Chapter 3 - Corporate Governance – Summary
To respond to stakeholder pressures to answer for organizational decisions and policies,
organizations must effectively implement policies that provide strategic guidance on
appropriate courses of action. Such policies are often known as corporate governance, the
formal system of accountability and control for organizational decisions and resources.
Accountability relates to how well the content of workplace decisions is aligned with the
firm’s stated strategic direction, whereas control involves the process of auditing and
improving organizational decisions and actions.
Both directors and officers of corporations are fiduciaries for the shareholders.
Fiduciaries are persons placed in positions of trust who use due care and loyalty in acting
on behalf of the best interests of the organization. There is a duty of care, also called a
duty of diligence, to make informed and prudent decisions. Directors have a duty to avoid
ethical misconduct in their director role and to provide leadership in decisions to prevent
ethical misconduct in the organization. Directors are not held responsible for negative
outcomes if they are informed and diligent in their decision making. The duty of loyalty
means that all decisions should be in the interests of the corporation and its stakeholders.
Conflicts of interest exist when a director uses the position to obtain personal gain,
usually at the expense of the organization.
There are two major conceptualizations of corporate governance. The shareholder
model of corporate governance focuses on developing and improving the formal system
of performance accountability between top management and the firm’s shareholders. The
stakeholder model of corporate governance views the purpose of business in a broader
fashion in which the organization not only has a responsibility for economic success and
viability but also must answer to other stakeholders. The shareholder model focuses on a
primary stakeholder—the investor—whereas the stakeholder model incorporates a
broader philosophy that focuses on internal and external constituents.
Governance is the organizing dimension for keeping a firm focused on continuous
improvement, accountability, and engagement with stakeholders. Although financial
return, or economic viability, is an important measure of success for all firms, the legal
dimension of social responsibility is also a compulsory consideration. The ethical and
philanthropic dimensions, however, have not been traditionally mandated through
regulation or contracts. This represents a critical divide in our social responsibility model
and associated governance goals and systems because there are some critics who
challenge the use of organizational resources for concerns beyond financial performance
and legalities.
In the late 1800s and early 1900s, corporate governance was not a major issue
because company owners made strategic decisions about their businesses. By the 1930s,
ownership was dispersed across many individuals, raising questions about control and
accountability. In response to shareholder activism, the Securities and Exchange
Commission required corporations to allow shareholder resolutions to be brought to a
vote of all shareholders. Since the mid-1900s, the approach to corporate governance has
involved a legal discussion of principals (owners) and agents (managers) in the business
relationship. The lack of effective control and accountability mechanisms in years past
has prompted a current trend toward boards of directors playing a greater role in strategy
formulation than they did in the early 1990s. Members of a company’s board of directors
assume legal responsibility and a fiduciary duty for organizational resources and
decisions. Boards today are concerned primarily with monitoring the decisions made by
managers on behalf of the company. The trend today is toward boards composed of
outside directors who have little vested interest in the firm.
Shareholders have become more active in articulating their positions with respect
to company strategy and executive decision making. Many investors assume the
stakeholder model of corporate governance, which implies a strategy of integrating social
and ethical criteria into the investment decision-making process. Although most activism
and investing take place on an organizational level through mutual funds and other
institutional arrangements, some individual investors have affected company strategy and
policy.
Another significant governance issue is internal control and risk management.
Controls allow for comparisons between actual performance and the planned
performance and goals of the organization. They are used to safeguard corporate assets
and resources, protect the reliability of organizational information, and ensure
compliance with regulations, laws, and contracts. Controls foster understanding when
discrepancies exist between corporate expectations and stakeholder interests and issues.
A strong internal control system should alert decision makers to possible problems or
risks that may threaten business operations. Risk can be categorized (1) as a hazard, in
which case risk management focuses on minimizing negative situations, such as fraud,
injury, or financial loss; (2) as an uncertainty that needs to be hedged through quantitative
plans and models; or (3) as an opportunity for innovation and entrepreneurship.
How executives are compensated for their leadership, service, and performance is
another governance issue. Many people believe the ratio between the highest paid
executives and median employee wages in the company should be reasonable. Others
argue that because executives assume so much risk on behalf of the organization, they
deserve the rewards that follow from strong company performance. One area for board
members to consider is the extent to which executive compensation is linked to company
performance.
The Organisation for Economic Co-operation and Development has issued a set
of principles from which to formulate minimum standards of fairness, transparency,
accountability, disclosure, and responsibility for business practice. These principles help
guide companies around the world and are part of the convergence that is occurring with
respect to corporate governance.
Most businesspeople and academicians agree that the benefits of a strong
approach to corporate governance outweigh its costs. Because governance is concerned
with the decisions taken by boards of directors and executives, it has the potential for farreaching positive, and negative, effects. The future of corporate governance is directly
linked to the future of social responsibility. Business leaders and managers will need to
embrace governance as an essential part of effective performance. Governments also
have a role to play in corporate governance. National competitiveness depends on the
strength of various institutions, with primacy on the effective performance of business
and capital markets. Other stakeholders may become more willing to use governance
mechanisms to affect corporate strategy or decision making.