Corporate Governance

Businesses thrive or collapse based on the rules they establish to serve the needs of everyone they serve, from shareholders and stakeholders to managers and customers. These policies and guidelines make up corporate governance. ‌

While corporate governance has evolved with new expectations and technologies, it remains the business’ driving force. It dictates how a company’s board of directors helps drive success in meeting short and long-term goals. Board members with the right tools for communication and corporate monitoring have a profound impact on their organizations.

What is corporate governance?

Corporate governance encompasses the rules, practices and processes that guide a company’s operations and decisions.

Whether publicly traded or not, a corporation is a complex enterprise: It’s an interconnected web that weaves together the business itself, its executive leadership, the customers who buy its offerings, and the investors and financiers who provide the capital to make it all happen. Other key players include government bodies that impose guardrails and regulations, suppliers who provide the resources an organization needs to function, and communities affected by a company’s operations. Good corporate governance aims to balance all these interests in a practical, fair and transparent manner.

The details vary across companies, geographies and industries, but strong corporate governance can typically be defined by these traits:

• It’s responsive, participatory and consensus-oriented
• It’s efficient and effective
• It upholds the rule of law in applicable jurisdictions
• It advances equity and inclusiveness, along with the company’s strategic vision — ensuring that the corporation “does good while doing well,” and vice versa
• It prioritizes transparency and accountability

As Marc Hodak, Partner at Farient Advisors, said at Diligent’s 2022 user conference, “Good governance is ultimately what is right for the long-term health of the company."

6 principles of corporate governance

The business landscape is constantly evolving, which means the principles of corporate governance are constantly changing. How can organizations maintain the core tenets of good governance while keeping up with the times?

In 2023, the G20 and the Organisation for Economic Co-operation and Development (OECD) issued six principles of corporate governance to help. These principles assist policymakers in evaluating and improving legal, regulatory and institutional frameworks. They also serve as a guide to help corporations innovate and adapt their practices to stay competitive in a changing world. So, what are these revised principles of corporate governance?

1. An effective corporate governance framework

Just like a house needs framing to determine its structure and “good bones” to remain standing over time, effective corporate governance requires a strong foundation.

According to the OECD, a corporate governance framework “should support transparent and fair markets and the efficient allocation of resources. It should be consistent with the rule of law and support effective supervision and enforcement.”

Each of these are essential elements of corporate governance. Consider consistency with the rule of law, which encompasses legislation in the jurisdictions where a company does business, rules for listing on various exchanges, and regulations that impact worker rights and the environment. These guardrails protect the rights of communities, customers, employees, shareholders and other parties. The first corporate governance principle helps ensure that a company is accountable and operates in a way that upholds these rights.

2. The rights and equitable treatment of shareholders and key ownership functions

As the owners of a publicly traded corporation, shareholders do more than reap the company’s profits. They’re also essential elements of corporate governance for many reasons, including:

• Participating and voting in general meetings
• Electing and removing members of the board, as well as an external auditor
• Approving or participating in fundamental corporate decisions, like the authorization of additional shares or amendments to governing documents

The second principle behind good corporate governance helps these rights play out equally for all shareholders, regardless of class. Take a shareholder’s right to obtain relevant and material information about the corporation on a timely, regular basis, for example. Insider trading laws in the United States make it illegal to share information with one set of stockholders — like a prominent pension fund or majority investor — unless that information is available to the entire market simultaneously.

3. Institutional investors, stock markets and other intermediaries

The immediate relationship between a company that issues shares and the investors who buy them is just one aspect of how capital markets work. Several intermediaries keep the gears turning. For example, stock exchanges and brokers connect buyers and sellers, while institutional investors buy, sell and manage stocks on behalf of other parties. Credit rating agencies, analysts, and proxy advisors deliver guidance throughout the process.

All these parties need oversight for fair and effective functioning. Enter corporate governance to maintain fairness, accountability and trust.

Imagine if a conflict of interest went unchecked in any of these areas. Say a personal connection among top leadership leads to the favorable treatment of one company over others: Brokers might promote one company’s stock over others, and the clients of institutional investors might not get the best mix of companies in their own portfolios. Meanwhile, investors wouldn’t be able to trust the objectivity of an analyst report or credit rating.

For that reason, considering those with an interest in the company is a foundational element of corporate governance — it’s the oil that keeps the engine’s many parts running smoothly.

