (Delaware Court of Chancery). The GM Board Guidelines reflect the company¶s efforts to improve its own governance capacity. In the United States. This was revised in 2004. Norman Veasey. in other words. participate on ABA committees. including former Delaware Supreme Court Chief Justice E. or should they create governance guidelines that ascend to the level of best practice. While Delaware does not follow the Act. other international organisations. For example. it still considers its provisions and several prominent Delaware justices. Building on the work of the OECD. private sector associations and more than 20 national corporate governance codes. companies are primarily regulated by the state in which they incorporate though they are also regulated by the federal government and. One of the most influential guidelines has been the 1999 OECD Principles of Corporate Governance. One issue that has been raised since the Disney decision [23] in 2005 is the degree to which companies manage their governance responsibilities. may have a wider multiplying effect prompting other companies to adopt similar documents and standards of best practice. a "snap-shot" of . the guidelines issued by associations of directors (see Section 3 above). standards. the United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) has produced voluntary Guidance on Good Practices in Corporate Governance Disclosure. Most states' corporate law generally follow the American Bar Association's Model Business Corporation Act. For example. if they are public. This internationally agreed [24] benchmark consists of more than fifty distinct disclosure items across five broad categories: [25] y y y y y Auditing Board and management structure and process Corporate responsibility and compliance Financial transparency and information disclosure Ownership structure and exercise of control rights The World Business Council for Sustainable Development WBCSD has done work on corporate governance. do they merely try to supersede the legal threshold. particularly on accountability and reporting. corporate managers and individual companies tend to be wholly voluntary. and in 2004 created an Issue Management Tool: Strategic challenges for business in the use of corporate responsibility codes. including more than half of the Fortune 500.

On the other hand. 1. and was responsive to investors' requests for information on governance issues. and webs. Other studies have linked broad perceptions of the quality of companies to superior share price performance. one measure of firm performance. Antunovich et al.And ownership can be changed by the stakeholders of the company. to locate the ultimate owner of a particular group of firms. It is a tool frequently employed by policy-makers and researchers in their analyses of corporate governance within a country or business group. McKinsey found that 80% of the respondents would pay a premium for well-governed companies. standards and frameworks relevant to the sustainability agenda. Egypt and Russia). who had no management ties. while others found no relationship between external board membership and profitability. In a recent paper Bhagat and Black found that companies with more independent boards are not more profitable than other companies. research into the relationship between specific corporate governance controls and some definitions of firm performance has been mixed and often weak. Others have found a negative relationship between the proportion of external directors and profitability. It is unlikely that board composition has a direct impact on profitability. 15. . concentration ratios) and then making a sketch showing its visual representation. The size of the premium varied by market. In a separate study Business Week enlisted institutional investors and 'experts' to assist in differentiating between boards with good and bad governance and found that companies with the highest rankings had the highest financial returns. The following examples are illustrative. Generally. 14. Some examples of ownership structures include pyramids. They defined a well-governed company as one that had mostly out-side directors. Board composition Some researchers have found support for the relationship between frequency of meetings and profitability.the landscape and a perspective from a think-tank/professional association on a few key codes. whilst the 'least admired' firms returned 80%. whenever possible. Corporate governance and firm performance In its 'Global Investor Opinion Survey' of over 200 institutional investors first undertaken in 2000 and updated in 2002. 15. cross-share holdings. undertook formal evaluation of its directors. rings. found that those "most admired" had an average return of 125%. In a study of five year cumulative returns of Fortune Magazine's survey of 'most admired firms'. from 11% for Canadian companies to around 40% for companies where the regulatory backdrop was least certain (those in Morocco. ownership structures are identified by using some observable measures of ownership concentration (i. Ownership structures Ownership structures refers to the various patterns in which shareholders seem to set up with respect to a certain group of firms. The idea behind the concept of ownership structures is to be able to understand the way in which shareholders interact with firms and.e.

Remuneration/Compensation The results of previous research on the relationship between firm performance and executive compensation have failed to find consistent and significant relationships between executives' remuneration and firm performance. rather than the short-term. while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. Standard & Poors 500 companies surged to a $500 billion annual rate in late 2006 because of the impact of options. Not all firms experience the same levels of agency conflict. . and less interested in the welfare of their shareholders. Federal Reserve Board economist Weisbenner) determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests. The results suggest that increases in ownership above 20% cause management to become more entrenched. Even before the negative influence on public opinion caused by the 2006 backdating scandal. that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and.S.15.S. However. and external and internal monitoring devices may be more effective for some than for others. Low average levels of pay-performance alignment do not necessarily imply that this form of governance control is inefficient. A compendium of academic works on the option/buyback issue is included in the study Scandal by author M. the backdating of option grants as documented by University of Iowa academic Erik Lie and reported by James Blander and Charles Forelle of the Wall Street Journal. A combination of accounting changes and governance issues led options to become a less popular means of remuneration as 2006 progressed. A particularly forceful and long running argument concerned the interaction of executive options with corporate stock repurchase programs. Numerous authorities (including U. in particular. These authors argued that. use of options faced various criticisms. and various alternative implementations of buybacks surfaced to challenge the dominance of "open market" cash buybacks as the preferred means of implementing a share repurchase plan. corporate stock buybacks for U. Some researchers have found that the largest CEO performance incentives came from ownership of the firm's shares. 2. in part. Gumport issued in 2006. Some argue that firm performance is positively associated with share option plans and that these plans direct managers' energies and extend their decision horizons toward the long-term. performance of the company.

http://www.jp/English/Publish/Download/Als/pdf/25.go.ide.pdf .