Understanding the topic of corporate governance is essential in business today. Such aspect is not only concerned with business owners, but also with various managerial, legal, and economical positions within the company. The present short paper summarizes the main points learned in corporate governance through the first two chapters of the textbook Corporate Governance by Kenneth A. Kim, John R. Nofsinger, and Derek J. Mohr.
The first aspect that should be paid attention to is the different forms of ownership. Each form has its specific characteristic, advantages, and disadvantages. Such advantages and disadvantages might be connected to business growth. Many businesses might start as a sole proprietorship and later grow to become corporations. From a country perspective corporations are the most important forms of business, which have many pros, although some cons can be also present. One of the main advantages of corporations, and at the same time one of the important concepts of corporate governance is the separation of ownership and control. The rationale for such separation is the inability of investors to control all companies they own.
Thus, one of the main points learned through the first chapter is the simple structure of corporations. Owners, have shares in the company, for which they elect a board of directors, who are simply representatives of the shareholders. The b, in turn, turn elects Chief Executive Officers (CEOs), who run the company. Such structure is governed through a monitoring process, and a system of incentives and rewards, which on the one hand prevent CEOs to use the assets of the company for their purposes, and on the other hand, make CEOs interested in the success of the corporation. The structure in which ownership, monitoring, and control are separated prevents owners from influencing the board or the managers, and accordingly, external monitoring prevents fraud, abuse, and tax evasion.
The purpose of incentives is to make CEOs and managers act in the best interest of shareholders and avoid the temptation to use the resources of the company. The type of incentives that link its value to the performance of the company is the best way to monitor CEOs, the latter includes stock options, which is the most common form of incentives, and bonuses, based on the performance of the company. The main learning outcomes from the second chapter show that there are no ideal options, where each type of incentive has its flaws, which might make the managers act so that their incentives increase. The real-world example showed that large incentives did not prevent CEOs from manipulating the profits of the corporation, focusing on short-term strategies, and/or taking unnecessary risks.
In addition to the pay incentives, CEOs receive many other benefits, such as cars, club memberships, and others. Nevertheless, it is not very clear whether increasing incentives serves its purpose of making managers act for the best interest of shareholders. Examples of CEO fraud show that there are cases when those CEOs were receiving large incentives, and nevertheless, were involved in cases of tax evasion, and manipulation of profits, serving their own interests rather than those of shareholders. The case of WorldCom and Tyco are exemplary in that matter, which led to the formation of an alternative method of monitoring, which is punishment.
Combining punishment and reward might be seen as a good option to monitor CEOs, as it is not known yet whether the punishment will serve its purpose better than rewards. However, it can be assumed that the large incentives paid to CEOs, in general, should be matched with strict punishment as well.