3.6 Corporate governance

Corporate governance is the system of rules and practices guiding company management. It ensures accountability, fairness, and transparency in relationships with stakeholders. Effective governance builds trust, attracts capital, manages risks, and creates long-term value for shareholders and society.

Key principles include accountability, transparency, fairness, responsibility, independence, and ethical behavior. Governance structures define roles and relationships among the board, management, and shareholders. The board oversees management and sets strategic direction, balancing various stakeholder interests.

Corporate governance overview

• Corporate governance is the system of rules, practices, and processes by which a company is directed and controlled, ensuring accountability, fairness, and transparency in a company's relationship with its stakeholders (shareholders, management, customers, suppliers, financiers, government, and the community)
• Effective corporate governance is essential for building trust with investors, attracting capital, managing risks, and creating long-term value for shareholders and society as a whole
• Corporate governance practices vary across countries and industries, influenced by factors such as legal and regulatory frameworks, ownership structures, and cultural norms

Importance of corporate governance

Top images from around the web for Importance of corporate governance

• 

  Corporate Law and Corporate Responsibility – Business Ethics View original

  Is this image relevant?

• 

  Corporate Governance | Bell Resources Limited | 2024 View original

  Is this image relevant?

• 

  How to Measure and Manage Your Corporate Reputation View original

  Is this image relevant?

• 

  Corporate Law and Corporate Responsibility – Business Ethics View original

  Is this image relevant?

• 

  Corporate Governance | Bell Resources Limited | 2024 View original

  Is this image relevant?

1 of 3

Top images from around the web for Importance of corporate governance

• 

  Corporate Law and Corporate Responsibility – Business Ethics View original

  Is this image relevant?

• 

  Corporate Governance | Bell Resources Limited | 2024 View original

  Is this image relevant?

• 

  How to Measure and Manage Your Corporate Reputation View original

  Is this image relevant?

• 

  Corporate Law and Corporate Responsibility – Business Ethics View original

  Is this image relevant?

• 

  Corporate Governance | Bell Resources Limited | 2024 View original

  Is this image relevant?

1 of 3

• Helps align the interests of management with those of shareholders, reducing agency problems and conflicts of interest
• Enhances transparency and disclosure, enabling investors to make informed decisions and hold management accountable
• Promotes ethical behavior and responsible decision-making, protecting the rights of stakeholders and maintaining the company's reputation
• Supports effective risk management and internal controls, preventing fraud, misconduct, and financial misstatements
• Facilitates access to capital markets and reduces the cost of capital by signaling good governance practices to investors

Key principles of effective governance

• Accountability: The board and management are accountable to shareholders and stakeholders for their decisions and actions
• Transparency: The company provides timely, accurate, and complete disclosure of material information to shareholders and the public
• Fairness: All shareholders are treated equitably, and their rights are protected, including minority shareholders
• Responsibility: The board sets the strategic direction of the company, oversees management, and ensures compliance with laws and regulations
• Independence: The board includes independent directors who can provide objective oversight and challenge management when necessary
• Ethical behavior: The company promotes a culture of integrity, honesty, and ethical conduct at all levels of the organization

Corporate governance structures

• Corporate governance structures define the roles, responsibilities, and relationships among the board of directors, management, shareholders, and other stakeholders
• Effective governance structures promote accountability, transparency, and alignment of interests, while enabling the board to provide strategic guidance and oversight

Board of directors composition

• The board of directors is the highest governing body of a company, elected by shareholders to represent their interests and oversee management
• Board composition should include a mix of skills, experience, and diversity to provide effective oversight and strategic guidance
• Factors to consider in board composition include industry expertise, financial acumen, risk management experience, and diversity (gender, race, age, background)
• Board size should be appropriate to the company's size and complexity, typically ranging from 7 to 15 members

Independent vs executive directors

• Independent directors are not employed by the company and have no material relationship with the company or its management, allowing them to provide objective oversight
• Executive directors are members of the company's management team, such as the CEO or CFO, and bring insider knowledge and operational expertise to the board
• Best practices recommend a majority of independent directors on the board to ensure effective oversight and avoid conflicts of interest
• The roles of CEO and chairman are often separated to maintain a balance of power and independence on the board

