INTRODUCTION TO CORPORATE GOVERNANCE

Expected Learning Outcomes

After studying the chapter, you should be able to:

1.Describe what governance involves

2.Enumerate the different contexts in which governance can be applied
3.Name and explain the characteristics of good governance
4.Explain the meaning, purpose and objectives of corporate governance
5.Know and describe the principles of effective corporate governance
6.Understand how the principle of good cooperate governance can applied

WHAT IS GOVERNANCE?
Generally, governance refers to a process whereby elements in society wield
power, authority and influence and enact policies and decisions concerning
public life and social upliftment.
It comprises all the processes of governing — whether undertaken by the
government of a country, by a market or by a network — over a social system
and whether through the laws, norms, power or language of an organized
society.

Governance therefore means the process of decision-making and the process

by which decisions are implemented (or not implemented) through the
exercise of power or authority by leaders of the country and / or organizations.
Governance can be used in several contexts such, as corporate governance,
international governance, national governance and local governance.

The focus of this book is on Corporate Governance.

CHARACTERISTICS OF GOOD GOVERNANCE

Whatever context good governance is used, the following major characteristics

should be present:
Participation

Rule of Law Accountability

Good
Transparency Governance Effectiveness &
Governance

Responsiveness Equity &

Consensus Inclusiveness
Oriented
These characteristics are briefly described as follows:

Participation

Participation by both men and women is a key cornerstone of good governance.

Participation could be either direct or through legitimate institutions or
representatives. It is important to point out that representative democracy does
not necessarily mean that the concern of the most vulnerable in society
would not be taken into consideration in decision making. Participation needs to
be informed and organized. This means freedom of association and
expression on one hand and an organized civil society on the other hand.

Rule of Law

Good governance requires fair legal frameworks that are enforced impartially. It
also requires full protection of human rights, particularly those of minorities.
Impartial enforcement of laws requires an independent judiciary and an
impartial and incorruptible police force.

Transparency

Transparency means that decisions taken and their enforcement are done in
a manner that follows rules and regulations. It means that information is freely
available and directly accessible to those who will be affected by such
decisions and their enforcement. It also means that enough information is
provided and that it is provided in easily understandable forms and media.

Responsiveness

Good governance requires that institutions and processes try to serve the needs
all stakeholders within a reasonable timeframe.

Consensus Oriented

Good governance requires mediation of the different interests in society to

reach a broad consensus on what is in the best interest of the whole
community and how this can be achieved. It also requires a broad and long-
term perspective on what is needed for sustainable human development
and how to achieve the goals of such development. This can only result
from an understanding of the historical cultural and social contexts of a given
society or community.

Equity and Inclusiveness

Ensures that all its members feel that they have a stake in it and do not feel
excluded from the mainstream of society. This requires all groups, but
particularly the most vulnerable, have opportunities to improve or maintain
their well being.

Effectiveness and Effiency

Good governance means that processes and institutions produce results that
meet the needs of society while making the best use of resources at their
disposal. The concept of efficiency in the context of good governance also
covers the sustainable use of natural resources and the protection of the
environment.

Accountability

Accountability is a key requirement of good governance. Not only

governmental institutions but also the private sector and civil society
organizations must be accountable to the public and to their institutional
stakeholders. Who is accountable to whom varies depending on whether
decisions or actions taken are internal or 'external to an organization or
institution. In general, an organization or an institution is accountable to
those who will be affected by its decisions or actions. Accountability, cannot
be enforced without transparency and the rule of law.

CORPORATE GOVERNANCE: AN OVERVIEW

Corporate governance is defined as the system of rules, practices and

processes by which business corporations are directed and controlled. It
basically involves balancing the interests of a company's many stakeholders,
such as shareholders, management, customers, suppliers, financiers,
government and the community.
Corporate governance is a topic that has received growing attention in the
public in recent years as policy makers and others become more aware of
the contribution good, corporate governance makes to financial market
stability and economic growth. Good corporate governance is all about
controlling one's business and so is relevant, and indeed vital, for all
organizations, whatever size or structure.

