Corporate governance refers to the rules, procedures, and administration of the firm’s contracts with its shareholders, creditors, employees, suppliers, customers, and sovereign governments. Governance is officially vested in a board of directors who have the duty to serve the interests of the corporation rather than their own interests or those of the firm’s management. The Cadbury committee describes it as "the system by which companies are directed and controlled".
It involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders; it deals with prevention or mitigation of the conflict of interests of stakeholders. Ways of preventing these conflicts of interests include the processes, customs, policies, laws, and institutions which have impact on the way a company is controlled. An important theme of corporate governance is the nature and extent of accountability of people in the business, and mechanisms that try to reduce the principal–agent problem.
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It also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. In contemporary business corporations, the main external stakeholder groups are shareholders, debtors, trade creditors, suppliers, customers and communities affected by the corporation's activities. Internal stakeholders are the board of directors, executives, and other employees. It guarantees that an enterprise is directed and controlled in a responsible, professional, and transparent manner with the purpose of safeguarding its long-term success.
It is intended to increase the confidence of shareholders and capital-market investors. 3. THE IMPORTANCE OF CORPORATE GOVERNANCE Sound corporate governance principles are the foundation upon which the trust of investors is built. These principles are critical to growing the reputation that we have established over decades as a company dedicated to excellence in both performance and integrity. This trust and respect are fostered by both the Assurant Board of Directors and management team who work together under the guidance of our Corporate Governance Guidelines.
Well managed and implemented Corporate Governance; * Improves operational performance within the organization * Creates more efficient and effective risk management * Creates higher firm valuation and share performance Corporate governance affects the firm’s performance in the following ways: * Corporate control: Changes in control due to takeover or insolvency bring dramatic changes in firm personnel and strategy. CEO and board member turnover increases radically in the event the firm goes into financial distress.
Managers will avoid being taking over by either increasing the firm’s cash flows or by some less productive avenue. * Board, Remuneration Committee, Pay and incentives: A research has found that the appointment of non-executives directors is associated to a company stock price increases. An Executive that wants to take the company in a direction that might be more in its personal interests could be sacked. Another research has found a positive relationship between the percentage of shares owned by managers and board members and firms’ market-to-book values.
The remuneration committee is made up of non-executives, so this creates a natural control to stop the executive directors awarding themselves unjustifiable salaries and benefits. The remuneration of the Directors should be in line with other similar companies, to remain competitive and retain its top executives. The remuneration packages are intended to align the interests of Director and Shareholders by linking cash and share incentives to performance. However, some argue that the increase in share price was also associated with a decline in the value of the firm’s outstanding debt.
And corporate performance cannot be reliably increased simply by adding outsiders to the board of directors or by increasing the CEO’s stockholdings. * Prevention of Corporate Scandals: Corporate governance failures can lead to disastrous consequences beyond anyone expectations. Parmalat- a world leader in the dairy food business, entered bankruptcy protection in 2003 when investors least expected it. How the Italian group so much praised siphoned billions of Euros without its shareholders, nor its top managers suspecting it?
One of the problems at Parmalat was due to its ownership and control structures-There was a limited presence of shareholders and mainly linked by family ties. Parmalat was a holding company with all the other companies within the group controlled by the Tanzani family. The family had the majority if not ‘all’ of the voting rights. As this happens, other shareholders had limited control over the activities of the group-hence limited power to block any decisions.
Managers had also limited power to influence decisions taken by the family shareholders. In that case, the family managed to siphoned away almost millions of Euros to other companies owned by the family. In summary, the demise of Parmalat was a failure to fully implement the corporate governance mechanisms listed above. * Use of Statutory auditors: Some thought that the Parmalat case was country-specific, however, Enron the giant American Energy failed victim to corporate governance problems with the help of Arthur Andersen-the US accounting firm.
4. LITERATURE REVIEW The importance of corporate governance can be seen in modern corporations as a result of the separation of management and ownership control in the organizations. This had lead to a conflict between the interests of the shareholders, and those of the managers or directors. There isn’t one single definition of corporate governance (as we have shown above in our definition) rather, it may be viewed from different angles.
Berle and Meaus (1932) and even earlier with Smith (1776) and later, Tringales (1998) define it as “allocation of ownership, capital, structure, managerial incentive schemes, take-over’s, board of directors pressure from institutional investors, products, market competition, labor market competition, organizational structure etc. ” Garvy and Swan (1994) assert that “governance determines how the firm’s top decisions makers (the executives) actually administer such contracts. ” Shleifer;Vishny (1997) defined it as “the process by which business corporations are directed and controlled.