Board committees and charters

• Board committees are smaller groups of directors tasked with specific oversight responsibilities, such as audit, compensation, nominating, and governance
• Audit committee oversees financial reporting, internal controls, and the external auditor, ensuring the integrity of financial statements
• Compensation committee sets executive compensation policies and aligns pay with performance, considering shareholder interests
• Nominating committee identifies and recommends candidates for board membership, considering skills, diversity, and independence
• Each committee should have a written charter outlining its purpose, responsibilities, composition, and procedures

Governance policies and guidelines

• Governance policies and guidelines provide a framework for the board and management to fulfill their responsibilities and make decisions in the best interests of the company and its stakeholders
• Key policies include:
  • Code of ethics and conduct, setting expectations for ethical behavior and compliance with laws and regulations
  • Conflict of interest policy, requiring disclosure and management of potential conflicts
  • Insider trading policy, prohibiting trading on material non-public information and setting trading windows
  • Whistleblower policy, providing a mechanism for employees to report misconduct or violations without fear of retaliation
• Governance guidelines outline the board's structure, composition, responsibilities, and procedures, such as:
  • Director independence standards, tenure limits, and retirement age
  • Board and committee meeting frequency and attendance expectations
  • Director orientation and continuing education programs
  • Board and committee self-evaluation processes

Shareholder rights and activism

• Shareholder rights refer to the legal and contractual rights of shareholders as owners of the company, including the right to vote, receive dividends, and participate in corporate actions
• Shareholder activism involves shareholders using their rights and influence to promote changes in corporate governance, strategy, or social and environmental practices

Voting rights and procedures

• Shareholders have the right to vote on key corporate matters, such as electing directors, approving mergers and acquisitions, and amending the company's charter or bylaws
• Voting can take place at the annual general meeting (AGM) or through proxy voting, where shareholders can cast their votes without attending the meeting in person
• Voting rights are typically proportional to the number of shares owned, with common stock carrying one vote per share
• Cumulative voting allows shareholders to concentrate their votes on a smaller number of candidates, increasing the chances of electing minority representatives to the board

Shareholder proposals and resolutions

• Shareholder proposals are resolutions submitted by shareholders for consideration at the AGM, typically related to corporate governance, social, or environmental issues
• Proposals can be binding (requiring the company to take action if approved) or non-binding (expressing shareholder sentiment and encouraging the board to consider the issue)
• SEC Rule 14a-8 governs the process for submitting and including shareholder proposals in the company's proxy materials, setting eligibility requirements and grounds for exclusion
• Successful shareholder proposals have led to changes in board composition, executive compensation, and sustainability practices at many companies

Activist investors and campaigns

• Activist investors are shareholders who acquire a significant stake in a company and use their influence to push for changes in governance, strategy, or operations
• Activist campaigns can take various forms, such as:
  • Proxy contests: Nominating alternative candidates for the board to challenge incumbent directors
  • Public pressure: Criticizing management or the board through media campaigns, open letters, or social media
  • Shareholder resolutions: Submitting proposals for governance or strategic changes at the AGM
  • Litigation: Filing lawsuits against the company or its directors for alleged breaches of fiduciary duties
• High-profile activist investors include hedge funds (Elliott Management, Pershing Square), pension funds (CalPERS), and individual investors (Carl Icahn, Bill Ackman)

Shareholder engagement strategies

• Shareholder engagement involves proactive communication and dialogue between the company and its shareholders to understand and address their concerns and expectations
• Effective engagement strategies include:
  • Regular investor meetings and conferences to discuss financial performance, strategy, and governance issues
  • Surveys and consultations to gather shareholder feedback on key topics, such as executive compensation or sustainability
  • Dedicated investor relations teams to manage shareholder communications and respond to inquiries
  • Transparent and timely disclosure of material information through press releases, SEC filings, and the company's website
• Constructive shareholder engagement can help build trust, align interests, and prevent adversarial activist campaigns

Executive compensation

• Executive compensation refers to the pay packages and incentives provided to a company's top management, including the CEO, CFO, and other senior executives
• Effective executive compensation aligns the interests of management with those of shareholders, rewards performance, and attracts and retains talented leaders

Components of executive pay

• Base salary: A fixed annual cash payment, typically based on the executive's role, experience, and market benchmarks
• Annual bonus: A variable cash payment tied to the achievement of short-term performance targets, such as revenue, profit, or operational metrics
• Long-term incentives: Equity-based awards, such as stock options, restricted stock, or performance shares, that vest over a multi-year period and align the executive's interests with long-term shareholder value creation
• Benefits and perquisites: Additional compensation elements, such as health insurance, retirement plans, company cars, or executive coaching, that provide security and support to the executive