The corporate governance structure specifies the distribution of rights

and responsibilities among different participants in the corporation, such
as the board, managers, shareholders, and other stakeholders, and
spells out the rules and procedures for making decisions on corporate
affairs. By doing this, it also provides the structure through which
the objectives are set and the means of attaining those objectives and
monitoring performance.

PURPOSE OF CORPORATE GOVERNANCE

The purpose of corporate governance is to facilitate effective,

entrepreneurial and prudent management that can deliver long-term
success of the company. In simple terms, the fundamental aim of
corporate governance is to enhance shareholders' value and protect
the interests of other stakeholders by improving the corporate
performance and accountability. It is also about what the board of
directors of a company does, how it sets the values of the business firm.

OBJECTIVES OF CORPORATE GOVERNANCE

The following are the basic objectives of corporate governance:

1. Fair and Equitable Treatment of Shareholders

A corporate governance structure ensures equitable and fair

treatment of all shareholders of the company. In some
organizations, a group of high-net-worth individual and
institutions who have a substantial proportion of their portfolios
invested in the company, remain active through occupation of
 top-level positions that enable them to guard their interest.
However, all shareholders deserve equitable treatment and this
equity is safeguarded by a good governance structure in any
organization.

2. Self-Assessment

Corporate governance enables firms to assess their behavior and

actions before they are scrutinized by regulatory agencies.
Business establishments with a strong corporate governance
system are better able to limit exposure to regulatory risks and
fines. An active and independent board can successfully point
out deficiencies or loopholes in the company operations and
help solve issues internally on timely basis

3. Increase Shareholders' Wealth

Another corporate governance's main objective is to protect the long

term interests of the shareholders. Firms with strong corporate
governance structure are seen to have higher valuation attached to
their shares by businessmen. This only reflects the positive
perception that good corporate governance induces potential investors
to decide to invest in a company.

4. Transparency and Full Disclosure

Good corporate governance aims at ensuring a higher degree of

transparency in an organization by encouraging full disclosure of
transactions in the company accounts.

BASIC PRINCIPLES OF EFFECTIVE CORPORATE GOVERNANCE

Effective corporate governance is transparent, protects the rights of

shareholders and includes both strategic and operational risk management.
It is concerned in both the long-term earning potential as well as actual
short-term earnings and holds directors accountable for their stewardship
of the business.
The basic principles of effective corporate governance are threefold as
presented below:

Transparency & Full Accountability

Disclosure
Is the board taking
Is the board telling us what is
responsibility?
going on?

Good and Effectiveness

of Governance

Corporate Control
Is the board doing the right thing?

Positive answers to the following questions indicate a fires' conformance and

compliance with the basic principles of good corporate governance:

A. Transparency and Full Disclosure

Does the board meet the information needs of investment

communities?

Does it safeguard integrity in financial reporting?

Does the board have sound disclosure policies and-practices?

 Does it make timely and balanced disclosure?

 Can an outsider meaningfully analyze the organization's actions and

performance?

B. Accountability

Does the board clarify its role and that of management?

 Does it promote objective, ethical and responsible -decision making?

 Does it lay solid foundations for management oversight?

  Does the composition mix of board membership ensure an appropriate
range and mix of expertise, diversity, knowledge and added value?

 Is the organization's senior official committed to widely accepted

standards of correct and proper behavior?

C. Corporate Control

Has the board built long-term sustainable growth in shareholders' value

for the corporation?
Does it create an environment to take risk?
 Does it encourage enhanced performance?
 Does it recognize and manage risk?
 Does it remunerate fairly and responsibly?
 Does it recognize the legitimate interests of stakeholders?
 Are conflicts of interest avoided such that the organization's best
interests prevail at all times?

