Corporate Governance - An essential of socio-economic discipline


By

Supreet Ahluwalia
Vivek Joshi
Senior Lecturers
Department of Business
Manipal University Dubai Campus
Block #7 International Academic City Dubai, United Arab Emirates
 


Corporate Governance has been in place for ages and still in modern day corporate world we see fiascos like Satyam taking place in modern India, which really raises doubt about our financial and commercial ethics, and make us look bad in front of the world. For a nonprofessional corporate governance is almost an alien concept but even they understand something called corporate social responsibility (CSR) and they expect the corporations to be honest and maintain very high level of integrity. Today large number of retail investors are entering in stock market in order to search for better returns or some even invest to earn their bread & butter or may be even for getting future security and in this scenario a big IT and outsourcing player like Satyam gets involved in creative accounting practices or in other words cooking their financial statements, which hurts the financial position of millions of small time investors who not only loose their hard earned money, savings but even their faith in corporate houses and their hope for better future. I term this failure as failure of Corporate Social Responsibility and this happened due to not following corporate governance code. We simply cannot over look the importance of governance of the company and say that it is the governance of country which is more important neither we can term failure of Satyam as failure of central or state government failure the company is more responsible for this fiasco as they were responsible for using public resources and they had the economic responsibility to enhance economic wealth in addition to generate stockholder value, this quote puts the situation more accurately 'The governance of companies is more important for world economic growth than the government of countries.'

The discussion seemed to be only about stock market, investments and to revolve around financial statements plus money and to a layman corporate governance may seem as a measure only related to protect their money in addition to financial future but it is not so The Corporate Governance is a wider concept and its coverage and scope touches almost all working socio-economic facets of a business. I consider corporate governance to be more of social relevance than economic aspects as well as it is a much wider concept than realised so before we dwell into relevance of corporate governance for modern day business houses especially for corporations let us try to understand what exactly is the concept of social governance and how it is a tool to bring in socio-economic discipline to corporate houses.

Introduction to the concept of Corporate Governance

The concept of corporate governance is poorly defined because it potentially covers a large number of distinct economic phenomenons. As a result, different people have come up with different definitions that reflect their special interest in the field. We will start with widely accepted explanation and will try to develop one of comprehensive explanation of the term. Internationally corporate governance is considered as an -

    International term for responsible corporate management and supervision oriented toward creating long-term added value.

    "Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment", The Journal of Finance, Shleifer and Vishny.

    In simple terms, it includes the practices, principles and values that guide a company and its business every day, at all levels of the organization, it is the framework of rules, relationships, systems, and processes within and by which authority is exercised and controlled in corporations.  To be more precise it involves series of principles and recommendations to be followed by the management of listed companies.

In this sense, it encompasses the mechanisms by which companies and those in control are held to account. This highlights one fact that in wider sense corporate governance at least covers set of relationships between a company's management, its board, its shareholders and other stakeholders. Based upon this we can easily draw the reference that it is a control measure that can result into overall economic growth and development of an economy plus will generate social justice, if implemented and executed correctly.


Corporate governance provides a firm foundation for the development of economies. A good corporate governance mechanism improves the health of the corporate sector, thus enhancing national competitiveness. The self-regulatory organizations of various countries have extensive experience in promoting corporate governance and creating a positive corporate governance culture but unfortunately, in India it is not the case.

Features of Corporate Governance
  • Started as economic or financial concept
  • Involves lot of parties
  • Involves organisational & social objective
  • Guiding practices, process & principles
  • Used to motivate management to perform better
  • Universal approach (world wide acceptance)
  • framework of rules, relationships, systems, and processes
  • Implemented at all levels in an organisation
  • Tool for benchmarking & controlling performance
  • Focuses on long term value addition (profitability, goodwill, brand recognition etc.)

Objectives of corporate governance - As discussed the concept of corporate governance is multi faceted and involves lot of dimensions therefore it covers several objectives rather a wide range of objectives ranging from managing & maintaining Operational transparency to something as simple as following legal mandatory disclosure norms.  Next diagram gives us an overview of corporate governance objectives.


Parties to corporate governance Parties to corporate governance covers various stakeholders and many more as it has wider coverage and influences society up to a very great extent plus we should not forget that business has greater social obligation as these business houses uses the resources of the society and common  men to generate wealth and to earn riches for their shareholders, lastly it should not be forgotten that only those who are directly involved with the business are not the parties whose life is being impacted by decisions of business there are lot of others who may not hold any direct interest in the business but their lives indirectly get influenced and the simple reason for this is the limited availability of resources and opportunity cost so the resources that business is using could have been used for much productive cause and which must have generated more value and benefit for these common men (shadow pricing).


