Fundamentals of

Corporate
Governance
CHAPTER XII
 Chapter Objectives
•Define corporate governance structure and its components of principles,
functions, and mechanisms.
•Provide an overview of the corporate governance theories.
•Understand the corporate governance structure, and mechanisms.
•Provide an overview on the corporate governance principles and
guidelines.
•Become familiar with the guiding principles and illustrate how each of
them contribute to the effectiveness of corporate governance.
•Provide an overview on the listing standards corporate governance
principles.
•Provide an overview on all the corporate governance functions.
 Key Terms
• Accountability • Oversight Function
• Agency theory • Legal Counsel / Financial Advisory
• Compliance functions Function

• Oversight board
• Corporate governance effectiveness
• Rebuilding Trust
• Corporate governance rating
• Remuneration
• Ethical conduct
• External Audit Function • Shareholder
• Shareholder democracy
• External governance mechanisms
• Independence • Stakeholder
• Internal Audit Function • Transparency
• Internal governance mechanisms • Value-adding philosophy
• Managerial Function
• Monitoring Function
 Corporate Governance Definitions
Agency Theory: A process of aligning interests of management with those of
shareholders

Legal Compliance: A process of compliance with all applicable laws, rules,

regulations, standards and best practices of corporate governance

Corporate Strategy: A process of effectively achieving the organization goals

and operating objective in creating shared value for all stakeholders, particularly
shareholders

Scholarly Research: A process of holding all corporate gatekeepers

accountable in effectively discharging their fiduciary responsibilities.
 Definition of Corporate Governance
The process affected by a set of legislative, regulatory, legal, market
mechanisms, listing standards, best practices, and efforts of all corporate
governance participants, including the Company’s directors, officers, auditors,
legal counsel, and financial advisors, which creates a system of checks and
balances with the goal of creating and enhancing enduring and sustainable
shareholder value, while protecting the interests of other stakeholders.
 Aspects of Corporate Governance
In the post-SOX era, corporate governance further evolved to the integrated
aspects of meeting both compliance requirements and promoting a strategic
business imperative. There are three aspects: shareholder aspect, stakeholder
aspect, and an integrated aspect.
Shareholder Aspect: This aspect is based on the premise that shareholders
provide capital to the corporations that exist for their benefit.
Stakeholder Aspect: Stakeholders are now becoming more engaged in a
company performance on a variety of economic, governance, ethical, social
and environment issues.
Integrated Aspect: Modern corporate governance emphasizes BOTH
financial aspects of increasing shareholders’ value AND an integrated
approach that considers the rights and interests of all stakeholders.
 Corporate Governance Theories
Shareholder Theory: The shareholder theory of corporate governance is derived
from the agency aspect of corporations and is based on the concept that the primary
objective of corporations is to create shareholder value and thus the purpose of
corporate governance is to align management interests with those of shareholders.
Stakeholder Theory: Stakeholder theory requires: (1) identification of all
stakeholders who affect and are affected by the organization’s business and affairs
including investors, creditors, customers, employees, suppliers, society and the
environment; (2) determination of rights, authorities, responsibilities and
accountability of each stakeholder; (3) development of a systematic process to ensure
proper accountability for the stewardship of the organization’s resources and capitals;
and (4) establishment of a fair system of rewards based on the risk taken by
stakeholders.
Legitimacy Theory: Legitimacy theory is based on a socio-political view and posits
that business organizations should preserve their legitimacy by fulfilling their social
and political contract. Business organizations should communicate their corporate
governance effectiveness to their stakeholders to obtain legitimacy and fulfill the
‘social contract.
 Corporate Governance Theories
Signaling Theory: Signaling theory suggests that firms disclose “good news” with
various mandatory financial reports governance reports and voluntary corporate to
differentiate themselves from peer firms with less effective corporate governance. The
signally theory suggests that firms should communicate their corporate governance
effectiveness with all stakeholders to build branding and good reputation for
themselves.
Institutional Theory: Institutional theory promotes the role of normative influences
in decision-making processes and thus corporate governance effectiveness. It focuses
on the social attributes of decision-making and corporate governance that could
impact society and the environment.
Stewardship Theory: Stewardship theory helps in explaining ways in which
business organizations should be held responsible stewards in creating shared value
by contributing to wealth creation for shareholders, as well as contributing to the
wellbeing of customers, employees, society, and the environment. Stewardship theory
is applicable to corporate governance because it considers management strategic
decisions and actions as stewardship behaviors in protecting interests of all
stakeholders.
 Corporate Governance Structure
Corporate governance is based on three interrelated components: corporate
governance principles, functions and mechanisms.
 Corporate Governance Principles
Honesty: Corporate communications with both internal and external
audiences, including public financial reports, should be accurate, fair,
transparent, and trustworthy.