ILLUSTRATIVE APPLICATION OF THE BASIC PRINCIPLES OF

CORPORATE GOVERNANCE AND BEST PRACTICE
RECOMMENDATIONS

Principles of Good Corporate Best Practice Recommendations

Governance

1. A company should lay 1-a, Formalize and disclose the

solid foundation for functions reserved to the board
management and and those delegated to
oversight. It should management.
recognize and publish the
respective roles and
responsibilities of board
and management.

2. Structure the board to 2-a. A board should have

add value. Have a board
of an effective
composition, size and
independent directors.
2-b. The roles of chairperson and
chief executive officer should not be
exercised by the same individual.
2-b. The board should establish a
 commitment to nomination committee

adequately discharge its

responsibilities and
duties.

3. Promote ethical and 3-a. Establish a code of conduct to

responsible decision- guide the directors, the chief

making. Actively promote executive officer (or equivalent), the

ethical and responsible chief financial officer (or equivalent)

decision-making. and any other key executives as to:

The practices necessary to
maintain confidence in
the company's integrity;
and
The responsibility and
accountability of individuals
for reporting and
investigating reports of
unethical practices

3-b. Disclose the policy

concerning trading I n
company securities by
directors, officers and
employees.

4. Safeguard integrity in 4-a. Require the chief executive of

financial reporting. Have a (or equivalent) and the chief
structure to independently verify financial officer (or equivalent) to state
and safeguard the integrity of the in writing to the board that the
company's financial reporting. company's financial reports present a
true and fair view, in all material
respects, of the company's financial
condition and operational results and
are in accordance with relevant
 accounting standards.

4-b. The board should establish an

audit committee.

4-c. Structure the audit committee so that

it consists of:
 Only non-executive or
independent directors;
 An independent chairperson,
who is not chairperson of the
board; and
 At least three (3) members

5. Make timely and balanced 5-a. Establish written policies and

disclosure. Promote timely and procedures designed to ensure
balanced disclosure of all compliance with IFRS.
material matters concerning the
company 5-b. Listing Rule disclosure
requirements and to ensure
accountability at a senior management
level for compliance.

6. Respect the rights of the 6-a. Design and disclose a

shareholders and communication strategy to promote

facilitate the effective effective communication with

exercise of those rights shareholders and encourage effective

participation at general meetings.

6-b. Request the external auditor to

attend the annual general meeting
and be available to answer
shareholder questions about the
audit.
7. Recognize and manage risk.
Establish a sound system of
risk oversight and management
and internal control.
8. Encourage enhanced
performance. Fairly review and
actively encourage enhanced
board and management
effectiveness.
9. Remunerate fairly and
responsibly. Ensure that the
level and composition of
remuneration is sufficient and
reasonable and that its
relationship to corporate and
7-a. The board or appropriate board
committee should establish policies on
risk oversight and management.
2-a. The chief executive officer (or
equivalent) and the chief financial
officer (or equivalent) should state to
the board in writing that:
 The statement given in
accordance with best practice
recommendation 4-a (the
integrity of financial
statements) . is founded on a
sound system of risk
management and internal
compliance and control which
implements the policies
adopted by the board; and
 The company's risk management
and internal compliance and
control system is operating
8-a. Disclose the process for
performance evaluation of the board,
its committees and individual
directors, and key executives.
9-a. Provide disclosure in relation to
the company's remuneration policies to
enable investors to understand:
 The costs and benefits of those
policies; and
 The link between remuneration
 individual performance is paid to directors and key
defined. executives and corporate
performance.

9-b. The board should establish a

remuneration committee.

9-c. Clearly distinguish the structure of

non-executive director's remuneration
from that of executives.

9-d. Ensure that payment of equity-

based executive remuneration is made
in accordance with thresholds set in
plans approved by shareholders.

10. Recognize legitimate 10-a. Establish and disclose a code of

interest of stakeholders. conduct guide accomplish with legal
Recognize legal and other and other obligation to legitimate
obligations to all legitimate stakeholders.
stakeholders.