Corporate governance is "the system by which companies are directed and controlled" (Cadbury Committee, 1992).

[1] It involves regulatory and market mechanisms, and the roles and relationships between a companys management, its board, its shareholders and other [Stakeholder (corporate)|stakeholder]]s, and the goals for which the corporation is governed.[2][3] In contemporary business corporations, the main external stakeholder groups are shareholders, debtholders, trade creditors, suppliers, customers and communities affected by the corporation's activities[4] . Internal stakeholders are the board of directors, executives, and other employees. Much of the contemporary interest in corporate governance is concerned with mitigation of the conflicts of interests between stakeholders. Ways of mitigating or preventing these conflicts of interests include the processes, customs, policies, laws, and institutions which have impact on the way a company is controlled.[5][6] An important theme of corporate governance is the nature and extent of accountability of people in the business, and mechanisms that try to decrease the principalagent problem.[7][8] A related but separate thread of discussions focuses on the impact of a corporate governance system on economic efficiency, with a strong emphasis on shareholders' welfare; this aspect is particularly present in contemporary public debates and developments in regulatory policy[9](see regulation and policy regulation).[10] There has been renewed interest in the corporate governance practices of modern corporations, particularly in relation to accountability, since the high-profile collapses of a number of large corporations during 2001-2002, most of which involved accounting fraud[11]. Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. In the U.S., these include Enron Corporation and MCI Inc. (formerly WorldCom). Their demise is associated with the U.S. federal government passing the Sarbanes-Oxley Act in 2002, intending to restore public confidence in corporate governance. Comparable failures in Australia (HIH, One.Tel) are associated with the eventual passage of the CLERP 9 reforms. Similar corporate failures in other countries stimulated increased regulatory interest (e.g., Parmalat in Italy).

Principles of corporate governance

Contemporary discussions of corporate governance tend to refer to principles raised in three documents released since 1990: The Cadbury Report (UK, 1992), the Principles of Corporate Governance (OECD, 1998 and 2004), the Sarbanes-Oxley Act of 2002 (US, 2002). The Cadbury and OECD reports present general principals around which businesses are expected to operate to assure proper governance. The Sarbanes-Oxley Act, informally referred to as Sarbox or Sox, is an attempt by the federal government in the United States to legislate several of the principles recommended in the Cadbury and OECD reports.

Rights and equitable treatment of shareholders:[12][13][14] Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by openly and effectively communicating information and by encouraging shareholders to participate in general meetings.

Interests of other stakeholders:[15] Organizations should recognize that they have legal, contractual, social, and market driven obligations to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers. Role and responsibilities of the board:[16][17] The board needs sufficient relevant skills and understanding to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment Integrity and ethical behavior:[18][19] Integrity should be a fundamental requirement in choosing corporate officers and board members. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. Disclosure and transparency:[20][21] Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

Parties to corporate governance

The most influential parties involved in corporate governance include government agencies and authorities, stock exchanges, management (including the board of directors and its chair, the Chief Executive Officer or the equivalent, other executives and line management, shareholders and auditors). Other influential stakeholders may include lenders, suppliers, employees, creditors, customers and the community at large. The agency view of the corporation posits that the shareholder forgoes decision rights (control) and entrusts the manager to act in the shareholders' best (joint) interests. Partly as a result of this separation between the two investors and managers, corporate governance mechanisms include a system of controls intended to help align managers' incentives with those of shareholders. Agency concerns (risk) are necessarily lower for a controlling shareholder. A board of directors is expected to play a key role in corporate governance. The board has the responsibility of endorsing the organization's strategy, developing directional policy, appointing, supervising and remunerating senior executives, and ensuring accountability of the organization to its investors and authorities. All parties to corporate governance have an interest, whether direct or indirect, in the financial performance of the corporation. Directors, workers and management receive salaries, benefits and reputation, while investors expect to receive financial returns. For lenders, it is specified interest payments, while returns to equity investors arise from dividend distributions or capital gains on their stock. Customers are concerned with the certainty of the provision of goods and services of an appropriate quality; suppliers are concerned with compensation for their goods or services, and possible continued trading relationships. These parties provide value to the

corporation in the form of financial, physical, human and other forms of capital. Many parties may also be concerned with corporate social performance. A key factor in a party's decision to participate in or engage with a corporation is their confidence that the corporation will deliver the party's expected outcomes. When categories of parties (stakeholders) do not have sufficient confidence that a corporation is being controlled and directed in a manner consistent with their desired outcomes, they are less likely to engage with the corporation. When this becomes an endemic system feature, the loss of confidence and participation in markets may affect many other stakeholders, and increases the likelihood of political action. There is substantial interest in how external systems and institutions, including markets, influence corporate governance.