Pay for performance alignment

• Pay for performance is the principle of linking executive compensation to the achievement of specific performance goals that drive shareholder value
• Performance metrics can include financial measures (EPS, TSR, ROIC), operational measures (market share, customer satisfaction), or strategic objectives (innovation, sustainability)
• Compensation plans should include a mix of short-term and long-term incentives to balance near-term performance with sustainable value creation
• Clawback provisions allow the company to recover bonuses or incentives if the performance targets were achieved through misconduct or financial misstatements

Compensation committee role

• The compensation committee is a board committee responsible for designing, implementing, and overseeing the company's executive compensation programs
• Key responsibilities include:
  • Setting performance goals and metrics aligned with the company's strategy and shareholder interests
  • Determining the mix of base salary, bonuses, and long-term incentives for each executive
  • Engaging independent compensation consultants to provide market data and advice on pay practices
  • Reviewing and approving employment agreements, severance arrangements, and change-in-control provisions
• The compensation committee should be composed entirely of independent directors to avoid conflicts of interest and ensure objective decision-making

Disclosure of executive compensation

• Public companies are required to disclose detailed information about executive compensation in their annual proxy statements (DEF 14A) filed with the SEC
• The Compensation Discussion and Analysis (CD&A) section provides a narrative explanation of the company's compensation philosophy, programs, and decision-making process
• The Summary Compensation Table presents a standardized overview of each named executive officer's total compensation, including salary, bonus, stock awards, option awards, and other compensation
• Additional tables and footnotes provide granular information on incentive plan targets, outstanding equity awards, and retirement benefits
• Shareholders have the right to cast an advisory "say on pay" vote on executive compensation, expressing their approval or disapproval of the company's pay practices

Financial reporting and transparency

• Financial reporting and transparency are essential for maintaining the trust of investors, regulators, and other stakeholders in the company's financial performance and governance
• Accurate, timely, and comprehensive disclosure of financial information enables informed decision-making and effective market oversight

Accurate and timely disclosures

• Public companies are required to file periodic reports with the SEC, including the annual report (10-K), quarterly reports (10-Q), and current reports (8-K) for material events
• Financial statements must be prepared in accordance with Generally Accepted Accounting Principles (GAAP) and audited by an independent registered public accounting firm
• Management is responsible for the accuracy and completeness of financial disclosures, with the CEO and CFO certifying the fairness of the financial statements under the Sarbanes-Oxley Act
• Timely disclosure of material information, such as earnings releases, acquisitions, or executive changes, is critical for maintaining an informed market and preventing insider trading

Auditor independence and oversight

• External auditors play a crucial role in providing independent assurance on the company's financial statements and internal controls
• Auditor independence is essential to maintain objectivity and skepticism, avoiding conflicts of interest that could compromise the integrity of the audit
• The Sarbanes-Oxley Act strengthened auditor independence by:
  • Prohibiting auditors from providing certain non-audit services (bookkeeping, valuation, internal audit) to their audit clients
  • Requiring audit partner rotation every five years to prevent excessive familiarity
  • Establishing the Public Company Accounting Oversight Board (PCAOB) to oversee the auditing profession
• The audit committee is responsible for appointing, compensating, and overseeing the external auditor, ensuring their independence and effectiveness

Internal controls over financial reporting

• Internal controls are policies, procedures, and systems designed to ensure the reliability of financial reporting, safeguard assets, and prevent fraud or errors
• The Sarbanes-Oxley Act requires management to assess and report on the effectiveness of internal controls over financial reporting (ICFR) in the annual 10-K filing
• The external auditor must also attest to management's assessment of ICFR and report any material weaknesses or significant deficiencies identified during the audit
• Effective internal controls include:
  • Segregation of duties to prevent any individual from having excessive control over financial transactions
  • Authorization and approval procedures for significant transactions and expenditures
  • Reconciliations and reviews to detect and correct errors or anomalies in financial records
  • IT controls to ensure the security, integrity, and reliability of financial data and systems

Management discussion and analysis

• The Management Discussion and Analysis (MD&A) is a narrative section of the company's annual and quarterly reports that provides context and insights into the financial statements
• The MD&A should cover:
  • Results of operations, including trends, drivers, and risks affecting revenue, expenses, and profitability
  • Liquidity and capital resources, discussing cash flows, debt, and funding sources
  • Critical accounting policies and estimates that require significant judgment or assumptions
  • Off-balance sheet arrangements and contractual obligations
  • Forward-looking information, such as projected sales, earnings, or capital expenditures
• The MD&A should be written in plain language, avoiding boilerplate disclosures, and providing a balanced view of the company's performance and prospects

