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Corporate Governance: Principles, Advantages, and Disadvantages

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  • Post published:November 24, 2023
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Last Updated on January 12, 2024 by Kanakkupillai

Corporate governance pertains to an organization’s operational procedures in its most basic sense. Corporate governance includes internal business operations and the laws, rules, policies, and procedures that apply to a firm. Corporate governance is based on several concepts. Adopting appropriate and generally transparent rules and procedures that safeguard the best interests of all parties concerned must be ensured by an entity’s governance. If everything goes wrong, the impacts of the tragedy will be felt throughout multiple nations, some more severely than others, in a world where multinational enterprises are common.

What is Corporate Governance?

Corporate governance refers to the set of regulations, customs, and procedures that regulate how an organization is run. Managing the goals of a company’s numerous stakeholders—which might include investors, senior management, clients, vendors, lenders, the government, and the community—is the fundamental task of corporate governance. Therefore, action plans, internal controls, performance evaluation, and corporate transparency are all in the broad corporate governance category.

Corporate Governance Principles

1. Transparency

Your level of certainty increases with your level of knowledge. The stakeholders sincerely adhere to this concept. In the corporate sector, transparency is also beneficial. Businesses that are transparent about their financial situation and operational details get the ultimate trust of the public.

2. Accountability

Accountability refers to the willingness or duty to take ownership of one’s conduct. Many people misunderstand accountability and perceive it negatively, believing it is connected to the old-fashioned “Blame Game.” Accountability answers more questions than merely the identity of the responsible individual. It must be seen positively as well since it acknowledges achievements as well.

Accountability promotes trust in the company’s shareholders by ensuring that those accountable will be handled appropriately should an unfavourable circumstance arise. Accountability creates a framework in which each person is responsible for their job and related responsibilities.  

3. Independence

Being independent means having the capacity to make choices unhindered by outside forces or restrictions. Additionally, it has been demonstrated that this is essential to efficiently running enterprises. The capacity to maintain one’s composure in the face of unsuitable stimuli is independence.

It enables the individual to behave honourably and make choices and decisions that consider the needs of all parties involved. For this reason, businesses choose independent directors to ensure that no undue influence is exerted or that any personal relationships with the firm impede the director’s independence of action.

4. Risk Management

The management and board have to decide how to efficiently manage every risk. They must implement those guidelines to handle risks and notify all pertinent parties about the presence and status of dangers.

5. Responsibility

The board is in charge of managing operations and overseeing business affairs. It must be conscious of and supportive of the company’s continuous, effective performance. The hiring and recruiting of a chief executive officer (CEO) is one of its duties. The business’s and its investors’ best interests should be its priority.

Corporate Governance’s Benefits

A good company may become great with the help of effective corporate governance. Excellent corporate governance standards are largely responsible for the leaders in any sector being at the top of their respective fields.

  • Law Compliance: Corporate governance encompasses the rules, regulations, and laws that allow a business to operate without any difficulties or legal annoyances, so compliance with various laws is easily handled when it is in place.
  • Lower fines and penalties: Businesses can save a lot on needless fines and compliances and maybe reroute that money towards company objectives to attain higher heights because the legal compliance side is handled thanks to corporate governance standards.
  • Better management: Controlling the activities and reaching goals is much easier when there is a framework for the entity’s daily operations. Working under solid corporate governance standards that promote efficiency, cohesion, cooperation, and a success-driven mindset, the work environment also takes care of itself.
  • Relationships and reputation: A company’s excellent reputation and brand image enable it to attract investors and outside financiers with relative ease if it practices effective corporate governance. Transparency is essential to corporate governance, involving releasing important internal data to stakeholders. By doing this, the organization strengthens its bonds with its constituents and plants the seeds of mutual trust between the business and society.
  • Lessening of disputes and frauds: By encouraging employees to have moral consciousness in all situations, workplace policies help to reduce the likelihood of fraud and conflict among coworkers.

The Drawbacks of Company Governance

There can be some issues with smaller organizations as the shareholders might act in the dual roles of management and director without distinguishing between them. Considering this, it is possible to derive the following conclusions:

  1. The price of maintaining legal compliance

Every sector has its own set of laws that businesses must follow, and many restrictions exist. Legal compliance is ensured by corporate governance, but it has a high price.