The importance of Corporate Governance

Why do we have to take corporate governance seriously? The creators of this website have spent many years espousing the importance of corporate governance, as authors, lecturers and consultants. Even before the issue came to the forefront of business with the Cadbury Committee following the Maxwell pensions scandal, we recognised that it was not actually a new concept at all and that as long as there has been large-scale trade people have recognised the importance of corporate governance - that is, responsibility in the handling of money and the conduct of commercial activities. We discuss the history of corporate governance and the definition of corporate governance in other areas of the website. With globalisation vastly increasing the scale of trade and the size and complexity of corporations and the bureaucracies constructed to attempt to control it, the importance of corporate governance and internal regulation has been amplified as it becomes increasingly difficult to regulate externally. Here we will explore four issues which in our view are key to understanding the importance of corporate governance:

The issue of integrity: are the boards and management of companies carrying out their duties in an ethical way (we define business ethics here)? Topicality - the bonus culture: could better corporate governance in financial institutions and their remuneration policies have prevented the credit crunch and resulting financial crisis? The regulatory framework: introducing more regulation has clearly failed - we need better regulation which ensures businesses recognise the importance of corporate governance as an integral part of management, not a box ticking exercise The importance of corporate governance in Directors' training: prevention is better than a cure, so including knowledge of the princples and practice of corporate governance in mainstream director training is essential

The Issue of Integrity Perception is in the eye of the beholder, and corporate governance, while a technical term for accountants, lawyers and the like, is known by the readers of the popular newspapers by names such as honesty, decency, fairness. Similarly, what the professional would call questionable

practice in this arena is criticised by the general public using words such as rip-off, cheating and crooked. The central issue today therefore in the field of corporate governance is not whether most listed companies comply with the various provisions of the Combined Code, Sarbanes-Oxley, King, etc. The key point is whether the top management of large organisations especially, but actually of that of business in general, is seen as possessed of integrity in the eyes of the general public. This is the spirit that gave support to the principle of setting up the Cadbury Committee, not simply a desire to lay down some rules on the financial aspects of corporate governance to prevent innocent fund managers being misled by greedy directors. And it is this integrity perceived and actual - which underlines the importance of corporate governance, as it is the tool by which integrity can be encouraged, measured and projected. The Bonus Culture The current financial crisis has brought into sharp focus the system of bonuses and remuneration operated by financial institutions. It is argued that it encouraged excessive risk taking and irresponsible lending. Combined with the complex financial instruments that the mainstream institutions constructed to move the risk off their books, this - highly simplistically stated - was, some say, what led to the so called 'credit crunch'. What is certainly true is that there was excessive risk and irresponsible lending and this led to the downfall of some of the world's biggest lenders and in turn the insurers insuring that risk. The importance of corporate governance in this scenario is, in our minds, unquestionable. A better system of checks and balances (the core definition of corporate governance) would have picked up the warning signs that many people were sending that the level and criteria of lending was getting dangerous. The OECD have published lessons from the financial crisis, which also conclude that "the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies." We strongly believe that our approach, which is different to the conventional, box ticking mechanisms, would have succeeded as it is not only places corporate governance and business ethics at the core of the organisation not as a separate issue, but is based on independent market research. This is covered in our corporate governance and research section. Directors' pay and the bonus culture are often seized upon by special interest groups and the media as a single issue, not in the context of business and society as a whole, and is therefore blinkered to the underlying factors causing and affecting remuneration. While the latter is an obvious manifestation of good or bad governance (if only because it exposes the quality of stakeholder communication!), it misses the basic point that companies should be run well and responsibly - in every way, not simply in how they pay salaries and bonuses. In a well run company, good performance is rewarded and rightly so - to attract talent and people dedicated to improving performance, not simply doing a job.

