Corporate governance encompasses all the processes and guidelines that shape the management of a company and molds the company’s policies accordingly. If effective, corporate governance can help guarantee these policies align with the company’s goals.
In the past, companies’ goals and success focused mainly on the financial bottom line. While profits and achieving sales targets are still worthy goals, making ethical decisions, demonstrating sustainability and showing transparency in corporate finance and executive compensation have never been more critical. Investors, governments, stakeholders, and the general public want to see organizations take their environmental, social, and governance (ESG) performance seriously and maintain accountability.
A corporate governance framework ensures a corporation implements ethical policies and is transparent about processes. We will examine corporate governance, its common principles and models, and why it matters.
Corporate governance explained
Corporate governance is the system of rules and policies that cover internal systems, controls, and procedures. It is a transparent overview of how a corporation governs its practices, created to provide comfort and knowledge about these practices for stakeholders and the general public. This overview addresses day-to-day concerns, short-term and long-term goals, board oversight and executive remuneration which are tied directly to ESG goals.
Corporate governance and ESG practices are closely connected. Effective corporate governance can help companies merge ESG considerations into their policies and practices. Companies that account for their ESG issues, can gain the trust of their stakeholders and show true social and environmental accountability by actively promoting their sustainability goals.
Corporate governance enforced
One of the driving forces behind effective corporate governance is a company’s board of directors, also known as a governance committee. This board, usually composed of both company members and shareholders, provides oversight of the company’s performance and practices. The board oversees the company’s management and can ensure the company’s policies and strategic goals reflect the interests of its shareholders.
There are also different governmental regulating bodies that help encourage good governance practices among companies.
Companies operating in the United States are asked to comply with the Securities and Exchange Commission (SEC), responsible for enforcing regulation on securities issues or governance violations and ensuring corporate integrity. The SEC plays a big part in encouraging public companies to foster good governance and best practices such as risk management and transparency. The SEC helps protect investors by issuing a number of rules and regulations such as the requirement for public companies to have an independent board of directors or the requirement to disclose information about executive compensation practices.
In Europe, there are several regulatory and legal frameworks working to enforce corporate governance. The European Union has several directives regarding corporate governance that aim to hold companies transparent and accountable, such as the EU Shareholder Rights Directive or the EU Non-Financial Reporting Directive. Both directives require the disclosure of information from companies about their governance practices. In addition, there are also laws and regulations specific to each member of the EU that oversee the management of companies and the health of their boards.
Institutional investors such as pension funds or asset managers also act as an enforcing entity for corporate governance and often encourage companies to sustain good governance practices. These investors might actively oppose management initiatives if they don’t align with governance standards. They are also bound to vote on certain topics during shareholder meetings, thus influencing important decision-making processes such as the CEO’s remuneration or assembling a corporate governance committee or a sustainability committee. Their involvement could allow the companies healthier governance practices.
There can be other mechanisms enforcing corporate governance that are not regulatory-based but wish to ensure the companies’ integrity to their stakeholders. These mechanisms can spring from either dissatisfied shareholders or reputational public pressure from customers or employees.
The principles of corporate governance
Corporations can create governance strategies that meet their needs and goals, so there is no one-size-fits-all solution. Each strategy prioritizes different principles, but below are a few of the most common principles of corporate governance.
- Transparency: At the core of corporate governance is providing easy-to-understand, accurate, and detailed data regarding internal processes and strategies to stakeholders and the general public.
- Risk management: The board of directors works alongside company executives and managers to compile possible risks and design mitigation strategies.
- Fairness: The board of directors guarantees fair treatment of their shareholders, vendors, employees and communities. Companies that implement fairness as a core value will better demonstrate social responsibility.
- Accountability: The board of directors shares the company’s ventures and impacts communicating the goals, capabilities, results and efficiency.
- Responsibility: The board of directors oversees senior management’s actions and corporate dealings. This includes recruiting a chief executive officer (CEO) and considering shareholder and company interests during the hiring process.
Corporate governance models
While a board of directors need not follow any specific model, the following corporate governance structures act as a guide for best practices for fostering corporate governance.
The Anglo-American model
This model places control in the hands of the board of directors and shareholders while removing authority from employees and vendors. Company management sets targets that maximize shareholders’ benefits and incentives managers to coordinate actions with shareholder interests. This approach prioritizes gaining shareholder capital.
Board composition consists of company executives and independent members, with the CEO and appointed Chairman having different duties. Communication between the board, shareholders, and management is vital for this model’s success.
The Continental European model
This framework divides authority between two groups: the management board and the supervisory board. All members of the management board are company associates; the supervisory board includes independent directors (directors that are external to the company) like union officials, shareholders, and institutional investors.
This model separates the management and supervisory boards with laws determining the supervisory board’s size, depending on the country. It prioritizes country-wide interests, with corporations likely coordinating with government objectives.
The Japanese model
This model grants several groups a voice in corporate governance issues, including associated entities, banks, the government, major shareholders referred to as Keiretsu, and management. These groups collaborate to create and maintain corporate governance guidelines. Company executives usually comprise the board of directors, and Keiretsu may dismiss members if the company’s performance falls short of expectations.
Why corporate governance matters
Good corporate governance frameworks provide clear policies for decision-makers, helping corporations reach targets across areas such as environmental sustainability, financial transparency, and social fairness. It also demonstrates to consumers, investors, and stakeholders that a company is trustworthy and forthright.
Here are some specific benefits of adequate governance models for stakeholders, the general public, and the organization.
The benefits of corporate governance to stakeholders and the general public include:
- Increased trust
- Action regarding climate change
- Increased knowledge about a company’s practices and policies
- Increased interest in joining transparent, trustworthy, and ethical organizations
- Assurance that stakeholder and general public interests are being prioritized
The benefits of corporate governance to the company include:
- A clear, well-thought-out plan for the company’s future
- An increased ESG score
- Loyal shareholders that stand behind business practices
- Improved long-term financial outlook and overall financial performance
- Good risk management plans in place
- A team of hard-working employees with concurrent values
- Management and executive teams with a clear understanding of how to handle unexpected situations
- Assistance in raising capital
- Improved knowledge and control regarding management and information systems
The bottom line
Corporate governance provides a detailed map for company leaders, guiding them toward making transparent, responsible, and fair decisions aligned with an organization’s objectives. Creating and following ethical guidelines regarding processes, risk management, and systems boosts community trust and keeps shareholders around.
Corporations with detailed corporate governance policies understand their mission, values, and goals better to ensure long-term success and can demonstrate to their stakeholders accountability and alignment with their goals.
*Disclaimer: This summary is for general education purposes only and may be subject to change. ESGgo, Inc., and its affiliates (the “Company”, “ESGgo”, “we”, or “us”) cannot guarantee the accuracy of the statements made or conclusions reached in this summary and we expressly disclaim all representations and warranties (whether express or implied by statute or otherwise) whatsoever.