What Is Corporate Governance? Corporate governance is essentially an organized way of overseeing and leading a professionally-run corporation with the aim of serving all of its shareholders fairly. At the center of this concept is the board of directors. While the management is responsible for running the business, it is the role of the board to supervise and provide guidance to the management. As part of its role, the board considers and decides on major business strategies, annual budgets, performance targets, as well as management compensation and appointments. It also ensures the integrity of the company’s financial reporting system and the accurate and regular disclosure of material information, including foreseeable business risks. Ultimately, the board answers to the shareholders, and its goal is to protect and maximize the interest of all shareholders without prejudice.
In order to act as a check against the management, the board needs to be as independent as possible. While it is customary for senior executives, e.g. the CEO, CFO etc., to retain seats on the board, a substantial majority of the directors should be non-executive and independent. Additionally, the functional committees, i.e. the audit, compensation, nomination committee, and others, should be composed wholly or predominantly of independent directors and be chaired by them. Corporate governance is only effective when there is adequate separation between the management and the board.
Why Is It Necessary?
APVCA is of the belief that corporate governance is necessary for several important reasons. First, corporate governance is a counterforce to the agency problem inherent in all organizations—there is always the possibility the appointed management or owner-manager may act out of self-interest, e.g. engage in connected transactions. Hence the board of directors is necessary as a check against any potential abuse of power by the management or controlling shareholder, and it helps to align the interest of the corporation with that of all its shareholders.
Second, non-executive directors can provide additional guidance, leadership, and networking contacts to the business. Since non-executive directors often have strong industry or financial experience, they can bring helpful and refreshing perspectives to the management with their insights and expertise. For example, directors from private equity firms, because of their involvement in portfolio companies, are knowledgeable about initial public offerings and mergers and acquisitions. And besides providing guidance and leadership to the management, non-executive directors can also prove invaluable with their established network of business contacts.
Third, corporate governance helps to enhance the value of the business. Investors, particularly institutional investors, are especially wary of companies with poor management accountability and transparency. With an independent board of directors overseeing management and ensuring proper disclosure, corporate governance can help to bolster the confidence of current and prospective investors, which in turn will translate into favorable valuation of the company.
Lastly, it helps to make the firm more attractive to other parties aside from investors. For example, potential employees, customers, and suppliers may feel more comfortable dealing with a company they know is transparent and well-run. And creditors may be more willing to lend to a company and management they feel they can trust better. All said, corporate governance simply puts the company on firmer footing in all respects.
Key Principles of Corporate Governance
A company requires a balanced board of directors, with at least 33% of the board comprised of independent, non-executive directors.
This is necessary in order to oversee management performance and conduct, advise on business strategy, ensure the integrity of the company's financial reporting system, and protect the rights of all shareholders.
All shareholders should have the right to participate in general meetings and to approve critical decisions affecting the corporation, such as a sale of key assets.
These are fundamental rights equity investors are entitled to, and observing these rights send positive signals to potential equity investors.
There should be only one vote for each share in each class of shares.
Deviation from "one share, one vote" such as multiple vote shares causes disproportional representation and diminishes investor interest.
Minority shareholders should be given due consideration by the controlling shareholders.
To protect minority shareholders' rights and interest; so that future investors will not be discouraged to take up minority stakes and to ensure the company receives the best valuation from the market.
For public companies, the board's audit, compensation, and nomination committee should be wholly or substantially composed of non-executive, independent directors.
So that the committees function impartially and independent of management, and their actions represent the interest of shareholders.
Board directors should have direct access to accurate and up-to-date and, if necessary, independent corporate information.
To enable active monitoring of business activities and allow directors to make decisions on a fully-informed basis.
Board meetings should be held regularly, around four times per year, and actively attended by the directors.
So that all appointed directors keep abreast of business developments and are able deal with them on a timely basis.
Discussion of key business strategy, past performance, operation, risks, competition, industry, etc. should be disclosed in an accurate and timely manner.
To allow current and potential investors to properly assess the company and make informed decisions.
Material financial information should be prepared, audited, and disclosed in an accurate and timely manner.
Again, to allow current and potential investors to properly assess the company and make informed decisions.
The management and directors should disclose any personal transactions involving or affecting the corporation.
To deter and disclose any potential conflict of interests by the management or directors.
Whether public or private, the company should issue a detailed "Report of the Directors,” describing the board's composition, the committees, its corporate governance policy, etc.
To serve as a blueprint for the board and to make transparent the company's corporate governance procedures and policy to all interested parties.
The compensation for the management and directors should be disclosed and aligned with the interest of all shareholders.
To ensure that compensation is reasonable and consistent with the individual and company's performance and that of the industry.
Appendix: OECD Principles of Corporate Governance *
I. The Board’s Responsibilities
I. Shareholders’ Rights
- Basic shareholder rights include the right to: 1) secure methods of ownership registration; 2) convey or transfer shares; 3) obtain relevant information on the corporation on a timely and regular basis; 4) participate and vote in general shareholder meetings; 5) elect members of the board; and 6) share in the profits of the corporation.
- Shareholders have the right to participate in, and to be sufficiently informed on, decisions concerning fundamental corporate changes such as: 1) amendments to the statutes, or articles of incorporation or similar governing documents of the company; 2) the authorization of additional shares; and 3) extraordinary transactions that in effect result in the sale of the company.
- Shareholders should be able to participate effectively and vote in general shareholder meetings and should be informed of the rules, including voting procedures, that govern general shareholder meetings:
- Shareholders should be furnished with sufficient and timely information concerning the date, location and agenda of general meetings, as well as full and timely information regarding the issues to be decided at the meeting.
- Opportunity should be provided for shareholders to ask questions of the board and to place items on the agenda at general meetings, subject to reasonable limitations.
- Shareholders should be able to vote in person or in absentia, and equal effect should be given to votes whether cast in person or in absentia.
III. Equitable Treatment of Shareholders
- Within any class, all shareholders should have the same voting rights. All investors should be able to obtain information about the voting rights attached to all classes of shares before they purchase. Any changes in voting rights should be subject to shareholder vote.
- Votes should be cast by custodians or nominees in a manner agreed upon with the beneficial owner of the shares.
- Processes and procedures for general shareholder meetings should allow for equitable treatment of all shareholders. Company procedures should not make it unduly difficult or expensive to cast votes.
IV. Disclosure & Transparency
* The text in the appendix is excerpted from sections of the OECD Principles of Corporate Governance. The complete document can be viewed and downloaded from the OECD website at www.OECD.org