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Corporate governance refers to the mechanisms, processes, practices, and relations by whichcorporations are controlled and operated by their boards of directors, managers, shareholders, and stakeholders.[1][2]
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"Corporate governance" may be defined, described or delineated in diverse ways, depending on the writer's purpose. Writers focused on a disciplinary interest or context (such asaccounting,finance,corporate law, ormanagement) often adopt narrow definitions that appear purpose specific. Writers concerned with regulatory policy in relation to corporate governance practices often use broader structural descriptions. A broad (meta) definition that encompasses many adopted definitions is "Corporate governance describes the processes, structures, and mechanisms that influence the control and direction of corporations."[1]
This meta definition accommodates both the narrow definitions used in specific contexts and the broader descriptions that are often presented as authoritative. The latter include the structural definition from theCadbury Report, which identifies corporate governance as "the system by which companies are directed and controlled" (Cadbury 1992, p. 15); and the relational-structural view adopted by the Organization for Economic Cooperation and Development (OECD) of "Corporate governance involves a set of relationships between a company's management, board, shareholders and stakeholders. Corporate governance also provides the structure and systems through which the company is directed, and its objectives are set, and the means of attaining those objectives and monitoring performance are determined" (OECD 2023, p. 6).[3]
Examples of narrower definitions in particular contexts include:
The firm itself is modelled as a governance structure acting through the mechanisms of contract.[6][7][8][9] Here corporate governance may includeits relation tocorporate finance.[10][11][12]
Contemporary discussions of corporate governance tend to refer to principles raised in three documents released since 1990: TheCadbury Report (UK, 1992), the Principles of Corporate Governance (OECD, 1999, 2004, 2015 and 2023), and theSarbanes–Oxley Act of 2002 (US, 2002). The Cadbury andOrganisation for Economic Co-operation and Development (OECD) reports present general principles around which businesses are expected to operate to assure proper governance. The Sarbanes–Oxley Act, informally referred to as Sarbox or Sox, is an attempt by the federal government in the United States to legislate several of the principles recommended in the Cadbury and OECD reports.
Some concerns regarding governance follows from the potential forconflicts of interests that are a consequence of the non-alignment of preferences between: shareholders and upper management (principal–agent problems); and among shareholders (principal–principal problems),[23] although also other stakeholder relations are affected and coordinated through corporate governance.
In large firms where there is a separation of ownership and management, theprincipal–agent problem[24] can arise between upper-management (the "agent") and the shareholder(s) (the "principals"). The shareholders and upper management may have different interests. The shareholders typically desire returns on their investments through profits and dividends, while upper management may also be influenced by other motives, such as management remuneration or wealth interests, working conditions and perquisites, or relationships with other parties within (e.g., management-worker relations) or outside the corporation, to the extent that these are not necessary for profits. Those pertaining to self-interest are usually emphasized in relation to principal-agent problems. The effectiveness of corporate governance practices from a shareholder perspective might be judged by how well those practices align and coordinate the interests of the upper management with those of the shareholders. However, corporations sometimes undertake initiatives, such as climate activism and voluntary emission reduction, that seems to contradict the idea that rational self-interest drives shareholders' governance goals.[25]: 3
An example of a possible conflict between shareholders and upper management materializes through stock repurchases (treasury stock). Executives may have incentive to divert cash surpluses to buying treasury stock to support or increase the share price. However, that reduces the financial resources available to maintain or enhance profitable operations. As a result, executives can sacrifice long-term profits for short-term personal gain. Shareholders may have different perspectives in this regard, depending on their owntime preferences, but it can also be viewed as a conflict with broader corporate interests (including preferences of other stakeholders and the long-term health of the corporation).