Corporate Governance- Dimensions

Diagram following indicates the several dimensions of corporate governance it also indicates how implementation of corporate governance can help an organisation in improving its operational performance. These dimensions are backbone of corporate governance as well as they are outcomes or working elements of corporate governance process. Corporate Social Responsibility is one of the most important dimensions as it is integral part of corporate governance in addition to being value-enhancing tool for corporate house it is also deliver satisfaction to all parties involved in corporate governance. Corporate governance must encompass and deliver effective resource allocation as by adopting corporate governance a company becomes accountable to society as well as towards other pressure groups. Ethical behavior and entrepreneurial development along with generating economic growth are other dimensions whose importance neither one can ignore nor question.


Economic Vs. Social Process

The arguments are levelled on corporate governance as only being financial, economic and commercial process but the discussion above especially dimensions of CSR, effective resource allocation, entrepreneurial growth and last but not the least the emphasis on economic growth all indicate that this process is not purely a economic concept or tool though a business is a commercial activity generating profits therefore the emphasis must have been given on commercial or economic aspects of the business in the initial stages of the concept but with time Corporate Governance has been moulded and adequate emphasis on social aspects has also been placed. Presence of various social interest groups in parties of corporate governance and in-depth coverage of social objectives in objectives of corporate governance also proves the point that this concept as on date is no longer a purely economic tool but now it is a mix of economic-social efforts and it is target towards bringing economic social discipline in the arena of business. Inclusion of social elements has made this tool more developed and wider in application. Corporate governance is now a more balanced concept that considers not only economic cost benefit but also uses the social cost benefit analysis as well as use fundamentals like shadow pricing, human resource accounting and social capital audits.  It is also important to note that corporate governance is evolutionary; implying that corporate governance practices will evolve in the light of the changing circumstances of a company and must be tailored to meet those circumstances. Corporate governance practices are also bound to be flexible enough to adapt influences of both domestic and international developments.

Instruments of corporate governance - Alian Cadbury reports listed the followings tools as instruments for corporate governance

  • Codes
  • Principles
  • Standards

These instruments provide wider coverage and cover the following areas:

  • Share holders rights and protection
  • Shareholders instruments
  • Employees and stakeholders right protection
  • Company board responsibility
  • Transparency of corporate structures and operations, and disclosure of it on time.

Process of corporate governance - The process of corporate governance involves four principal activities, which are scheduled as the following:

  • Direction formulating the strategic direction for the future of the enterprise in the long-term ( policy and objective ) 
  • Executive action involvement in crucial executive decisions.
  • Supervision monitoring and oversight of management.
  • Accountability recognizing responsibilities to those making a legitimate demand for accountability.

Importance of corporate governance - Corporate governance is a key element in enhancing investor confidence, promoting competitiveness, and ultimately improving economic growth. It is at the top of the international development agenda.

The positive effect of good corporate governance on different stakeholders will ultimately result in a strengthened economy, and hence good corporate governance is a tool for socio-economic development.

Principles of corporate governance

  • Rights and equitable treatment of shareholders
  • Interests of other stakeholders
  • Role and responsibilities of the board
  • Integrity and ethical behaviour
  • Disclosure and transparency

These principles are universal in application and try their level best to provide comprehensive coverage along with complete protection.

Corporate governance and firm performance

In its 'Global Investor Opinion Survey' of over 200 institutional investors first undertaken in 2000 and updated in 2002, McKinsey found that 80% of the respondents would pay a premium for well-governed companies.

They defined a well-governed company as one that had mostly out-side directors, who had no management ties, undertook formal evaluation of its directors, and was responsive to investors' requests for information on governance issues.

Conclusion

With this changing times the need to corporate governance cannot be over emphasised over and above that these troublesome times are the best times to check the effectiveness and efficiency of this practice, this tools has to be provided with razor sharp teeth so incidents like Satyam can not be repeated and trust of millions of innocent investors and other stakeholders can be maintained in this system.

It has to be remembered that key elements of good corporate governance principles include HONESTY, TRUST, INTEGRITY, OPENNESS, PERFORMANCE ORIENTATION, RESPONSIBILITY along with ACCOUNTABILITY, MUTUAL RESPECT, and COMMITMENT TO THE ORGANIZATION. Most important thing is to recognise the fact that corporate governance has succeeded in attracting a good deal of public interest because of its apparent importance for the economic health of corporations and society in general. 

Reference:

Corporate Governance by John L. Colley, Jacqueline L. Doyle, Wallace Stettinius, George Logan - Excel Press

Corporate Governance by Robert A. G. Monks, Nell Minow - Blackwell Publishers; 2nd edition (August 2001)

Corporate Governance: Promises Kept, Promises Broken by Jonathan Macey - University Presses of California, Columbia and Princeton (October 2008)
 


Supreet Ahluwalia
Vivek Joshi
Senior Lecturers
Department of Business
Manipal University Dubai Campus
Block #7 International Academic City Dubai, United Arab Emirates
 

Source: E-mail February 27, 2009

          

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