BM2210

CORPORATE GOVERNANCE AND ETHICAL CONSIDERATIONS

I. What is Corporate Governance?

Corporate governance has succeeded in attracting a good deal of public interest because of its apparent
importance for the economic health of corporations and society.

According to Sir Adrian Cadbury (1992), corporate governance is the system by which companies are
directed and controlled. It is concerned with holding the balance between economic and social goals and
between individual and communal goals.

According to International Finance Corporation (2018), corporate governance refers to structures and
processes for the direction and control of companies. Corporate governance concerns the relationships
among the management, board of directors, controlling shareholders, minority shareholders, and other
stakeholders.

Corporate Governance in the Philippines

Corporate governance is needed to make corporate management more accountable and their auditors more
rigorous. But good governance requires fair legal frameworks that should be enforced impartially. In this
country, the Philippine Securities and Exchange Commission (SEC), a principal player in corporate
governance matters, recently issued Memorandum Circular 2, Series of 2002, otherwise known as the Code
of Corporate Governance, under resolution no. 135, dated April 4, 2002.

The Code aims to promote corporate governance reforms that will raise investor confidence, develop the
capital market, and help achieve high sustained growth for the corporate sector and the economy.

The Code applies to:

• Corporations whose securities are registered or listed
• Corporations that are grantees of permits/licenses and secondary franchises from the
Commission
• Public companies and;
• Branches or subsidiaries of foreign corporations operating in the Philippines whose securities are
registered or listed

II. Elements of Corporate Governance

Corporate governance is the role that company boards or executive teams play in leadership and oversight.
While the specific elements of corporate governance are many, they generally emphasize creating and
maintaining company direction and promoting goodwill with shareholders and other stakeholders.
a. Good board practices
• Clearly defined roles and authorities
• Duties and responsibilities of directors understood
• Board is well structured
• Appropriate composition and mix of skills
b. Appropriate control and processes
• Independent audit committee established
• Risk-management framework present
• Internal control procedures
• Internal audit function
c. A stable regime of disclosure and transparency
• Financial information disclosed
• Non-financial information disclosed
• Financials prepared according to standard protocols

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• A high-quality annual report published

d. Protection of (minority) shareowner rights
• Well-defined shareowner rights
• Minority shareowner rights formalized
• Well-organized general assembly conducted
e. Strong commitment to corporate governance reforms
• The board discusses organizational governance issues and has created a corporate governance
committee
• The company has a corporate governance champion
• A corporate governance code has been developed

III. Agency Theory

Agency theory defines the relationship between the principals (shareholders of the company) and agents
(directors of the company). According to this theory, the company's principals hire agents to perform work.
The principals delegate the task of running the business to the directors or managers, who are agents of
shareholders. The shareholders expect the agents to act and make decisions in the principal's best interest.
On the contrary, the agent does not need to make decisions in the best interests of the principals. The agent
may succumb to self-interest and opportunistic behavior and fall short of the principal's expectations. The
critical feature of agency theory is the separation of ownership and control. The theory prescribes that
people or employees are held accountable for their tasks and responsibilities. Rewards and punishments
can be used to correct the priorities of agents.

IV. Stewardship Theory

The steward theory states that a steward protects and maximizes shareholders' wealth through firm
performance. Stewards are company executives and managers working for the shareholders, protecting
and making profits. The stewards are satisfied and motivated when organizational success is attained. It
stresses the position of employees or executives to act more autonomously so that the shareholders' returns
are maximized. The employees take ownership of their jobs and work at them diligently.

V. Stakeholder Theory
Stakeholder theory incorporated the accountability of management to a broad range of stakeholders. It
states that managers in organizations have a network of relationships to serve – this includes the suppliers,
employees, and business partners. The theory focuses on managerial decision-making and the interests of
all stakeholders.

VI. FACTORS INFLUENCING ETHICAL BEHAVIORS

Business ethics refers to the moral principles or values that generally govern the conduct of an individual
or group. Ethical behavior is acting in ways consistent with how the business world views moral principles
and values. Business ethics determine employees' everyday conduct.

A. Individual Factors
Many individual factors affect a person's ethical behavior at work, such as knowledge, values, personal
goals, morals, and personality.

Values, Integrity, and Background

• Personal values are individual beliefs about desirable behaviors and goals that are stable over
time.
▪ Values are about the behaviors and things that we deem necessary in life; ensuring well-
being collectively and individually (e.g., family values; work ethic; environmental benefits; self-
respect; equality)
• Integrity is a person's ability to adhere to a consistent set of moral principles or values

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o Living virtuously
o Walking the talk – being consistent in actions and beliefs
o Background and Experience: exposure to different environments (e.g., business and
economics students cheat more)

Psychological Factors
• Locus of Control: the extent to which a person believes they have control over the events in their
life.
o Internal = blame yourself
o External = blame external reasons/others
o A way of predicting the moral behavior of people if you know what their general locus of
control is like
• Moral Imagination: the creativity with which one can reflect on an ethical dilemma.
o Seeing beyond the rules of the game to find solutions
o Rationalization can lead to bending morals or bad situations

B. SITUATIONAL INFLUENCES
Ethics intensity or issue intensity indicates the degree to which a situation is recognized to pose
ethical challenges.