The principal–agent problem can be intensified when upper management acts on behalf of multiple shareholders—which is often the case in large firms (seeMultiple principal problem).[23] Specifically, when upper management acts on behalf of multiple shareholders, the multiple shareholders face acollective action problem in corporate governance, as individual shareholders may lobby upper management or otherwise have incentives to act in their individual interests rather than in the collective interest of all shareholders.[26] As a result, there may be free-riding in steering and monitoring of upper management,[27] or conversely, high costs may arise from duplicate steering and monitoring of upper management.[28] Conflict may break out between principals,[29] and this all leads to increased autonomy for upper management.[23]
Ways of mitigating or preventing these conflicts of interests include the processes, customs, policies, laws, and institutions which affect the way a company is controlled—and this is the challenge of corporate governance.[30][31] To solve the problem of governing upper management under multiple shareholders, corporate governance scholars have figured out that the straightforward solution of appointing one or more shareholders for governance is likely to lead to problems because of the information asymmetry it creates.[32][33][34] Shareholders' meetings are necessary to arrange governance under multiple shareholders, and it has been proposed that this is the solution to the problem of multiple principals due to median voter theorem: shareholders' meetings lead power to be devolved to an actor that approximately holds the median interest of all shareholders, thus causing governance to best represent the aggregated interest of all shareholders.[23]
An important theme of governance is the nature and extent ofcorporate accountability. A related discussion at the macro level focuses on the effect of a corporate governance system oneconomic efficiency, with a strong emphasis on shareholders' welfare.[9] This has resulted in a literature focused on economic analysis.[35][36][37] A comparative assessment of corporate governance principles and practices across countries was published by Aguilera and Jackson in 2011.[38]
Different models of corporate governance differ according to the variety of capitalism in which they are embedded. The Anglo-American "model" tends to emphasize the interests of shareholders. The coordinated ormultistakeholder model associated with Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community. A related distinction is between market-oriented and network-oriented models of corporate governance.[39]
Some continental European countries, including Germany, Austria, and the Netherlands, require a two-tiered board of directors as a means of improving corporate governance.[40] In the two-tiered board, the executive board, made up of company executives, generally runs day-to-day operations while the supervisory board, made up entirely of non-executive directors who represent shareholders and employees, hires and fires the members of the executive board, determines their compensation, and reviews major business decisions.[41]
Germany, in particular, is known for its practice ofco-determination, founded on the German Codetermination Act of 1976, in which workers are granted seats on the board as stakeholders, separate from the seats accruing to shareholder equity.
The so-called "Anglo-American model" of corporate governance emphasizes the interests of shareholders. It relies on a single-tiered board of directors that is normally dominated by non-executive directors elected by shareholders. Because of this, it is also known as "the unitary system".[42][43] Within this system, many boards include some executives from the company (who areex officio members of the board). Non-executive directors are expected to outnumber executive directors and hold key posts, including audit and compensation committees. In the United Kingdom, theCEO generally does not also serve as chairman of the board, whereas in the US having the dual role has been the norm, despite major misgivings regarding the effect on corporate governance.[44] The number of US firms combining both roles is declining, however.[45]
In the United States, corporations are directly governed by state laws, while the exchange (offering and trading) of securities in corporations (including shares) is governed by federal legislation. Many US states have adopted theModel Business Corporation Act, but the dominant state law for publicly traded corporations isDelaware General Corporation Law, which continues to be the place of incorporation for the majority of publicly traded corporations.[46] Individual rules for corporations are based upon thecorporate charter and, less authoritatively, the corporatebylaws.[46]Shareholders cannot initiate changes in the corporate charter although they can initiate changes to the corporate bylaws.[46]
It is sometimes colloquially stated that in the US and the UK that "the shareholders own the company." This is, however, a misconception as argued by Eccles and Youmans (2015) and Kay (2015).[47] The American system has long been based on a belief in the potential ofshareholder democracy to efficiently allocate capital.
The Japanese model of corporate governance has traditionally held a broad view that firms should account for the interests of a range of stakeholders. For instance, managers do not have a fiduciary responsibility to shareholders. This framework is rooted in the belief that a balance among stakeholder interests can lead to a superior allocation of resources for society. The Japanese model includes several key principles:[48]
An article published by theAustralian Institute of Company Directors called "Do Boards Need to become more Entrepreneurial?" considered the need for founder centrism behaviour at board level to appropriately manage disruption.[49]
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Corporations are created aslegal persons by the laws and regulations of a particular jurisdiction. These may vary in many respects between countries, but a corporation's legal person status is fundamental to all jurisdictions and is conferred by statute. This allows the entity to hold property in its own right without reference to any real person. It also results in the perpetual existence that characterizes the modern corporation. The statutory granting of corporate existence may arise from general purpose legislation (which is the general case) or from a statute to create a specific corporation. Now, the formation of business corporations in most jurisdictions requires government legislation that facilitatesincorporation. This legislation is often in the form ofCompanies Act orCorporations Act, or similar. Country-specific regulatory devices are summarized below.