  1. Increased costs

Organizations with corporate governance incur significant administrative expenditures due to the numerous requirements that must be followed. A few papers that need to be maintained currently are listed below:

  • Stock purchases and sales.
  • Documentation of legal compliance.
  • Annual Registration 
  1. Maintenance of segregation

No matter the business size, every protocol and requirement must be strictly followed. Breaking these rules puts the business at serious risk of things like “piercing the corporate veil,” when people look behind the corporation’s position as a separate legal entity to see what goes on behind closed doors.

  1. Conflict between principal and agent

Large organizations often select a well-known management team with previous experience to oversee the business’s daily operations. Unfortunately, as they could have quite different objectives and points of view, this could result in conflict between shareholders and management. This usually leads to a conflict between the two, affecting the organization’s ability to run operations smoothly and effectively.

The tension that arises when a large organization assigns a well-known manager with a solid track record to oversee day-to-day operations is a regular practice among these companies. Unfortunately, because they may have quite different goals and viewpoints, this leads to conflict between the management and the shareholders.  

Models of Corporate Governance

There are a variety of corporate governance models in use worldwide. A handful are listed here.

1. The Anglo-American Model

This concept has several variations, including the Political, Stewardship, and Shareholder models. Right now, the main model is the shareholder model.

The board of directors and shareholders maintain control under the Shareholder Model. Although recognized, stakeholders, including employees and vendors, are powerless.

Management’s responsibility is to operate the business in a way that optimizes shareholder value. Most importantly, appropriate incentives ought to be made accessible to match management conduct with the objectives of owners and shareholders.

The approach takes into consideration the fact that investors fund the business and have the option to stop doing so if they’re not happy. This is meant to maintain the efficiency of management.

Typically, the board will have both independent and insider members. While the CEO and board chairperson might typically be the same person, this approach aims to have two distinct individuals fill both positions.

2. The Continental Model

According to the Continental Model, the governing power is represented by two groups. They are the leadership board and the supervisory board.

Within this two-tiered structure, executives and other firm insiders comprise the management board. The other members of the supervisory board are the union members and stockholders. Representatives from banks that own stock in a corporation may also sit on the supervisory board.

The two boards don’t get any closer. The laws of a nation establish the size of the supervisory board, which is not negotiable by shareholders.

Under this corporate governance approach, firms are heavily influenced by national interests. Businesses should be expected to support governmental goals.

The involvement of stakeholders is also highly valued in this approach as it may help and reinforce a business’s ongoing operations.

3. The Japanese Model

Banks, connected firms, large shareholders known as Keiretsu—who may own shares in common companies or have trade relationships—management, and the government are the main participants in the Japanese model. Individual shareholders who are smaller and independent do not have a voice or influence. These important individuals set and oversee company governance together.

Executives from the corporation often make up the insiders on the board of directors. If earnings start to decline, Keiretsu might remove directors from the board.

The laws and regulations of the government have an impact on the operations of company management.

Due to the centralization of power and the emphasis on the needs of those in positions of authority, corporate transparency is less probable under this paradigm.

Conclusion

A company’s policies, practices, and rules that manage, regulate, and oversee operations are known as corporate governance. The phrase describes external and internal factors that impact a company’s stakeholder interests, including vendors, clients, shareholders, governmental organizations, and management.

Gaurvi

Welcome to www.kanakkupillai.com! Greetings, I'm Gaurvi, a Regulatory Compliance Manager deeply committed to ensuring that businesses meet and exceed regulatory standards in their operations. With a wealth of experience in navigating complex regulatory environments across various industries, I am here to be your trusted advisor in achieving and maintaining regulatory compliance. In today's dynamic business landscape, regulatory compliance is not just a legal requirement but a critical component of sustainable success. My mission is to help your business thrive by ensuring it adheres to all relevant regulations and standards. Diversity and inclusivity in the business world are paramount, and I firmly believe that every business, regardless of its size or background, should have access to the expertise needed for seamless regulatory compliance. I am honored to embark on this regulatory journey with you through this blog, where I will provide valuable insights, best practices, and strategies tailored to your compliance needs. Thank you for entrusting me with the opportunity to contribute to your path to regulatory excellence. For more information and resources, please visit www.kanakkupillai.com.