Resilience: A resilient corporate governance structure is sustainable and

enduring in the sense that it will easily recuperate from setbacks and abuses.

Responsiveness: Effective corporate governance is responsive to the interests

and desires of all stakeholders, as well as to emerging initiatives and changes
in political, regulatory, social, and environmental issues.

Transparency: Transparency means that the company is not hiding relevant

information, and disclosures are fair, accurate, and reliable.
Guiding Principles of Good Governance (GPGG)
The Global Network of Director Institutes
(GNDI), May 2015
Principle 1
Responsibility: Every organization should be headed by an effective board that is
collectively responsible for overseeing the long-term success of the organization and is
charged with its direction

Principle 2
Organizational culture: The board sets the cultural and ethical tone for the
organization. Governance structures should be designed to encourage an appropriate
organizational culture of integrity, ethics and corporate social responsibility and be
tailored to the needs of the organization.

Principle 3
Disclosure of practices: The governance structures and practices that have been
adopted by the board should be disclosed

Principle 4
Independence: All directors should exercise independent judgment. They must also
provide independent oversight of management.
Guiding Principles of Good Governance (GPGG)
The Global Network of Director Institutes (GNDI),
May 2015
Principle 5
Composition and leadership: The board should comprise an appropriate number of
directors who have a relevant and diverse range of skills, expertise, experience and
background and who are able to effectively understand the issues arising in the
organization's business, provide insight and add value.
Principle 6
Nomination: A formal, rigorous and transparent procedure should be in place for the
nomination of directors and re-election of directors to the board.
Principle 7
Knowledge: Directors should act diligently on an appropriately informed basis and have
access to accurate, relevant and timely information.
Principle 8
Risk: The board should have an appropriate system of risk oversight and internal
controls in place.
 Guiding Principles of Good Governance (GPGG)
The Global Network of Director Institutes (GNDI)
Principle 9
Relationship with management: There should be a clear division of responsibilities between the board and
the management with the board overseeing management functions.
Principle 10
CEO and senior executives: The board is responsible for the appointment of the CEO and the continuing
evaluation of his or her performance.
Principle 11
Communication: The board should require that the organization communicates with shareholders and other
stakeholders in a regular and timely manner, to the extent that the board thinks is in the best interests
Principle 12
Evaluation: The board’s performance (including the performance of its chair, the individual directors and,
where appropriate, the board’s committees), needs to be regularly assessed and appropriate actions taken to
address any issues identified.
Principle 13
Remuneration: There should be formal and transparent processes for setting the level and composition of
remuneration for the CEO and senior executives, as well as the remuneration of non-executive directors.
Listing Standards Corporate Governance Principles
Principle 1: The board’s fundamental objective should be to create sustainable shareholder value and is
responsible and accountable to shareholders for its performance in achieving this objective.
Principle 2: Managements primary responsibility is to create an environment in which a culture of
performance with integrity can flourish.
Principle 3: Shareholders have the right, a responsibility, and a long-term economic interest to exercise
their voting rights to influence director behavior, corporate governance, and communicate their issues of
concern.
Principle 4: Good corporate governance should be integrated with the company’s business strategy and
objectives.
Principle 5: Legislation and agency rulemaking are important to establish the basic tenets of corporate
governance; market-based best practices of corporate governance should also be employed.
Principle 6: Corporate governance policies, practices, and performance should be effectively
communicated to shareholders.
Principle 7: Listed companies should strike the proper balance between the selection of independent and
non-independent directors to take a full advantage of expertise, diversity, and knowledge on the board.
Principle 8: Advisory should be held to appropriate standards of transparency and accountability.
Principle 9: The SEC should work with the NYSE and other exchanges to ensure effective, efficient,
useful, and transparent the proxy voting process.
Principle 10: The SEC and/or the NYSE should periodically assess the impact of major corporate
governance reforms on the achievement of sustainable performance.
CORPORATE GOVERNANCE
FUNCTION
OVERSIGHT
MANAGERIAL Board of Directors
Audit Committee
MONITORING
Management