It is generally perceived that regulatory attention on the corporate governance practices of publicly listed corporations, particularly in relation totransparency andaccountability, increased in many jurisdictions following the high-profilecorporate scandals in 2001–2002, many of which involvedaccounting fraud; and then again after the2008 financial crisis. For example, in the U.S., these included scandals surroundingEnron andMCI Inc. (formerly WorldCom). Their demise led to the enactment of theSarbanes–Oxley Act in 2002, aU.S. federal law intended to improve corporate governance in the United States. Comparable failures in Australia (HIH,One.Tel) are linked to with the eventual passage of theCLERP 9 reforms there (2004), that similarly aimed to improve corporate governance.[50] Similar corporate failures in other countries stimulated increased regulatory interest (e.g.,Parmalat inItaly). Also see
In addition to legislation the facilitates incorporation, many jurisdictions have some major regulatory devices that impact on corporate governance. This includes statutory laws concerned with the functioning ofstock or securities markets (also seeSecurity (finance),consumer and competition (antitrust) laws,labour or employment laws, andenvironmental protection laws, which may also entail disclosure requirements. In addition to thestatutory laws of the relevant jurisdiction, corporations are subject tocommon law in some countries.
In most jurisdictions, corporations also have some form of a corporate constitution that provides individual rules that govern the corporation and authorize or constrain its decision-makers. This constitution is identified by a variety of terms; in English-speaking jurisdictions, it is sometimes known as the corporate charter orarticles of association (which also be accompanied by amemorandum of association).
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Incorporation in Australia originated under state legislation but has been underfederal legislation since 2001. Also seeAustralian corporate law.Other significant legislation includes:
Incorporation in Canada can be done either under either federal or provincial legislation. SeeCanadian corporate law.
Dutch corporate law is embedded in theondernemingsrecht and, specifically for limited liability companies, in thevennootschapsrecht.
In addition The Netherlands has adopted a Corporate Governance Code in 2016, which has been updated twice since.In the latest version (2022),[51] theExecutive Board of the company is held responsible for the continuity of the company and itssustainable long-term value creation.The executive board considers the impact of corporate actions on People and Planet and takes the effects on corporate stakeholders into account.[52] In the Dutch two-tier system, theSupervisory Board monitors and supervises the executive board in this respect.
Polish Corporate Law is regulated in Code of Commercial Companies.[53] The code regulates most of the aspects of corporate governance, incl. rules of incorporation and liquidation, it defines rights, obligations and rules of operations of corporate bodies (Management Board, Supervisory Board, Shareholders Meeting).[54]
The UK has a single jurisdiction forincorporation. Also seeUnited Kingdom company lawOther significant legislation includes:
The UK passed theBribery Act in 2010. This law made it illegal to bribe either government or private citizens or make facilitating payments (i.e., payment to a government official to perform their routine duties more quickly). It also required corporations to establish controls to prevent bribery.
Incorporation in the US is under state level legislation, but there important federal acts. in particular, seeSecurities Act of 1933,Securities Exchange Act of 1934, andUniform Securities Act.
TheSarbanes–Oxley Act of 2002 (SOX) was enacted in the wake of a series of high-profile corporate scandals, which cost investors billions of dollars.[55] It established a series of requirements that affect corporate governance in the US and influenced similar laws in many other countries. SOX contained many other elements, but provided for several changes that are important to corporate governance practices:
The U.S. passed theForeign Corrupt Practices Act (FCPA) in 1977, with subsequent modifications. This law made it illegal to bribe government officials and required corporations to maintain adequate accounting controls. It is enforced by theU.S. Department of Justice and theSecurities and Exchange Commission (SEC). Substantial civil and criminal penalties have been levied on corporations and executives convicted of bribery.[57]
Corporate governance principles and codes have been developed in different countries and issued from stock exchanges, corporations, institutional investors, or associations (institutes) of directors and managers with the support of governments and international organizations. As a rule, compliance with these governance recommendations is not mandated by law, although the codes linked to stock exchangelisting requirements may have a coercive effect.
