A CORPORATE GOVERNANCE BRIEF:

What is Corporate Governance?

Dr. Demir Yener
Corporate Governance Team Leader
USAID/EE/MT/ILE

What does the term, "Corporate Governance" mean?

One of the key elements in improving economic efficiency is corporate governance, which involves a set of
relationships between a companys management, its board, its shareholders and other stakeholders.

Corporate governance is concerned with the appropriate structuring of corporations and enterprises. It is of
fundamental importance to the performance of economies, in particular those of developing and transition
economies.

Corporate governance structures are conditioned by and in turn affect legal and regulatory policies.

Policies at the global and national levels need to be guided by sound advice based on facts

The study of corporate governance practices globally and historically assist in the formulation of appropriate
policies. These policies should draw on knowledge in a broad range of academic disciplines. The
development of effective policies will benefit from collaboration between academics and practitioners in
many different countries.

Any research efforts on corporate governance ought to take into account the interests and concerns of the
corporate, financial and public sectors.

"Corporate governance is.... holding the balance between economic and social goals and between
individual and communal goals. The governance framework is there to encourage the efficient use of
resources and equally to require accountability for the stewardship of these resources. The aim is to
align as nearly as possible the interests of individuals, corporations, and society. The incentive to
corporations is to achieve their corporate aims and to attract investment. The incentive for states is to
strengthen their economies and discourage fraud and mismanagement."

Sir Adrian Cadbury, author of "The Financial Aspects of Corporate Governance", London Stock Exchange:
London, December 1992.

What needs to be done in order to achieve success in creating the environment for effective corporate
governance practices?
In order to achieve effective corporate governance practices in a global sense, and despite the many differences
that shape the existing country specific corporate governance regimes, the four fundamental pillars of corporate
governance apply globally:

responsibility,
accountability,
fairness and
transparency.

These are truly universal values, once applied successfully, will properly result in the maximization of wealth
of the shareholders. For this economic reason these pillars serve as the aspirational benchmarks even though
the implementation of the basic rules may differ from country to country, and depending on the legal and
regulatory structures.
The set of relationships that make up corporate governance can be complex. Who are the primary
stakeholders?

Shareholders
Boards of Directors / Managing Boards
Executive Management

Who are some of the other stakeholders?

Managers,
Suppliers,
Employees,
Financiers,

Customers,
Environmentalists,
Communities in which companies operate (the
community could be global).

How many variations of corporate governance are there?

There are just about as many variations of corporate governance as there are countries in the world. Even within
countries there are variations of corporate governance.
What are the characteristics of the corporate governance models?
There are two generally referred models of corporate governance:
1

The Broad vs. Narrow Definitions:

Shareholders Model: This is the narrower sense of the phenomenon involves shareholders, managers and the
board.
Stakeholders Model: This is the broader sense that involves the greater business environment of the
enterprise, beyond its shareholders, managers and its board.
2

The Ownership Concentration Model:

Insiders Model: Continental Approach, universal banks dominate financial sector, weak capital markets)
Outsiders Model: Widely dispersed share ownership, strong capital markets focus)

What are the OECD Principles of Corporate Governance?

Corporate governance is only part of the larger economic context in which firms operate, which includes the
macroeconomic policies and the degree of competition in product and factor markets.
The corporate governance framework also depends on the legal, regulatory and institutional environment. In
addition factors such as business ethics and corporate awareness of the environmental and social interests of the
communities in which it operates can also have an impact on the reputation and the long term success of the
firm. The "OECD Principles of Corporate Governance" focus on governance problems that result from the
conflicts of interest due to separation of ownership and control.
The five principles are as follows:
I)
II)
III)
IV)
V)

The rights of shareholders;

The equitable treatment of shareholders;
The role of stakeholders;
Disclosure and transparency and:
The responsibilities of the board.

In the transition countries where central planning model for state-owned enterprises played a major role in the
conduct of economic transactions, the process of transformation into a market economy has so far achieved
mixed results. Managers often still control "their" companies and shareholders have insufficient information to
evaluate the performance of companies and little legal support to hold directors or managers accountable.
What needs to be done to move from a centrally planned economy to a market economy?
The United States Agency for International Developments (USAID) Strategic Plans in general state in part, that
in centrally planned economies, governments need to move ". ..from being the producer and controller to
facilitator and regulator." Privatization programs were designed to achieve this. Political will issue, or its
lack thereof, is a serious impediment to the rapid transformation of the enterprise sector into private hands. In
many cases, consolidation of ownership in privatized firms, created forms of oligopoly, lead to insider dealings
and appropriation of public assets because of the weak application of corporate governance principles.
Oligopolistic ownership structures and non-transparent corporate governance practices drove the existing and
would be investors out of the system due to complete lack of confidence. The private sector can only gain better
access to finance as systemic risks are reduced to acceptable levels and corporate governance practices are
improved.

Why is corporate governance important?

Corporate governance is a concern for those who want to make sure that corporations have access to the capital
they need for viable investments. The quality of corporate governance will influence how well we will succeed
in our ambitions to mobilize capital, to allocate this capital efficiently, and to monitor the use of it in individual
companies. That is to say that it influences all stages of the investment process.
Potential outcomes for USAID intervention in corporate governance
Corporate reform in governance points to three major policy benefits that may justify intervention by USAID
missions in the region:

Full convergence on the corporate governance best practices including independent oversight and the
discipline of takeovers would createa level playing field in international trade and provide a way to
discipline the excesses of partially privatized state enterprises. Corporate reform program will put pressure
on the managers of all firms to maximize shareholder value, which in turn discourages so-called profitless
growth and other distortions that fuel many trade disputes. Moreover, governance convergence eliminates
these trade disputes more or less automatically through market discipline rather than by politically
motivated bureaucratic intervention or country by country negotiations.

Convergence to the corporate governance best practice reduces the systemic risk due to financial meltdowns
and currency crises that have dragged the U.S. government into several bailout programs. It strengthens the
internal governance of banks, improving their external transparency. Poor governance in the financial sector
has triggered the recent financial crises in East Asia, Russia and Latin America. Corporate governance
reform is the single most important micro-institutional reform that could allow the major donors to exit from
the self-reinforcing cycle of moral hazard losses and crisis bailouts when they happen.

Good corporate governance is essential in eliminating corruption and money-laundering abroad. Persistent
corruption is one of the biggest threats to democratic regimes in emerging markets; the flow of black money
sustains terrorists such as the Al Qaida network, regional separatists, and narco-trafficantes alike. Similarly,
the implementation of the best practice governance is a threat to authoritarian regimes in emerging markets,
by removing the control of assets and employment from the state and by making the managers of firms
accountable to public markets.

Good corporate governance will reduce the systemic risk, thereby reducing the required risk adjusted return
on investors capital. This will increase the chances that a better managed enterprise, whether it is small,
medium or large in size, that is seeking to create shareholder value will gain better access to corporate
finance. This means maximization of wealth for the shareholder, leading to lower cost of capital, thus the
rapid expansion of private sector and accelerated development of financial sector.