What is Corporate Governance? Principles, Examples & More
Hello readers! Today we are back with another intriguing topic from the core world of finance – Corporate Governance! Put your reading glasses on and stay glued!
In this era of globalization where information is just a tap away, we all are pretty much familiar with the names of top-notch companies like Coca-Cola, Starbucks, Asian Paints, ITC, Unilever, and etcetera! Over the years, they have continued to grow in manifolds in spite of the emergence of various substitutes. Have you ever wondered what could be the secrets behind the success and sustainability of these companies apart from their brand value and consistent sales? Well, let’s dive in without further delay!
In order to flag off the session on a lighter note, we will put forward an example on a micro-level.
In schools and colleges, the fests are held annually with pomp and glory! The responsibilities and tasks are carried out in a chained way. Preparations begin prior to one to two months and require proper governance! The absence of a good governing committee would have led them to a path of big failure. Similarly, every company require sound corporate governance to grow and augment in the long run.
What is Corporate Governance?
Corporate Governance is the procedure by means of which a corporation guidelines itself. In a nutshell, it is a process of administering a company like a monarchial state which installs its own customs, laws, and policies from the highest to the lowest levels.
In financial terms, Corporate Governance is the collaboration of well -defined rules, processes and laws by which functions and regulations of business take place. Most companies leave no stone unturned to achieve a high degree of corporate governance. It is the responsibility of the board of directors to build a framework for corporate governance that syncs with the objectives and mission of the business.
In the last decade, corporate governance has gained immense and serious attention because of high-profile scams and criminal activity by corporate officers in power. Poor corporate governance can have an adverse effect on a company’s financial health and level of trustworthiness.
The structure and frame of the Corporate Governance comprise of the Board Of Directors, Management and Shareholders! Let us first understand each of their key roles in-depth.
The Structure of Corporate Governance
— Board of Directors
The Board Of Directors plays a pivotal character in commanding the company’s management and business blueprints to accomplish long-term value creation. The most important functions of the board are:
- Determine the company’s vision and mission to guide and set the pace for its current operations and future development.
- Monitoring/examining the CEO’s performance and overseeing the procedure regarding CEO succession.
- Understand and take into account the interests of shareholders and relevant stakeholders.
- Avoiding conflicts of Interest
Chief Executive Officer (CEO) leads the management of the company. Important aspects like strategic planning, risk alleviation, and financial reporting falls under the umbrella of the management. An efficient team of management escorts the company with the determination of achieving the business strategies over a considerable time horizon and avoids focusing on short-term metrics.
Shareholders invest in a public company by purchasing its stock from the exchange via brokers and earn capital gains with a rise in the price of the stocks. However, Shareholders are not embroiled in the day-to-day management of business affairs but enjoy the right to elect representatives i.e. Directors. They also receive a Quarterly/Annual Report which consists of information regarding investments and voting decisions.
Competent Corporate Governance needs crystal clear generosity and interaction between Board Of Directors, Management and Shareholders in accelerating a company’s performance. Efficient corporate governance shapes up a transparent bunch of rules and regulations in which directors, management and shareholders have aligned ambitions. The framework allows the board of directors to affirm fairness, accountability, and transparency in a company’s relationship with all stakeholders (management, financiers, customers employees, government, and the community).
Principles of Corporate Governance
A company that follows the hardcore core fundamentals of good corporate governance will generally surpass other companies in terms of financial advancement. The core principles of sound corporate governance include Fairness, Accountability, Responsibility & Transparency. Let us discuss all these principles one by one.
Fairness touches on the points of uniform and equal treatment of all the shareholders in reference to receival of considerations regarding shareholdings. The fairer the company appears to stakeholders, the more likely it is that it can endure in the league.
Corporate accountability is an act of responsibility and obligation to provide an explanation for the company’s actions and activities. Corporate Accountability includes the followings:
- Presentation of a balanced and simple analysis of the company’s orientation and prospects.
- Responsibility for determining the character and extent of the adopted risks by the company.
- Maintenance of adequate risk management and internal control structure.
- Setting up formal and unclouded arrangements for corporate reports and a suitable relationship with the company’s auditor.
- Proper communication with shareholders regarding diversification, progress and financial reports at frequent
The CEO and Board of Directors are accountable to the shareholders on behalf of the company regarding the execution of responsibilities. Thus, they should exercise their authority with full responsibility. The Board of Directors is responsible for conducting the management of the business, appointing the suitable CEO, overseeing the affairs of the company and keeping an eye on the performance of the company.
Transparency means a company should reveal an informative piece of data about their activities to shareholders and other stakeholders. It also includes the open-mindedness and willingness to divulge financial figures which are genuine and correct in reality. The unveiling of reports regarding the organization’s accomplishments and activities should be on time and strive for accuracy. Such steps ensure the investors’ access to transparent and factual data which finely mirrors the financial, environmental and social position of the organization.
Benefits of Corporate Governance
Here are a few of the major benefits of having good corporate governance in a company:
— A good corporate governance practice gives rise to a strict compliance culture. It is advantageous in multiple ways and is directly related to improved performances. Due to the existence of such a strict environment, all the members are bound to adhere to the work culture, establish proper lines of communication with the rest of the organization and are promptly responsive to any evidence when there is any signal of non-compliance.
