Corporate Governance: The Business Management Principles
Corporate governance is one of the core terms of business management. It encapsulates a variety of regulations and legal requirements which oblige a business to operate on the market successfully and in compliance with the law.
We provide an overview of which principles and objectives are associated with corporate governance, how the principles are reflected in corporate practice, and which sets of rules apply internationally.
What is Corporate Governance?
Corporate governance refers to the entirety of all regulations, laws and procedures that define and govern the conduct of businesses. The legal and regulatory framework for corporate governance comprises not only a company’s internal regulations (e.g. corporate constitution), but also provisions that affect the company’s external relationships to the capital market. In this way both business management and legislators shape the structuring of corporate governance within a company.
Most importantly, corporate governance plays a role in market-listed companies, as its structures serve the purpose of coordinating the diverse interests of shareholders and management in order to avoid conflicts between both parties or within respective groups. In the meantime, however, other business forms and medium-sized businesses will also be increasingly viewed from the perspective of corporate governance.
The objectives of corporate governance structures vary according to company. What is common to all structures, however, is that they provide business management with a framework, and furthermore contribute to stability within the market. Both have a positive impact on the company’s success and create economic opportunities and more jobs.
Important objectives of corporate governance are:
- Adequate risk management
- Process improvement
- Equal treatment and protection of diverse interests
Corporate Governance vs. Compliance
The terms “corporate governance” and “compliance” are often used in the same context, and not selectively. In fact, some sources use both terms synonymously. In both cases, regulations and laws that a company has to comply with are considered.
The difference between the two terms lies in their perspectives: Corporate governance focuses on relationships – it aims to create transparency and trust between shareholders and business management, and for investors and the capital market. Compliance, from the perspective of the company, focuses on the measures that are required in order to comply with the provisions needed for organized and successful business management.
Corporate governance and compliance, along with risk management, are often regarded summarily as one set of issues: “governance, risk and compliance”.
Corporate Governance Structures in Practice
In order to comply with legal and voluntary requirements, companies must establish corporate governance structures. How such structures are organized varies to according to the country in which the company is located. There are fundamental differences between the USA and continental Europe.
In the USA and United Kingdom, the shareholder approach, which focuses on the relationship with actors in the market, is used. This is why the board of directors is dominated by non-executive members elected by shareholders.
In Europe the stakeholder approach, which includes all the groups affected by business activities, is paramount. Here the supervisory board has an important role in determining which employee representatives and representatives from other stakeholders, such as customers or suppliers, monitor business management.
According to which approach you look at, the processes to be implemented will vary, as will the supervisory bodies. Independently of the chosen system, however, it is necessary in the vast majority of cases to establish a corporate governance division, as compliance with all governance provisions involves a substantial amount of work.
History of Corporate Governance
The origins of corporate governance can be traced back to the 1930s, when the first relevant principles were published by US scientists in the aftermath of the great stock market crash of 1929. These observed a divergence between shareholder and management interests.
With the emergence of international corporations following the Second World War, the ideas of corporate governance continued to spread within the USA and the number of publications increased. Starting in the 1970s, business executives then also committed themselves to these principles with greater zeal, going beyond legally binding regulations.
Internationally, however, the term first became well-known in the 1990s, as corporations used it in order to report about their practical implementation of good business management.
The State of Corporate Governance Internationally
Different codes and guidelines exist for each country. In the European Union various directives and guidelines apply. A corporate governance code for banks and investment companies is specified in European corporate law. In the US, state corporate laws such as the Delaware General Corporation Law (DGCL) and federal securities laws can regulate corporate governance. On the federal level, the main sources are the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (the Exchange Act). In 2002, the Sarbanes-Oxley Act was enacted in response to corporate scandals which cost investors billions of dollars, and in 2010 following the financial crisis of 2008-2009 the Dodd-Frank Act restructured financial regulation. There is also a number of corporate governance guidelines and codes of best practice.
The Organization for Economic Cooperation and Development (OECD) has also established standards for corporate governance. The OECD principles were first published in 1999 and most recently updated in 2015. The principles aim to maintain economic efficiency, sustainable growth and financial stability as well as the fair handling of shareholders and stakeholders.
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