Organizational Context
• Incentives: The systems of reward and punishment within the organization.
o Employee 1 achieves a 20% increase using hard work.
o Employee 2 completes a 25% increase by cheating.
o Employee 2 gets promoted.
• Authority: The exercise of hierarchical power to compel a subordinate to act in a certain way
o "What is right in the organization is what the guy above you wants from you."
▪ But, what if the superiors, or the system, are corrupt?

Informal Organization Effects

• Peer effects: Direct or indirect influence of others on one's behavior (due to pressure or mere
exposure)
o Students in the classroom
o Stockbrokers in finance
• Routines: Repeated patterns of behavior or interactions. Often mechanically performed activities
or procedures.
o Doping becomes a routine
o Illegal downloads, copying the song from your friend

Organization Culture
Organization Culture is the meanings, beliefs, and practical knowledge shared among members of an
organization and represented in taken-for-granted assumptions, norms, and values.

• Work roles: Functional and hierarchical

o People adapt to the tasks they are assigned to
o Adopts behavior different than what they exhibit in healthy life
• Bureaucracy: Suppresses morality by freeing the individual from moral reflection and decision-
making.
o Characterized by detailed rules and policies, set within impersonal hierarchies
o They need to follow the prescribed rules and procedures

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VII. POTENTIAL PROBLEMS IN CORPORATE GOVERNANCE

Corporate governance is the term used to describe the balance among participants in the organizational
structure. They have an interest in the way in which the corporation runs, such as executive staff,
shareholders, and members of the community. Corporate governance directly impacts the profits and
reputation of the company, and having poor policies can expose the company to lawsuits, fines, reputational
damage, and loss of capital investment.

A. CONFLICTS OF INTEREST
Avoiding conflicts of interest is vital. A conflict of interest within the corporate governance framework
occurs when an officer or other controlling member of a corporation has other financial interests that
directly conflict with the corporation's objectives.
B. OVERSIGHT ISSUES
Effective corporate governance requires the board of directors to oversee the company's procedures
and practices substantially. Oversight is a broad term that encompasses the executive staff reporting
to the board and the board's awareness of the company's daily operations and how its objectives are
achieved.
C. ACCOUNTABILITY ISSUES
Accountability is necessary for effective corporate governance. From the top-level executives to lower-
tier employees, each level and division of the corporation should report and be accountable to one
another as a system of checks and balances. Above all else, the actions of each level of the corporation
are responsible to the shareholders and the public. Without accountability, one corporation's division
might endanger the entire company's success or cause stockholders to lose the desire to continue their
investment.
D. TRANSPARENCY
To be transparent, a corporation must accurately report its profits and losses and make those figures
available to those who invest in the company. Overinflating profits or minimizing losses can seriously
damage the company's relationship with stockholders because they are enticed to invest under
pretenses. A lack of transparency can expose the company to fines from regulatory agencies.
E. ETHICS VIOLATIONS
Executive board members have an ethical duty to make decisions based on the stockholders' best
interests. Further, a corporation has a moral responsibility to protect the social welfare of others,
including the greater community in which they operate.

References:
Cadbury, S. A., & Cadbury, C. A. (2002). Corporate governance and chairmanship: A personal view. Oxford University
Press on Demand.
Cadbury, A., (1992), The Financial Aspects of Corporate Governance (Cadbury Report), London, UK: The Committee on
the Financial Aspect of Corporate Governance (The Cadbury Committee) and Gee and Co, Ltd, pp
Cortez, F. G. F. (2016). Business ethics and social responsibility. Quezon City: Vibal
Crane, A., & Matten, D. (2016). Business ethics: managing corporate citizenship and sustainability in the age of
globalization. Oxford: Oxford University Press
International Finance Corporation. (2018). Why Corporate Governance. www.ifc.org/corporategovernance
Muir, J. (2019, August 6). Corporate governance issues | J Muir & Associates. J. Muir & Associates.
https://jmuirandassociates.com/corporate-governance-issues/
Ozery, T. (2016, September 8). Principles of corporate governance. The Harvard Law School Forum on Corporate
Governance. https://corpgov.law.harvard.edu/2016/09/08/principles-of-corporate-governance/
Strenger, C. (2018, March 5). Key governance issues—Ways for the future. The Harvard Law School Forum on Corporate
Governance. https://corpgov.law.harvard.edu/2018/03/05/key-governance-issues-ways-for-the-future/

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