— Marvelous Corporate Governance has instant access to information and excellent communication. Rapid access to information and good communication among the members of a company leads to the formulation of robust strategies. Such strategies include efficient allocation of resources, leveraging technology and etcetera.
— Good Corporate Governance can lift up a company’s influence and reputation. Strong schemes like strict fiscal policies and internal controls help to gain trust and reliability among stakeholders. Such genuine practices also help the company to borrow funds at a lower rate than those with weak corporate governance because lenders will be able to have faith in an organization that is seen to be stable, reliable and able to mitigate potential risks In today’s volatile environment.
— Increasing cognizance and consensus about the importance of good corporate governance among investors results in more number of investments in companies that have a prosperous track record. It also shields investors from possible scandals and aids to raise capital efficiently by gaining investors’ confidence. Thus, there is a positive influence on the share price and helps in brand formation and development.
— In this age of globalization and liberalization, there is a positive correlation between an excellent Corporate Governance and inflow of Foreign Investment. According to statistics, studies imply that Foreign Institutional Investors (FII) take notice of well- managed companies and respond positively by infusing capital for investment in the capital market. In order to reap the full benefits of the global capital markets and attract long-term capital, it is extremely important to implement basic principles of good corporate governance which can be well understood across borders. The huge influx of foreign investment will immensely churn up the economic growth and will prove to be a priceless step in enabling the organization to stand against tough economic storms and back a company’s
— Demonstration of good corporate governance also enables corporate social responsibilities like environmental awareness, health, education, sanitation, and other social aspects.
— At times, good corporate governance can help ensure that officials of a company do not take unwarranted advantage at the expense of their shareholders. For example- of Insider Trading.
Insider Trading refers to trading inequities of a company by internal members (directors, managers,employees) of the company based on the sensitive information which is unknown to outsiders. It is a scandalous activity that is committed by the officials of the company and is critically connected to the arenas of Corporate Governance. The wisest way of handling this problem is by pushing the companies to imbibe self- regulation and adopting preventive measures. Such prophylactic action sends off a signal regarding the exercise of self-regulatory practices and assurance of safety to invest in the company’s securities. Hence, Good corporate governance also reduces corruption.
— Good corporate governance also provides the elasticity to apply customized practices that fits the companies’ requirements and to alter those practices in light of ever-changing conditions, benchmarks, and standards.
Examples of Corporate Governance
Now, after the elongated discussion and explanation, let us understand the concept with two examples!
— HDFC Bank
(Industry – Private Banking and Financial Services)
HDFC Bank identifies the significance of good corporate governance, which takes care of the long-term interests of shareowners and helps to win the public trust in the Company. Therefore, the Corporate Governance scheme is introduced to proffer a course and structure for managing and regulating the bank in accordance with the principles of superlative corporate governance policies.
HDFC Bank was amongst the first four companies which earned a Corporate Governance and Value Creation (GVC) rating by The Credit Rating Information Services of India Limited (CRISIL). The bank has been successful in achieving a ‘CRISIL GVC Level 1’ rating for the last two consecutive years. This symbolizes that the bank has the potential to create wealth for all its stakeholders while preaching the highest degree of corporate governance practices. The Bank truly believes in transparent disclosures and the empowerment of shareholders for weaving value.
The chart shows the past 17 years of data from the year 2000. Going by the chart, HDFC bank has generated huge wealth over the years and is known for its laurel worthy Corporate Governance.
On the contrary, in recent times, there are several specimens that have grabbed headlines regarding massive failures of corporate governance. One such is the Punjab National Bank ( PNB) Scandal.
— Punjab National Bank (PNB)
(Industry: Public Sector Bank)
Punjab National Bank (PNB) scam was put up across all news channels for a scam size of size 12,000 crores. The fact that the main accused i.e. Nirav Modi was able to siphon off funds without being suspected by investigating committees or, the income tax department points out to the mammoth loopholes in the governance. The existence of proper corporate governance in Punjab National Bank (PNB) could have singled out the large scale scandal of this level.
In the chart, it is clearly evident how te share prices started falling just prior to the announcement of the scam and went on a downhill journey since then.
Let us quickly summarize what we discussed in this article. Corporate Governance is the procedure by means of which a corporation guidelines itself. In a nutshell, it is a process of administering a company like a monarchial state which installs its own customs, laws, and policies from the highest to the lowest levels.
In financial terms, Corporate Governance is the collaboration of well -defined rules, processes and laws by which functions and regulations of business take place. Most companies leave no stone unturned to achieve a high degree of corporate governance. The structure and frame of the Corporate Governance comprise of the Board Of Directors, Management and Shareholders!
A company that follows the hardcore core fundamentals of good corporate governance will generally surpass other companies in terms of financial The core principles of sound corporate governance include Fairness, Accountability Responsibility, and Transparency. There is a multitude of benefits arising out of good governance which helps a company to ride on the waves of growth.