Corporate governance
1. INTRODUCTION
This chapter provides a definition of corporate governance and examines importance
of, and the principles underpinning corporate governance. It also reviews prior
research examining corporate governance disclosures and in particular, those which
have investigated corporate governance disclosure in ECMs.
2. DEFINITIONS OF CORPORATE GOVERNANCE
Modern corporations have dispersed ownership structure (Jenkinson and Mayer,
1994). Due to this, these corporate entities are characterised by contractual
relationships between (shareholders) owners and managers (agents). Management is
hired by owners (i.e. investors) to run the business on their behalf (Sarpong, 1999).
Within the agency theory framework, it is theorised that managers may seek to
maximise their wealth to the detriment of shareholders and bondholders through the
consumption of perquisites (Jensen and Meckling, 1976). Decisions of agents have
the tendency of unfavourably transferring wealth from one principal to another i.e.
from bondholders to shareholders (Watts and Zimmerman, 1978). John and Senbet,
(1998 p. 372) define corporate governance “as a means by which stakeholders of a
corporation exercise control over corporate insiders and management such that their
interest will be well protected”. Similarly, it is proposed that “corporate governance
issues arise in an organization whenever two conditions are present. First, there is an
agency problem, or conflict of interest, involving members of the organization –
these might be owners, managers, workers or consumers. Second, transaction costs
are such that this agency problem cannot be dealt with through a contract” (Hart,
1995, p. 678)
To avert the agency problem, there is the need to ensure that adequate and effective
corporate governance structures are put in place to prevent abuse of power by
managers (Cadbury, 1992). Corporate disclosure through annual reports is one of the
essential instruments for the monitoring of managerial behaviour (Watts, 1977; Watts
and Zimmerman, 1978). This requires frequent evaluation of managerial activities and
performances particularly, through independent non-executive directors (Roberts et
al 2005). Berle and Means (2003) view corporate governance as a relatively new
concept in both the public and academic domains, although the central issues the
concept seeks to address have been in existence for a longer period. The most
common definition of the concept has been provided by the Organization for
Economic Cooperation and Development (OCED).
It defines Corporate governance as: ‘’ a system by which business corporations are
directed and controlled. Corporate governance structures specify 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 company’s objectives are set and the means of attaining
those objectives and monitoring performance” (OECD, 1999 p. 11).
The influential Cadbury report defines corporate governance fundamentals and
somewhat simplistically as ‘’ the systems by which companies are directed and
controlled” (Cadbury 1992). This will require putting in place appropriate mechanisms
which will ensure that corporate resources are safeguarded. Johnson and Scholes
(1998) explained that corporate governance is concerned with both the functioning
of organizations and the distribution of powers between different stakeholders. They
argue that corporate governance determines whom the organization is there to serve
and how the purpose and priorities of the organization should be decided. Thus,
among other things, corporate governance is concerned with structures and
processes for decision making, ensures accountability and controls managerial
behaviour. It therefore, seeks to address issues facing board of directors, such as the
interaction with top management and relationship with owners and others interested
in the affairs of a company.
The definitions outlined, directly or indirectly, share common elements. They all
acknowledge the existence of conflict of interest between managers and
shareholders as a result of the existence of separation of ownership and control in
corporate activities. They further recognize the need to put in place effective
corporate governance mechanisms to ensure that shareholders and investors interest
are well protected.
1. IMPORTANCE OF CORPORATE GOVERNANCE
As a result of globalization and the increasing complexity of business there is a
greater reliance on the private sector as the engine of growth in both developed and
developing countries. Organizations do not exist in a vacuum; they rather interrelate
with a number of interest groups, known as stakeholders (Freeman, 1984). These
stakeholders include shareholders, governments, regulatory bodies, creditors and the
general public (Pease and Macmillan, 1993). Stakeholders are impacted by the
activities of companies. In this regard, and in the context of this study, adequate and
effective corporate governance disclosure becomes relevant to investors and other
stakeholders from a number of standpoints.
Effective corporate governance disclosure promotes transparency in corporate
structures and operations. It strengthens accountability and oversight among
managers and board members to shareholders (Bosch, 2002). This oversight and
accountability combined with the efficient use of resources, improved access to
lower-cost capital and increased responsiveness to societal needs and expectations
leads to improved corporate performance. Many studies exist linking good corporate
governance with better Performance. Fianna and Grant (2005) explains that good
corporate governance helps to bridge the gap between the interests of those that a
company, by increasing investor confidence and lowering the cost of capital for the
company. Furthermore, they also add that it also helps in ensuring company
honours, its legal commitments and forms value-creating relations with stakeholders.
Coles et al. (2001) and Durnev and Han (2002, also found that companies with better
corporate governance enjoy higher valuation. These studies’ results, helps in
confirming the idea of good corporate governance, result in better decisions at all
levels of the organization, not at top-management and board levels, but also in the
better performance of the organization
Again adequate and effective corporate governance disclosure ensures that
corporate activities are run in an open and transparent manner (Brain 2005). Last,
corporate governance practices boost market confidence and ensure effective
allocation of capital in the market (Greenspan, 2002).
From the forgoing discussions, the realization of the importance of good corporate
governance practices is largely dependent on a number of internal factors. As a way
of achieving this, a number of principles have been established.
3. PRINCIPLES UNDERPINNING CORPORATE GOVERNANCE
DISCLOSURE
A number of principles underpin effective corporate governance. These principles are
business probity, responsibility and fairness or equal opportunity. Corporate entities
are expected to exhibit these qualities to ensure good governance. Embracing the
outlined principles will improve relationships between companies, their shareholders
and the overall welfare of every economy. These principles are briefly discussed.
Business probity requires individuals in charge of companies to be open and honest
in the discharge of their activities. According to Brain (2005) openness implies a
willingness to provide information to individuals and groups about the activities of a
company. In this regard, it is important to recognize that shareholders and investors
need to know the position of a company in order to evaluate their performance.
Timely delivery of information will enable them achieve this purpose.
Good corporate governance disclosure requires handlers of companies to be honest
in the discharge of their activities. Honesty requires managers to deliver factual
information. A sign of honesty is that statements of companies are believed.
However, Brain (2005 p. 26) contends that “honesty might seem an obvious quality
for companies, but, in an age of spin, and the manipulation of facts, honest
information is perhaps by no means as prevalent as it should be.”
Corporate governance requires handlers of corporate entities to be responsible in
the discharge of their duties. Investors require confidence that company’s financial
systems are secured and credible. Managers are therefore expected to work in this
direction to meet investor’s expectation. Responsibility in the context of corporate
governance includes other issues such as transparency and accountability. These
principles are vital to the survival and welfare of every company. Thus, managers
have a duty to explain their actions to shareholders as well as investors so as to
enhance their understanding of the direction of the company’s activities.
The principle of fairness requires impartiality and a lack of bias in corporate activities.
In the context of corporate governance, the quality of fairness is achieved when
managers behave in reasonable and unbiased manner. In this sense, to ensure good
governance shareholders are expected to receive equal consideration. This means
minority shareholders should be treated the same way as majority shareholders.
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