One of the most influential guidelines on corporate governance are theG20/OECD Principles of Corporate Governance, first published as the OECD Principles in 1999, revised in 2004, in 2015 when endorsed by the G20, and in 2023.[58] The Principles are often referenced by countries developing local codes or guidelines. Building on the work of the OECD, other international organizations, private sector associations and more than 20 national corporate governance codes formed theUnited NationsIntergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) to produce their Guidance on Good Practices in Corporate Governance Disclosure.[59] This internationally agreed[60] benchmark consists of more than fifty distinct disclosure items across five broad categories:[61]
TheOECD Guidelines on Corporate Governance of State-Owned Enterprises[62] complement the G20/OECD Principles of Corporate Governance,[63] providing guidance tailored to the corporate governance challenges ofstate-owned enterprises.
Companies listed on theNew York Stock Exchange (NYSE) and other stock exchanges are required to meet certain governance standards. For example, the NYSE Listed Company Manual requires, among many other elements:
The investor-led organisation International Corporate Governance Network (ICGN) was set up by individuals centred around the ten largest pension funds in the world in 1995. The aim is to promote global corporate governance standards. The network is led by investors that manage US$77 trillion, and members are located in fifty countries. ICGN has developed a suite of global guidelines ranging from shareholder rights to business ethics.[64]
TheWorld Business Council for Sustainable Development (WBCSD) has done work on corporate governance, particularly on accounting and reporting.[65] In 2009, theInternational Finance Corporation and theUN Global Compact released a report, "Corporate Governance: the Foundation for Corporate Citizenship and Sustainable Business",[66] linking the environmental, social and governance responsibilities of a company to its financial performance and long-term sustainability.
Most codes are largely voluntary. An issue raised in the U.S. since the 2005Disney decision[67] is the degree to which companies manage their governance responsibilities; in other words, do they merely try to supersede the legal threshold, or should they create governance guidelines that ascend to the level of best practice. For example, the guidelines issued by associations of directors, corporate managers and individual companies tend to be wholly voluntary, but such documents may have a wider effect by prompting other companies to adopt similar practices.[citation needed]
In 2021, the first everinternational standard, ISO 37000, was published as guidance for good governance.[68] The guidance places emphasis on purpose which is at the heart of all organizations, i.e. a meaningful reason to exist. Values inform both the purpose and the way the purpose is achieved.[69]
Robert E. Wright argued inCorporation Nation (2014) that the governance of early U.S. corporations, of which over 20,000 existed by theCivil War of 1861–1865, was superior to that of corporations in the late 19th and early 20th centuries because early corporations governed themselves like "republics", replete with numerous "checks and balances" against fraud and against usurpation of power by managers or by large shareholders.[70] (The term"robber baron" became particularly associated with US corporate figures in theGilded Age—the late 19th century.)
In the immediate aftermath of theWall Street crash of 1929 legal scholars such asAdolf Augustus Berle, Edwin Dodd, andGardiner C. Means pondered on the changing role of the modern corporation in society.[71] From theChicago school of economics,Ronald Coase[72] introduced the notion of transaction costs into the understanding of why firms are founded and how they continue to behave.[73]
US economic expansion through the emergence of multinational corporations afterWorld War II (1939–1945) saw the establishment of themanagerial class. SeveralHarvard Business School management professors studied and wrote about the new class:Myles Mace (entrepreneurship),Alfred D. Chandler, Jr. (business history),Jay Lorsch (organizational behavior) and Elizabeth MacIver (organizational behavior). According to Lorsch and MacIver "many large corporations have dominant control over business affairs without sufficient accountability or monitoring by their board of directors".[citation needed]
In the 1980s,Eugene Fama andMichael Jensen[74] established theprincipal–agent problem as a way of understanding corporate governance: the firm is seen as a series of contracts.[75]
In the period from 1977 to 1997, corporate directors' duties in the U.S. expanded beyond their traditional legal responsibility of duty of loyalty to the corporation and to its shareholders.[76][vague]
In the first half of the 1990s, the issue of corporate governance in the U.S. received considerable press attention due to a spate of CEO dismissals (for example, atIBM,Kodak, andHoneywell) by their boards. The California Public Employees' Retirement System (CalPERS) led a wave ofinstitutional shareholder activism (something only very rarely seen before), as a way of ensuring that corporate value would not be destroyed by the now traditionally cozy relationships between the CEO and the board of directors (for example, by the unrestrained issuance of stock options, not infrequentlyback-dated).