Stakeholders
Public Trust and
Investor Confidence
COMPLIANCE

Governing Bodies Corporate Governance EXTERNAL AUDIT

Effectiveness

External
Auditors
INTERNAL
AUDIT ADVISORY

Internal
Legal Counsel
Auditors
Financial
Analysts
 Corporate Governance Functions
Oversight Function: The board of directors should provide strategic advice to management and oversee
managerial performance, yet avoid micromanaging
Managerial Function: The effectiveness of this function depends on the alignment of management’s
interests with those of shareholders
Compliance Function: The set of laws, regulations, rules, standards, and best practices developed by
state and federal legislators, regulators, standard-setting bodies, and professional organizations to create a
compliance framework for public companies in which to operate and achieve their goals
Internal Audit Function: Assurance and consulting services to the company in the areas of operational
efficiency, risk management, internal controls, financial reporting, and governance processes
Legal and Financial Advisory Function: Legal advice and assists the company, its directors, officers,
and employees in complying with applicable laws and other legal obligations and fiduciary duties
External Audit Function: External auditors lend credibility to the company’s financial reports and thus
add value to its corporate governance through their integrated audit of both internal control over financial
reporting and financial statements
Monitoring Function: Shareholders, particularly institutional shareholders, empowered to elect and, if
warranted, remove directors
 Corporate Governance Mechanisms
The corporate governance structure is shaped by internal and external governance
mechanisms, as well as policy interventions through regulations. Both internal and
external corporate governance mechanisms of the company have evolved over time to
monitor, bond and control management.

Internal Mechanisms: External Mechanisms:

• Board of directors
• Independent directors
• Audit committee
• Compensation committee
• Nomination committee
• Management
• Internal controls
• Internal audit functions
• Market for corporate control
• Capital market
• Labor market
• Federal and state statutes
• Court decisions
• Shareholders’ proposals
• Best practices of investors’
activists
Sources of Corporate Governance Measures
Corporate Laws
The Federal Securities Laws
May vary from state to state, but most have adopted
Model Business Corporation Act as their corporate
law
Fundamental laws are: the Securities Act of 1933 and the
Securities Exchange Act of 1934,
Sarbanes-Oxley (SOX) Act of 2002, Dodd-frank Act of
2010, JOBS Act of 2012 expanded the role of federal
statutes by providing measures to improve corporate
governance, financial reports, and audit activities.

Adopted by national stock exchanges, these standards are

Listing Standards applicable to all public companies listing their equity
shares with some exceptions.

Recommended by professional organizations (e.g. The

Best Practices Conference Board, the Business Roundtable Institute) and
investor activists (e.g. Council of Institutional Investors),
Europe Corporate Governance
 NYSE Corporate Governance Rules:
Section 303A
Independent Directors:
Listed companies must have a majority of independent directors.
Independence Tests:
Companies must identify which directors are independent (have no material
relationships with the company) and disclose the basis for that determination.
Executive Sessions:
The nonmanagement directors of each listed company must meet at regularly
scheduled executive sessions without management.
Nominating/Corporate Governance Committee:
Listed companies must have a nominating/corporate governance committee
composed entirely of independent directors. The nominating committee must
have a written charter.
 NYSE Corporate Governance Rules:
Section 303A
Compensation Committee:
Listed companies must have a compensation committee composed entirely of
independent directors.
Audit Committee:
Listed companies must have an audit committee that satisfies the requirements of Rule
10A-3 under the Exchange Act.
Audit Committee Additional Requirements:
The audit committee must have a minimum of three members.
In addition to any requirement in Rule 10A.3(b)(1), all audit committee members must
satisfy the requirements for independence set out in Section 303A.02.
Shareholder Approval of Equity Compensation Plans:
The shareholders must be given the opportunity to vote on all equity-compensation
plans and material revisions thereto, with limited exemptions defined by the NYSE
corporate governance rules.
 NYSE Corporate Governance Rules:
Section 303A
Corporate Governance Guidelines:
Listed companies must adopt and disclose corporate governance guidelines that address
certain subjects.