” As we can see, this is very similar to the definition by Cadbury that we had mentioned in the introduction. The corporate governance structure specifies the distribution of rights and responsibilities amongst different participants in the corporation, such as the board of directors, managers, shareholders and other stakeholders. It also spells out the rules and procedures for making decisions on corporate affairs. Doing this also provides the structure through which the company’s objectives are set, the means of attaining those and monitoring performance.
Good corporate governance therefore embodies both; * Enterprise (performance) and * Accountability (conformance). La Porta, Sileugs and Schleifer (2000, 2002) view corporate governance as a set of mechanisms through which outside investors (shareholders) protect themselves from inside investors (managers). However, the Organization for Economic and Corporation development provides another perspective by stating that “Corporate Governance is the system by which corporations are directed and controlled” which is the same view as Cadbury. 5. REPORT AND REVIEW
There are many different models of corporate governance around the world. These differ according to the variety of capitalism in which they are embedded. The Anglo-American "model" tends to emphasize the interests of shareholders. The coordinated or multi-stakeholder model associated with Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community. Continental Europe: Some continental European countries, including Germany and the Netherlands, require a two-tiered Board of Directors as a means of improving corporate governance.
In the two-tiered board, the Executive Board, made up of company executives, generally runs day-to-day operations while the supervisory board, made up entirely of non-executive directors who represent shareholders and employees, hires and fires the members of the executive board, determines their compensation, and reviews major business decisions. India: India's SEBI Committee on Corporate Governance defines corporate governance as the "acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders.
It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company. " The United States and the UK: The so-called "Anglo-American model" (also known as "the unitary system") emphasizes a single-tiered Board of Directors composed of a mixture of executives from the company and non-executive directors, all of whom are elected by shareholders. Non-executive directors are expected to outnumber executive directors and hold key posts, including audit and compensation committees.
Keeping the above mentioned in mind, we now look at the reports on Corporate Governance that were provided by three committees (namely; Cadbury, Greenbury and Hampel) that were set up in the 1990s in order to consider the aspects of corporate governance. They reported the following; * Cadbury: This report focused on the control functions of the board of directors and the roles of the auditors in the organization. This report was done in 1992. * Greenbury: This report was done in 1995 and focused on the setting and disclosure of the remuneration for the organization’s directors.
* Hampel: This report combined the recommendations provided in the Cranberry and Greenbury and then used that information in developing a proposed Code which listed what standards and practices companies should comply with, which they then submitted to the Stock Exchange. This was done in 1998. Later, in June that year (1998), The Stock Exchange then went on to publish the final version of what they termed “Principles of good governance and code of best practice” which was better known as the “Combined Code”.
As a result, an amendment was made to the Listing Rules for companies listed on the Stock Exchange so that now, in their annual reports and accounts, companies have to disclose how they have applied the principles and complied with the Code. 6. CHALLENGES The implementation and effectiveness of Corporate Government usually faces the following challenges: * Demand for information: In order to influence the directors, the shareholders must combine with others to form a voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting.
* Monitoring costs: A barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional answer to this problem is the efficient market hypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are efficient), which suggests that the small shareholder will free ride on the judgments of larger professional investors. * Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors.
Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process. 7. DIRECTOR’S RESPONSIBILITIES The board of directors is expected to play a key role in corporate governance. The board has the responsibilities of; * Endorsing the organization's strategy through setting the Organizations’ strategic aims.
* Developing directional policy through providing leadership to help put the policies and strategies in effect. * Appointing, supervising and remunerating senior executives/ top management and lastly, * Ensuring accountability of the organization to its investors and authorities by reporting to the shareholders on a regular basis. 8. Conclusion The endeavor to understand of Corporate Governance as a whole has now been achieved.
We provided a clear definition of it and have clearly stated its importance in an organization and how it affects the organization’s performance. We also provided a literature review in which we discussed how the research relates to other studies (how is it similar or different, what other studies have been done) as well as to demonstrated how it relates to our work. We further went on to examine the reports and reviews on corporate governance that that have done all over the world, over the years.
On top of that, we have looked at the challenges that face the success of corporate governance and lastly, took a look at the responsibilities of the organization’s directors with regards to corporate governance and what is expected of them. 9. References: 1. http://en. wikipedia. org/wiki/Corporate_governance 2. http://ir. assurant. com/investor/governance. cfm 3. http://kalyan-city. blogspot. com/2011/10/importance-of-corporate-governance-need. html 4. http://ivoireconsultancy. hubpages. com/hub/The-Importance-Of-Corporate-Governance 5. www. york. cuny. edu/~washton/student/... /lit_rev_eg. pdf - United
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