In its Principles of Corporate Governance, the OECD acknowledges that: "Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring." Clearly, it is not in the best interests of the company for it to go out of business or be bailed out by governments. So it is not the principle that should be debated here, but the implementation. As we said earlier, while the board, management - and even the shareholders may feel that remuneration is fair, it is clear that current corporate policy is not in line with public perception. In the US this is perhaps more evident than in more reserved UK society if the internet searches are anything to go by - Wordtracker, the keyword research tool, reports nearly 8,500 searches over the last year relating to the AIG bonus payouts alone, the vast majority including the word 'outrage'. So in spite of the bonus culture being hijacked at times to attack business generally, the issue does highlight the importance of corporate governance and the need to assess the quality of the system of checks and balances in all sizes of company (bearing in mind many of the "toxic mortgages" were sold by small local brokers). The Regulatory Framework - better not more regulation As we argue elsewhere, the importance of corporate governance could be restated as the importance of good management. Put in that simple way it seems obvious, but we see instances daily of a lack of recognition that good governance is actually just good management and a failure of governance is a failure of management. Awarding bank and insurance company bosses generous bonuses and pension packages after government bailouts of failing institutions, apart from being a huge public relations gaff is rewarding poor management and hence poor management itself. But while reform is clearly needed, a knee-jerk reaction will always result in building a sledge hammer to miss a nut. The regulators have openly admitted that they did not understand the complex financial instruments that ultimately folded in on themselves and led to the collapse of the financial system. Constructing new regulations to try to control circumstances that have yet to emerge - every crisis has different causes - is a futile task. Restricting the range of products available to address the problem has major implications on innovation and consumer choice. Some of the knock-on effects of this are that products become more expensive; large providers will not take on certain sectors of society because they are not profitable; and niche providers providing those innovative products will cease to operate or be closed down by the regulators. That clearly represents a significant backward step in the financial services market. The importance of corporate governance in the financial markets is particularly topical but the solution to bad governance is universal and any system of regulation needs to strike the right balance between encouraging innovation and customer choice and enforcing a minimum set of standards. Fundamentally, though, it should provide the incentives to go far beyond these minimum standards and try to demonstrate that, by changing the corporate culture, the long term rewards are actually greater (not least because it should result in less regulation!) Just as punitive tax regimes encourage evasion, avoidance or relocation, it has been proven that the regulatory

burden, while in many cases adding cost and confusion, has caused people to invent more and more complex systems to avoid detection. There is, of course, much excellent regulation which has indeed improved the consumers' lot by forcing companies to disclose information, reduce costs/charges and generally act in a fair manner. We need to build on those good aspects and not simply impose more box ticking exercises. The importance of corporate governance in directors' training A corollary to the focus on corporate behaviour and the behaviour of senior corporate employees is the attention increaseingly being paid to the qualification of these senior people to carry out their responsibilities. There has never been any formal qualification required to run an organisation, and none to be a director - although in recent years organisations like the UK Institute of Directors has introduced qualifications such as the Chartered Director to address the issue. In practice, of course, most large and well run organisations will look for suitable professional qualifications in their senior staff, and there is an increasing number of organisations offering non-executive director training and selection services. In the last ten years or so, especially following the dot com boom and bust and the collapse of Enron and WorldCom, the role of direction has finally begun to be seen as a profession or at least a discipline requiring specific training and development. It is clear that it is the importance of corporate governance has been a major influence here and the IoD qualifications specifically mention corporate governance as a significant element - and benefit. To make a real difference long term, it should start much earlier in professional development, and corporate governance is starting to filter down, with some MBA courses, especially in Australia, offering it as part or all of the course content (though the latter has the potential to persist the notion of corporate governance being a separate issue, which as you will realise by now, we think it wrong. Others, such as the London Business School, include modules on ethics and Corporate Social Responsibility. It is our sincerest hope that this trend continues and that the true importance of corporate governance is fully recognised and acted upon

Why is Corporate Governance Important?

Corporate governance is the way a corporation polices itself. In short, it is a method of governing the company like a sovereign state, instating its own customs, policies and laws to its employees from the highest to the lowest levels. Corporate governance is intended to increase the accountability of your company and to avoid massive disasters before they occur. Failed energy giant Enron, and its bankrupt employees and shareholders, is a prime argument for the importance of solid corporate governance. Well-executed corporate governance should be similar to a police departments internal affairs unit, weeding out and eliminating problems with extreme prejudice. A company can also hold meetings with

internal members, such as shareholders and debtholders as well as suppliers, customers and community leaders, to address the request and needs of the affected parties.