4. Disclosure and transparency

If a decision affects the material health of a publicly traded company, boards must make investors aware promptly. The fourth principle of corporate governance requires clear and transparent communication with all shareholders and stakeholders.

Take the appointment of a new CEO, for example. A publicly traded company can’t just slip a new CEO into such an important and fiduciarily responsible leadership position without solid explanation, rationale and context.

When choosing new leadership, companies should follow a structured process that addresses the recruitment-related elements of corporate governance: succession planning, conducting the appropriate due diligence, considering diversity and representation in the recruitment process, and choosing leaders who fit the skills needs of the board, marketplace and corporate strategy — while providing visibility into the entire process.

Such thoughtfulness and transparency engender confidence, showing shareholders that the company has nothing to hide. It also demonstrates the company’s commitment to protecting shareholder interests and a willingness to be held accountable.

5. The responsibilities of the board

The fifth principle ensures the board structure supports effective oversight and accountability so directors can exercise objective and independent judgment, oversee risk, and monitor managerial performance — in effect, perform their fiduciary duties.

This principle gets into the nitty gritty of board operations:

• Are processes like meetings and minutes in place to keep directors fully informed?
• What about conflict-of-interest measures and a balance of independent vs. executive directors to ensure they act in good faith?
• Do committees and the full board regularly delve into important areas like audit and cybersecurity to exercise due diligence and care? And does this due diligence extend to their own ranks when choosing new directors?
• Finally, do appropriate disclosure, engagement and accountability measures exist to ensure the board is operating in the best interests of the shareholders?

6. Sustainability and resilience

Ensuring that a company can withstand the winds of change and thrive well into the future involves a great deal of decision-making and risk management. Sustainability frameworks, practices, policies and incentives are integral elements of corporate governance that yield long-term success.

One example is climate change and the transition to net zero operations. What are the potential risks of moving from fossil-fueled operations to renewable energy sources? What are the risks of not doing so, like non-compliance with evolving regulations or a poor reputation among environmentally-minded future workers? What are the potential opportunities, like cost savings and increased goodwill?

Within a company, good corporate governance enables sound management of these risks. Within the greater capital market ecosystem, disclosing material data in a consistent, comparable and reliable way ensures that investors, exchanges and advisors have the information they need for smart, timely decisions.

In essence, the six principles of corporate governance, recently outlined by the G20 and OECD, stand as indispensable guidelines for fostering resilience, transparency, and ethical practices in an ever-changing business landscape.

Pillars upholding the corporate governance structure

Corporate governance is often synonymous with boards of directors. But the reality is that boards are merely at the top of an extensive chain of command, each level of which must collaborate to enact effective governance practices.

While these structures may vary between organizations, a typical corporate governance structure includes:

• Board of directors: Elected by shareholders, boards set the corporate strategy, approve policies, oversee executives and make major decisions according to the governance structure.
• Shareholders: Those who own company shares can influence board decisions and vote on issues like board and executive appointments.
• Executive leadership: Led by the Chief Executive Officer, company leaders manage day-to-day operations according to the board’s strategy. They’re also accountable to both the board and shareholders.
• Internal control systems: The corporate governance structure trickles down to internal controls, which are policies and practices that ensure the accuracy of financial statements, protect assets and comply with laws and regulations.

Common corporate governance structure examples

An organization’s unique corporate governance structure depends on how they combine the individual pieces, a few of which we listed above. A company’s size, industry and legal jurisdiction can also shape its governance formula. Some common examples of corporate governance structures are:

• Unitary board structure: Corporations with a unitary structure will have a single board that includes executives and non-executives, and the CEO typically chairs the board. This structure is much more common in small and medium-sized entities.
• Two-tier board structure: Larger corporations may begin to separate the management board (overseeing daily activities) and the supervisory board (overseeing and appointing the management board). This structure tends to be more prevalent in European countries.
• Board committees: Many boards will enact committees as part of the corporate governance structure. Committees can include an audit committee to oversee financial reporting and internal controls or a compensation committee to determine executive remuneration.
• Stakeholder governance: Enterprises are increasingly orienting themselves around the needs of their stakeholders, which can include shareholders, employees and the communities in which they operate.

Ensuring stability and growth: What is the purpose of corporate governance in the United States?

The role of corporate governance in the United States is to maximize long-term shareholder value while ensuring transparency, accountability, and fairness for all stakeholders involved. This includes shareholders, employees, creditors, customers, and the broader community. By establishing a clear framework for decision-making and oversight, effective corporate governance fosters stability and growth for modern organizations, ultimately contributing to a healthy and sustainable business environment.