Code of Business Conduct and Ethics:

Listed companies must adopt and disclose a code of business conduct and ethics for
directors, officers, and employees, and promptly disclose any waivers of the code for
directors or executive officers.

Foreign Private Issuer Disclosure:

Listed foreign private issuers must disclose any significant ways in which their corporate
governance practices differ from those followed by domestic companies under NYSE
listing standards.
 NYSE Corporate Governance Rules:
Section 303A
Certification Requirements
Each listed company CEO must certify to the NYSE each year that he or she is
not aware of any violation by the company of NYSE corporate governance
listings standards, qualifying the certification to the extent necessary.
Each listed company must submit an executed Written Affirmation annually to the
NYSE and promptly report any material incompliance with application of Section
303A.

Public Reprimand Letter

The NYSE may issue a public reprimand letter to any listed company that violates
an NYSE listing standard.

Web Site Requirement

Listed companies must have and maintain a publicly accessible Web site

Source: NYSE Corporate Governance Rules: Section 303A. Available at:

www.nyse.com/pdfs/finalcorpgovrules.pdf.
 Corporate Governance Reporting
Corporate Governance Reporting (CGR) entails assessing the quality and
effectiveness of the organization’s corporate governance and reporting
findings to interested stakeholders, including the board of directors,
executives, auditors, regulatory agencies, and shareholders.

Corporate Governance Reporting:

1. Disclose all relevant information about the effectiveness of the company’s
corporate governance.
2. Focus on the company’s sustainability performance.
3. Provide transparent information about the company’s performance and its
impacts on all stakeholders.
4. Assess the company’s responsiveness to the needs of its stakeholders.
 Efficacy of Regulations
Regulations must be efficient, cost-effective and scalable.
Well-conceived, science-based regulations are essential to protect human
health and safety.
Regulations can help ensure that businesses retain the capacity to innovate
and simultaneously promote the health and welfare of our employees,
customers and communities.
Overlapping, conflicting and poorly executed regulations can—and do—
impose substantial costs on the U.S. economy.
 Smart Regulation
Smart regulation seeks to realize the goals of regulation without harming
economic growth and job creation.
Both the U.S. House of Representatives and the Senate have introduced
similar versions of bipartisan legislation, the
Regulatory Accountability Act of 2013, which would write smart
regulation into law.
 Chapter Summary
•Corporate governance structure consists of principles, mechanisms, and seven
interrelated functions to achieve a primary goal of creating sustainable shareholder
value.
•Corporation should establish a corporate governance structure that ensures the goals
of both shareholder value creation and stakeholder value protection for public
companies based on the principles of: value-adding philosophy, ethical conduct,
accountability, shareholder democracy and fairness, integrity of financial reporting,
transparency, and independence.
•The role of corporate governance is to align management incentives with investor
interests.
•Good corporate governance is committed to transparency which leads to an increase
in capital inflows from domestic and foreign investors.
•The corporate governance structure is shaped by internal and external governance
mechanisms as well as policy interventions through regulations.
•Corporate governance mechanisms are viewed as a nexus of contracts that are
designed to align the interests of management with those of major and controlling as
well as minority shareholders.
 Key Points
• Increase commitments to business sustainability in terms of board and management attention and sound
investment.
• Reconsider and re-evaluate the role and responsibilities of the board of directors, management, internal
and external auditors and legal counsel to ensure that they comply with regulatory reforms.
• Link executive compensation to long term, enduring and sustainable performance.
• Ensure vigilant oversight function by the board of directors on internal control over financial reporting.
• Improve board oversight of management in achieving sustainable corporate governance.
• Encourage and enable all stakeholders, particularly shareholders, to take a more proactive role in
corporate governance.
• Develop and implement global market mechanisms that allow shareholders to vote on a company’s legal
jurisdiction in a country that has better investor protection laws and more effective corporate governance.
• Establish effective and enforceable global corporate governance rules and guidelines.
• Hold companies worldwide accountable to their shareholders and other stakeholders including creditors,
employees, customers, suppliers, society and the environment.
Concluding Remarks and
Questions?
Thank you for your Attention