In the early 2000s, the massive bankruptcies (and criminal malfeasance) ofEnron andWorldcom, as well as lessercorporate scandals (such as those involvingAdelphia Communications,AOL,Arthur Andersen,Global Crossing, andTyco) led to increased political interest in corporate governance. This was reflected in the passage of theSarbanes–Oxley Act of 2002. Other triggers for continued interest in the corporate governance of organizations included the2008 financial crisis and the level of CEO pay.[77]
Some corporations have tried to burnish their ethical image by creating whistle-blower protections, such as anonymity. This varies significantly by justification, company and sector.
The1997 Asian financial crisis severely affected the economies ofThailand,Indonesia,South Korea,Malaysia, and thePhilippines through the exit of foreign capital after property assets collapsed. The lack of corporate governance mechanisms in these countries highlighted the weaknesses of the institutions in their economies.[citation needed]
In the 1990s, China established the Shanghai and Shenzhen Stock Exchanges and theChina Securities Regulatory Commission (CSRC) to improve corporate governance. Despite these efforts, state ownership concentration and governance issues such as board independence and insider trading persisted.[78]
In November 2006 theCapital Market Authority (Saudi Arabia) (CMA) issued a corporate governance code in the Arabic language.[79] The Kingdom ofSaudi Arabia has made considerable progress with respect to the implementation of viable and culturally appropriate governance mechanisms (Al-Hussain & Johnson, 2009).[80][need quotation to verify]
Al-Hussain, A. and Johnson, R. (2009) found a strong relationship between the efficiency of corporate governance structure andSaudi bank performance when usingreturn on assets as a performance measure with one exception—that government and local ownership groups were not significant. However, usingrate of return as a performance measure revealed a weak positive relationship between the efficiency of corporate governance structure and bank performance.[81]
Key parties involved in corporate governance include stakeholders such as the board of directors, management and shareholders. External stakeholders such as creditors, auditors, customers, suppliers, government agencies, and the community at large also exert influence. The agency view of the corporation posits that the shareholder forgoes decision rights (control) and entrusts the manager to act in the shareholders' best (joint) interests. Partly as a result of this separation between the two investors and managers, corporate governance mechanisms include a system of controls intended to help align managers' incentives with those of shareholders. Agency concerns (risk) are necessarily lower for acontrolling shareholder.[82]
In private for-profit corporations, shareholders elect the board of directors to represent their interests. In the case of nonprofits, stakeholders may have some role in recommending or selecting board members, but typically the board itself decides who will serve on the board as a 'self-perpetuating' board.[83] The degree of leadership that the board has over the organization varies; in practice at large organizations, the executive management, principally the CEO, drives major initiatives with the oversight and approval of the board.[84]
Former Chairman of the Board ofGeneral MotorsJohn G. Smale wrote in 1995: "The board is responsible for the successful perpetuation of the corporation. That responsibility cannot be relegated to management."[85] Aboard of directors is expected to play a key role in corporate governance. The board has responsibility for: CEO selection and succession; providing feedback to management on the organization's strategy; compensating senior executives; monitoring financial health, performance and risk; and ensuring accountability of the organization to its investors and authorities. Boards typically have several committees (e.g., Compensation, Nominating and Audit) to perform their work.[86]
The OECD Principles of Corporate Governance (2025) describe the responsibilities of the board; some of these are summarized below:[58]