Examples of corporate governance

Corporate governance isn’t always obvious. Though a corporate governance scandal like Enron can go down in the history books, effective and ethical governance more easily flies under the radar. Yet, many of the most beloved corporations today are examples of corporate governance at work. That includes:

Johnson & Johnson

The company’s mission is to help “people around the world live better, healthier lives.” Corporate governance is one of the many ways Johnson & Johnson works toward this aim. It’s transparent about the organization’s guiding principles, including its decentralized structure, diverse board and ethical business practices. It’s also won the favor of fellow corporations and consumers alike by quickly responding to crises, including product recalls.

Unilever

Like Johnson & Johnson, Unilever walks the walk of good corporate governance. It’s especially committed to sustainability and social responsibility, having outlined its goals for reducing environmental impact in its Sustainable Living Plan. The Unilever governance structure prioritizes long-term value creation over short-term profit, which helps the enterprise live out its commitment to ethical business practices.

Microsoft

“Long-term thinking guides everything we do,” according to Microsoft’s corporate governance overview. Its ubiquity in the ever-evolving tech space makes Microsoft one of the most compelling corporate governance. It’s thrived for decades thanks to its commitment to value creation and focus on ESG.

The consequences of bad corporate governance

Understanding effective governance is essential, but many organizations equally wonder: “What is bad corporate governance?”

Failing to follow the six principles of corporate governance adversely impacts any business. Time and again, corporations have shown how damaging bad corporate governance is. Any misstep or unethical practice can ruin a business in a heartbeat in a world of fast-paced news and instant information. Take these notorious examples of bad corporate governance:

The 2008 financial crisis

The 2008 financial crisis is an example of a complete failure of corporate governance. Greed permeated every level of multiple industries, creating unnecessary and uncontrolled risk, even as foreclosure data raised alarms. Banks were prime examples of companies with bad corporate governance, issuing risky loans to numerous individuals and companies despite the lessons of the past.

The result was a debt trap comparable to the credit crisis of the 1920s and one of the worst recessions in world history. Neither regulators nor corporations implemented proper risk analysis and accountability. Shareholders and companies fell to bad governance.

The Enron corporate governance scandal

Some of the worst outcomes occur when there’s no governance. The Enron scandal represents cases of bad corporate governance at nearly every level.

‌Cooking the books, suspending the code of ethics, deceptive business practices, and outright lying all brought down Enron, a corporation Fortune deemed “America’s Most Innovative Company” — not once, but six years in a row. It turns out that their profits were nothing more than a figment of the imagination.

Enron may have started as a legitimate venture. However, mixing the board of directors with bad actors and self-interested parties soon saw a disaster in the making. A lack of oversight allowed former CEO and COO Jeffrey Skilling and former chairman and CEO Kenneth Lay to take advantage of their positions in a highly unethical and illegal way.

The company eventually collapsed under the weight of its own deceit, leaving damage to the California power grid that continues to resonate today. Shares tumbled from $90.75 to a meager $0.26, and Congress enacted the Sarbanes-Oxley Act to prevent similar fraudulent financial reporting and manipulation of economic laws.

Assessing corporate governance

Monitoring governance standards is a crucial task alongside environmental and social criteria. This is the essence of ESG, which stands for Environmental, Social and Governance.

These three factors play an essential role in the choices investors make. Many mutual funds and brokers use them to help their clients pick stocks. They also directly impact your bottom line. ESG criteria are interrelated. They all affect your company’s risk management and business strategies.

Social criteria relate directly to your business relationships. Critical choices in how the company treats surrounding communities and acts on social issues reflect its quality and revenue. Shown to increase the available talent pool by 25% and even drive profits, social responsibility and transparency are now firmly entrenched in the corporate landscape.

Every decision a company makes should reflect ESG criteria. They reveal just how open, accountable, and responsible your organization is.

Using technology to achieve solid corporate governance

Successful corporate governance often uses a data-driven approach to setting the rules and policies that guide an organization. The board of directors must act, following the six principles of governance for the best interest of stakeholders, shareholders and the business.

Equipping your organization with the right tools, such as Diligent’s Board & Leadership Collaboration solution, part of the Diligent One Platform, enables you to implement strong governance practices for effective decision-making and a thriving company.