Risk management and oversight

• Risk management is the process of identifying, assessing, and mitigating potential threats to the company's operations, financial performance, and reputation
• Effective risk oversight is a critical responsibility of the board of directors, ensuring that management has appropriate systems and controls in place to manage risks

Board role in risk oversight

• The board is responsible for overseeing the company's risk management framework and ensuring that material risks are identified, assessed, and mitigated
• The board should:
  • Set the tone at the top for a strong risk culture, emphasizing the importance of risk awareness and ethical behavior
  • Approve the company's risk appetite and tolerance levels, aligning them with strategic objectives
  • Review and discuss the company's major risks and risk management strategies with management
  • Ensure that risk management is integrated into decision-making processes and performance evaluations
• The audit committee often takes a lead role in risk oversight, focusing on financial reporting, compliance, and internal control risks

Risk appetite and tolerance

• Risk appetite is the level of risk a company is willing to accept in pursuit of its strategic objectives, considering its industry, culture, and stakeholder expectations
• Risk tolerance is the acceptable level of variation in performance relative to the risk appetite, setting boundaries for risk-taking activities
• The board should articulate the company's risk appetite and tolerance in a risk appetite statement, which guides decision-making and resource allocation
• The risk appetite should be regularly reviewed and updated to reflect changes in the business environment, strategy, or risk profile

Enterprise risk management framework

• An enterprise risk management (ERM) framework provides a structured approach to identifying, assessing, managing, and monitoring risks across the organization
• Key components of an ERM framework include:
  • Risk identification: Systematically identifying potential risks from internal and external sources
  • Risk assessment: Evaluating the likelihood and impact of each risk, considering both inherent and residual risk levels
  • Risk response: Determining the appropriate strategy for each risk (avoid, reduce, share, or accept) based on the risk appetite and available resources
  • Risk monitoring and reporting: Tracking risk levels, mitigation efforts, and emerging risks, and providing regular reports to the board and management
• ERM should be a continuous and iterative process, integrated into the company's strategy, operations, and culture

Emerging risks and mitigation strategies

• Emerging risks are new or evolving threats that have the potential to significantly impact the company, but are often difficult to predict or quantify
• Examples of emerging risks include:
  • Cybersecurity threats, such as data breaches, ransomware attacks, or intellectual property theft
  • Climate change and sustainability risks, such as physical damage from extreme weather events or transition risks from shifting to a low-carbon economy
  • Geopolitical risks, such as trade tensions, social unrest, or political instability
  • Disruptive technologies or business models that could render the company's products or services obsolete
• Mitigation strategies for emerging risks may include:
  • Scenario planning and stress testing to assess potential impacts and develop contingency plans
  • Investing in risk management capabilities, such as cybersecurity defenses, business continuity planning, or sustainability initiatives
  • Engaging with stakeholders, policymakers, and industry partners to monitor and respond to emerging risks
  • Diversifying the business portfolio or supply chain to reduce exposure to specific risks

Stakeholder considerations

• Stakeholders are individuals or groups who can affect or be affected by the company's actions, decisions, and performance, such as shareholders, employees, customers, suppliers, communities, and the environment
• Effective corporate governance requires balancing the interests of various stakeholders and considering their perspectives in decision-making

Balancing shareholder and stakeholder interests

• Shareholders are the owners of the company and have a financial stake in its success, expecting a return on their investment through dividends and share price appreciation
• Other stakeholders, such as employees, customers, and communities, have different interests and expectations, such as fair wages, quality products, and environmental responsibility
• The board and management must navigate potential trade-offs between short-term shareholder returns and long-term stakeholder value creation
• Strategies for balancing stakeholder interests include:
  • Adopting a long-term, sustainable approach to business strategy and performance
  • Engaging with stakeholders to understand their concerns and expectations
  • Incorporating stakeholder considerations into decision-making processes and performance metrics
  • Communicating transparently about the company's stakeholder management approach and outcomes

Corporate social responsibility initiatives

• Corporate social responsibility (CSR) refers to the company's commitment to managing its environmental, social, and governance (ESG) impacts and contributing to sustainable development
• CSR initiatives can include:
  • Environmental programs, such as reducing greenhouse