All parties, not just shareholders, to corporate governance have an interest, whether direct or indirect, in the financial performance of the corporation.[2] Directors, workers and management receive salaries, benefits and reputation, while investors expect to receive financial returns. For lenders, it is specified interest payments, while returns to equity investors arise from dividend distributions or capital gains on their stock. Customers are concerned with the certainty of the provision of goods and services of an appropriate quality; suppliers are concerned with compensation for their goods or services, and possible continued trading relationships. These parties provide value to the corporation in the form of financial, physical, human and other forms of capital. Many parties may also be concerned withcorporate social performance.[2]
A key factor in a party's decision to participate in or engage with a corporation is their confidence that the corporation will deliver the party's expected outcomes. When categories of parties (stakeholders) do not have sufficient confidence that a corporation is being controlled and directed in a manner consistent with their desired outcomes, they are less likely to engage with the corporation. When this becomes an endemic system feature, the loss of confidence and participation in markets may affect many other stakeholders, and increases the likelihood of political action. There is substantial interest in how external systems and institutions, including markets, influence corporate governance.[87]
In 2016 the director of theWorld Pensions Council (WPC) said that "institutional asset owners now seem more eager to take to task [the] negligent CEOs" of the companies whose shares they own.[88]
This development is part of a broader trend towards more fully exercised asset ownership—notably from the part of theboards of directors ('trustees') of large UK, Dutch, Scandinavian and Canadian pension investors:
No longer 'absentee landlords', [pension fund] trustees have started to exercise more forcefully theirgovernance prerogatives across the boardrooms of Britain,Benelux andAmerica: coming together through the establishment of engaged pressure groups […] to 'shift the [whole economic] system towards sustainable investment'.[88]
This could eventually put more pressure on theCEOs ofpublicly listed companies, as "more than ever before, many [North American,] UK and European Unionpension trustees speak enthusiastically about flexing theirfiduciary muscles for the UN'sSustainable Development Goals", and otherESG-centric investment practices.[89]
In Britain, "The widespread social disenchantment that followed the [2008–2012]great recession had an impact" on all stakeholders, includingpension fund board members and investment managers.[90]
Many of the UK's largest pension funds are thus already active stewards of their assets, engaging withcorporate boards and speaking up when they think it is necessary.[90]
Control and ownership structure refers to the types and composition of shareholders in a corporation. In some countries such as most of Continental Europe, ownership is not necessarily equivalent to control due to the existence of e.g. dual-class shares, ownership pyramids, voting coalitions, proxy votes and clauses in the articles of association that confer additional voting rights to long-term shareholders.[91] Ownership is typically defined as the ownership of cash flow rights whereas control refers to ownership of control or voting rights.[91] Researchers often "measure" control and ownership structures by using some observable measures of control and ownership concentration or the extent of inside control and ownership. Some features or types of control and ownership structure involvingcorporate groups include pyramids,cross-shareholdings, rings, and webs. German "concerns" (Konzern) are legally recognized corporate groups with complex structures. Japanesekeiretsu (系列) and South Koreanchaebol (which tend to be family-controlled) are corporate groups which consist of complex interlocking business relationships and shareholdings. Cross-shareholding is an essential feature of keiretsu and chaebol groups. Corporate engagement with shareholders and other stakeholders can differ substantially across different control and ownership structures.
In smaller companies founder‐owners often play a pivotal role in shaping corporate value systems that influence companies for years to come. In larger companies that separate ownership and control, managers and boards come to play an influential role.[92] This is in part due to the distinction between employees and shareholders in large firms, where labour forms part of the corporate organization to which it belongs whereas shareholders, creditors and investors act outside of the organization of interest.
