Corporate governance refers to a system that enables us to control and direct organisations. The IUFC defines corporate governance as “the relationships among the management, Board of Directors, controlling shareholders, minority shareholders, and other shareholders” (IFC 1).
While the traditional definition of corporate governance recognizes the existence and significance of the terms “other stakeholders”, however, there is still a lot of debate on the kind of relationship between on the one hand, self-serving managers and on the other hand, disconnected owners (Applied Corporate Governance para. 2). Corporate governance consists of two key components:
- The long-term relationship between the management and owners of a firm and the incentives for managers, checks and balances, as well as communication between investors and the management;
- Transactional relationships that include issues of authority and disclosure.
What the above two elements appears to suggest is that business owners are suspicious of the activities of their managers, as explained by the need for checks and balances. In addition, both the management and investors share an adversarial relationship. Corporate governance consists of five components that are worth of consideration by both investors and the management.
They include the long-term strategic goals of an organisation, customers, the environment, employees, and regulatory/legal compliance (Applied Corporate Governance para. 5). As such, corporate governance can be thought of as a culture that is founded on strong business ethics.
Corporate governance enables managers of a firm to fulfill the long-term strategic goals of the shareholders. In the process of fulfilling such goals, there is need to also consider that the expectations of the various stakeholders of the organisation (Kirkpatrick 6).
Therefore, the past, present and future interests of employees at the firm need to be addressed. In addition, the management should endevour to enhance excellent relationships with both suppliers and customers. At the same time, the needs and interests of the local community should also be fulfilled.
Importance of corporate governance
Globalisation has seen organisations becoming more complex as most of them have increased in terms of size and scale of trade. As a result, most organisations have ended up with a very bureaucratic structure as they try to manage the emerging complexity (Applied Corporate Governance para. 5). This has led to an augmentation of the importance of internal regulation and corporate governance owing to the increased difficulty of regulating organisations externally.
Many organisations view corporate governance as an important undertaking when it comes to the issue of integrity. Shareholders and the general public would want to be associated with an organisation that is led by leaders with integrity (Kirkpatrick 9). In this respect, corporate governance acts as a vital tool for measuring, encouraging, and projecting integrity within the organisation.
Corporate governance in an organisation is also important in as far as the bonus culture is concerned. The recent financial crisis helped to reveal the system of remuneration and bonuses operated by many financial institutions. There is a widely held argument that this system of remuneration and bonuses encouraged irresponsible lending and excessive risk taking by financial institutions, thereby triggering the global financial crisis (Applied Corporate Governance para. 6).
Ideally, the existence of a better checks and balances system would have sounded warning bells before it was too late. A number of financial experts outside the financial systems who were privy to the dangerous levels of lending practiced by many financial institutions had tried to raise an alarm but in the absence of a sound system of corporate governance, it was hard to ascertain these allegations.
In this case, sound corporate governance practices would have helped to contain the situation. Indeed, weaknesses and failures in corporate governance arrangements played a key role in the financial crisis experienced by financial institutions. Good corporate governance offers the right incentives for both the management and the Board of Directors to pursue the goals that are in the best interest of shareholders and the organisations at large (Tricker and Tricker 27).
In addition, good corporate governance also facilitates effective monitoring, thereby making it easy to detect deviations from the accepted norm and practices. Consequently, remedial measures can be taken before it is too late.
Corporate governance results in better regulatory framework within the organisation. What this means is that corporate governance leads to sound management of the organisation (Applied Corporate Governance para. 7). In the same way, when governance within a corporation fails, the management is deemed to have failed as well. In the recent global financial crisis, many financial institutions were rewarding their CEOs with hefty pension and bonus packages, even as the government struggled to bail out failing firms.
This is a reflection of poor management because it does not make financial sense to award a CEO a hefty package to leave office while the organisation is in financial limbo. In the financial markets, good corporate governance requires the right balance between on the one hand, customer choice and innovation and on the other hand, implementing basic standards. This may require organisations to change their corporate culture but in the end, the ensuing rewards are worth the sacrifice.
Corporate governance is also important to an organisation when it comes to the issue of training the directors. Following the collapse of such organisations as WorldCom and Enron in the past decade, questions have been raised on the need to re-assess the qualifications of directors. In the past, there has never been any formal yardstick with which to assess the qualifications of the senior people who run an organisation (Applied Corporate Governance para. 8).
From a practical point of view, majority of the large and well run corporations seek for the most fitting qualifications from among their senior staff; however, an increasingly larger number of organisations are now offering selection services and training to non-executive directors.
The collapse of the above mentioned firms and a dozen others has seen more professionals reassessing the role of direction as a discipline or professionals that demands specific forms of training and development. In this case, corporate governance has played a crucial role in efforts to re-evaluate the qualifications of directors charged with the responsibility of overseeing the operations of organisations (Tricker and Tricker 33).
Some MBA courses now include corporate governance as part of their course content. Such a trend should be encouraged so that the true importance of corporate governance can get the recognition it deserves.
In summary, corporate governance refers to the system that ensures the control and management of organisations. It enshrines the components of the long-term relationship between the owners of an organisation and the management. A sound corporate governance system should take into account the interests of the firms, the shareholders, the employees, suppliers, and the local community as well.
Corporate governance is important to an organisation with regard to the issue of integrity because shareholders and the general public would want to be associated with an organisation that has integrity. Also, corporate governance helps to contain the bonus culture within organizations. It also leads to better regulatory framework, as well as in the training of directors.
Applied Corporate Governance. The importance of corporate governance. 2009. Web. 15 May 2012. http://www.applied-corporate-governance.com/importance-of-corporate-governance.html
IFC. Corporate Governance. 2005. Web. 16 May 2012. http://www.ifc.org/ifcext/corporategovernance.nsf/AttachmentsByTitle/WhyCG_Print_Friendly/$FILE/WhyCG.pdf
Kirkpatrick, Grant. The Corporate Governance Lessons from the Financial Crisis. 2009. Web. 16 May 2012. http://www.oecd.org/dataoecd/32/1/42229620.pdf
Tricker, Robert and Tricker, Bob. Corporate Governance: Principles, Policies and Practices. Oxford, UK: Oxford University Press, 2009. Print.