Principles of Corporate Governance

Shareholder recognition is key to maintaining a companys stock price. More often than not, however, small shareholders with little impact on the stock price are brushed aside to make way for the interests of majority shareholders and the executive board. Good corporate governance seeks to make sure that all shareholders get a voice at general meetings and are allowed to participate. Stakeholder interests should also be recognized by corporate governance. In particular, taking the time to address non-shareholder stakeholders can help your company establish a positive relationship with the community and the press. Board responsibilities must be clearly outlined to majority shareholders. All board members must be on the same page and share a similar vision for the future of the company. Ethical behavior violations in favor of higher profits can cause massive civil and legal problems down the road. Underpaying and abusing outsourced employees or skirting around lax environmental regulations can come back and bite the company hard if ignored. A code of conduct regarding ethical decisions should be established for all members of the board. Business transparency is the key to promoting shareholder trust. Financial records, earnings reports and forward guidance should all be clearly stated without exaggeration or creative accounting. Falsified financial records can cause your company to become a Ponzi scheme, and will be dealt with accordingly.

Corporate Governance as Risk Mitigation

Corporate governance is of paramount importance to a company and is almost as important as its primary business plan. When executed effectively, it can prevent corporate scandals, fraud and the civil and criminal liability of the company. It also enhances a companys image in the public eye as a self-policing company that is responsible and worthy of shareholder and debtholder capital. It dictates the shared philosophy, practices and culture of an organization and its employees. A corporation without a system of corporate governance is often regarded as a body without a soul or conscience. Corporate governance keeps a company honest and out of trouble. If this shared philosophy breaks down, then corners will be cut, products will be defective and management will grow complacent and corrupt. The end result is a fall that will occur when gravity in the form of audited financial reports, criminal investigations and federal probes finally catches up, bankrupting the company overnight. Dishonest and unethical dealings can cause shareholders to flee out of fear, distrust and disgust.

The Disadvantages of Corporate Governance

Corporate governance is one of the law's most intensely regulated fields. This is because corporations are privately owned but are treated as independent legal entities, rendering their assets vulnerable to a variety of potential abuses. Corporate governance is generally governed by state law, although the federal government has also enacted legislation to curb abuses.

Ownership-Management Separation
The officers and directors who run the day-to-day affairs of a corporation and make most of its policy decisions are not necessarily shareholders. This can become a problem in large, publicly traded corporations. If no shareholder holds a controlling interest in the corporation, and most shareholders vote by proxy, the corporation's assets are controlled by the board of directors and the officers. The separation of ownership and management can lead to a conflict of interest between management's duty to maximize shareholder value and its interest in maximizing its own income. A CEO, for example, might be paid a large bonus even as the corporation approaches bankruptcy.

Illegal Insider Trading

The term "corporate insiders" refers to corporate officers, directors and employees because they may have access to confidential, non-public information about the corporation that might affect the value of its shares. Corporate insiders are not strictly prohibited from trading corporate shares but must report these trades to the Securities and Exchange Commission. Illegal insider trading occurs when a shareholder, while in possession of confidential information relevant to the future value of his shares, sells shares to a buyer without access to this information. Illegal insider trading can also be committed by a shareholder not directly affiliated with the corporation, such as an outside auditor, a government regulator or a relative of a corporate insider. Because access to confidential corporate information can be widely dispersed, laws against insider trading can be difficult to enforce.

Misleading Financial Statements

There are many ways to present factually accurate information on a financial statement in a manner that is misleading to investors -- by, for example, selling property from a parent company to a subsidiary to maximize parent company revenues. It is also possible to present factually incorrect information that is difficult to detect by establishing complex networks of subsidiaries and cross-shareholdings.

Costs of Regulation
The abuse of corporate governance has triggered the enactment of a large body of state and federal laws designed to prevent such abuses from recurring. Compliance with these laws can be burdensome and expensive for corporations. For example, the Securities and Exchange Act of

1933 requires companies seeking to list on a stock exchange to make such extensive disclosures to potential investors that compliance can cost hundreds of thousands of dollars. More recently, the Sarbanes-Oxley Act of 2002 requires corporations to establish extensive systems of internal controls to ensure that their financial statements are both factually accurate and non-misleading. Disadvantage stems from that same idea of risk. Risks that corporation takes do not go away, they are more or less shared by other parties: customers, creditors, and others who deal with a corporation. There is also a legal notion that corporation is a person. And can be sued. So directors of a corporation often make collective decisions that may negatively affect the rest of society, in order to make profit for shareholders. Collectivism is a problem in corporations just as it is in Socialism. Individually directors and other officers would not make decisions they otherwise make in a corporation. So you could say incentives are different.