Family interests dominate ownership and control structures of some corporations, and it has been suggested that the oversight of family-controlled corporations are superior to corporations "controlled" by institutional investors (or with such diverse share ownership that they are controlled by management). A 2003Business Week study said: "Forget the celebrity CEO. Look beyond Six Sigma and the latest technology fad. One of the biggest strategic advantages a company can have, it turns out, is blood lines."[93] A 2007 study byCredit Suisse found that European companies in which "the founding family or manager retains a stake of more than 10 per cent of the company's capital enjoyed a superior performance over their respective sectoral peers", reportedFinancial Times.[94] Since 1996, this superior performance amounted to 8% per year.[94]
The significance of institutional investors varies substantially across countries. In developed Anglo-American countries (Australia, Canada, New Zealand, U.K., U.S.), institutional investors dominate the market for stocks in larger corporations. While the majority of the shares in the Japanese market are held by financial companies and industrial corporations, these are not institutional investors if their holdings are largely with-on group.[citation needed]
The largest funds of invested money or the largest investment management firm for corporations are designed to maximize the benefits of diversified investment by investing in a very large number of different corporations with sufficientliquidity. The idea is this strategy will largely eliminate individual firmfinancial or other risk. A consequence of this approach is that these investors have relatively little interest in the governance of a particular corporation. It is often assumed that, if institutional investors pressing for changes decide they will likely be costly because of "golden handshakes" or the effort required, they will simply sell out their investment.[citation needed]
Particularly in the United States, proxy access allows shareholders to nominate candidates which appear on theproxy statement, as opposed to restricting that power to the nominating committee. The SEC had attempted a proxy access rule for decades,[95] and the United StatesDodd–Frank Wall Street Reform and Consumer Protection Act specifically allowed the SEC to rule on this issue, however, the rule was struck down in court.[95] Beginning in 2015, proxy access rules began to spread driven by initiatives from major institutional investors, and as of 2018, 71% of S&P 500 companies had a proxy access rule.[95]
Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise frommoral hazard andadverse selection. There are both internal monitoring systems and external monitoring systems.[96] Internal monitoring can be done, for example, by one (or a few) large shareholder(s) in the case of privately held companies or a firm belonging to abusiness group. Furthermore, the various board mechanisms provide for internal monitoring. External monitoring of managers' behavior occurs when an independent third party (e.g. theexternal auditor) attests the accuracy of information provided by management to investors. Stock analysts and debt holders may also conduct such external monitoring. An ideal monitoring and control system should regulate both motivation and ability, while providing incentive alignment toward corporate goals and objectives. Care should be taken that incentives are not so strong that some individuals are tempted to cross lines of ethical behavior, for example by manipulating revenue and profit figures to drive the share price of the company up.[73]
Internal corporate governance controls monitor activities and then take corrective actions to accomplish organisational goals. Examples include:
In publicly traded U.S. corporations, boards of directors are largelychosen by the president/CEO, and the president/CEO often takes the chair of the board position for him/herself (which makes it much more difficult for the institutional owners to "fire" him/her). The practice of the CEO also being the chair of the Board is fairly common in large American corporations.[99]
While this practice is common in the U.S., it is relatively rare elsewhere. In the U.K., successive codes of best practice have recommended against duality.[citation needed]
External corporate governance controls the external stakeholders' exercise over the organization. Examples include:
The board of directors has primary responsibility for the corporation's internal and externalfinancial reporting functions. Thechief executive officer andchief financial officer are crucial participants, and boards usually have a high degree of reliance on them for the integrity and supply of accounting information. They oversee the internal accounting systems, and are dependent on the corporation'saccountants andinternal auditors.
Current accounting rules underInternational Accounting Standards and U.S.GAAP allow managers some choice in determining the methods of measurement and criteria for recognition of various financial reporting elements. The potential exercise of this choice to improve apparent performance increases the information risk for users. Financial reporting fraud, including non-disclosure and deliberate falsification of values also contributes to users' information risk. To reduce this risk and to enhance the perceived integrity of financial reports, corporation financial reports must be audited by an independentexternal auditor who issues a report that accompanies the financial statements.
One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management. The power of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and dismiss accounting firms contradicts the concept of an independent auditor. Changes enacted in the United States in the form of theSarbanes–Oxley Act (following numerous corporate scandals, culminating with theEnron scandal) prohibit accounting firms from providing both auditing and management consulting services. Similar provisions are in place under clause 49 of Standard Listing Agreement in India.
A basic comprehension of corporate positioning on the market can be found by looking at which market area or areas a corporation acts in, and which stages of the respective value chain for that market area or areas it encompasses.[100][101]
A corporation may from time to time decide to alter or change its market positioning – throughM&A activity for example – however it may loose some or all of its market efficiency in the process due to commercial operations depending to a large extent on its ability to account for a specific positioning on the market.[102]
Well-designed corporate governance policies also support the sustainability and resilience of corporations and in turn, may contribute to the sustainability and resilience of the broader economy. Investors have increasingly expanded their focus on companies' financial performance to include the financial risks and opportunities posed by broader economic, environmental and societal challenges, and companies' resilience to and management of those risks. In some jurisdictions, policy makers also focus on how companies' operations may contribute to addressing such challenges. A sound framework for corporate governance with respect to sustainability matters can help companies recognise and respond to the interests of shareholders and different stakeholders, as well as contribute to their own long-term success. Such a framework should include the disclosure of material sustainability-related information that is reliable, consistent and comparable, including related to climate change. In some cases, jurisdictions may interpret concepts of sustainability-related disclosure and materiality in terms of applicable standards articulating information that a reasonable shareholder needs in order to make investment or voting decisions.
Increasing attention and regulation (as under theSwiss referendum "against corporate rip-offs" of 2013) has been brought to executive pay levels since the2008 financial crisis. Research on the relationship between firm performance andexecutive compensation does not identify consistent and significant relationships between executives' remuneration and firm performance. Not all firms experience the same levels of agency conflict, and external and internal monitoring devices may be more effective for some than for others.[77][104] Some researchers have found that the largest CEO performance incentives came from ownership of the firm's shares, while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. The results suggest that increases in ownership above 20% cause management to become more entrenched, and less interested in the welfare of their shareholders.[104]
Some argue that firm performance is positively associated withshare option plans and that these plans direct managers' energies and extend their decision horizons toward the long-term, rather than the short-term, performance of the company. However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants as documented by University of Iowa academic Erik Lie[105] and reported by James Blander and Charles Forelle of theWall Street Journal.[104][106]
Even before the negative influence on public opinion caused by the 2006 backdating scandal, use of options faced various criticisms. A particularly forceful and long running argument concerned the interaction of executive options with corporate stock repurchase programs. Numerous authorities (including U.S. Federal Reserve Board economist Weisbenner) determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests. These authors argued that, in part, corporate stock buybacks for U.S. Standard & Poor's 500 companies surged to a $500 billion annual rate in late 2006 because of the effect of options.[107]
A combination of accounting changes and governance issues led options to become a less popular means of remuneration as 2006 progressed, and various alternative implementations of buybacks surfaced to challenge the dominance of "open market" cash buybacks as the preferred means of implementing ashare repurchase plan.
Shareholders elect a board of directors, who in turn hire achief executive officer (CEO) tolead management. The primary responsibility of the board relates to the selection and retention of the CEO. However, in many U.S. corporations the CEO and chairman of the board roles are held by the same person. This creates an inherent conflict of interest between management and the board.
Critics of combined roles argue the two roles that should be separated to avoid the conflict of interest and more easily enable a poorly performing CEO to be replaced.Warren Buffett wrote in 2014: "In my service on the boards of nineteen public companies, however, I've seen how hard it is to replace a mediocre CEO if that person is also Chairman. (The deed usually gets done, but almost always very late.)"[108]
Advocates argue that empirical studies do not indicate that separation of the roles improves stock market performance and that it should be up to shareholders to determine what corporate governance model is appropriate for the firm.[109]
In 2004, 73.4% of U.S. companies had combined roles; this fell to 57.2% by May 2012. Many U.S. companies with combined roles have appointed a "Lead Director" to improve independence of the board from management. German and UK companies have generally split the roles in nearly 100% of listed companies. Empirical evidence does not indicate one model is superior to the other in terms of performance. However, one study indicated that poorly performing firms tend to remove separate CEOs more frequently than when the CEO/Chair roles are combined.[110]
Certain groups of shareholders may become disinterested in the corporate governance process, potentially creating a power vacuum in corporate power. Insiders, other shareholders, and stakeholders may take advantage of these situations to exercise greater influence and extract rents from the corporation.
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