Compliance Glossary

Governance

The activities of corporations must be directed to meet the needs of shareholders, executive management teams, employees, customers, suppliers, government regulators, and the community. To effectively balance the needs of many stakeholders while achieving their strategic business objectives, corporations follow a set of rules, policies, and procedures known as a corporate governance framework.

What is Corporate Governance?

Corporate governance is a formalized framework of rules, policies, processes, and procedures used to direct or control a corporation. Effective governance has three main objectives in the corporation:

  1. To resolve conflicts of interest between shareholders and executive management teams, or among shareholders.
  2. To control risk and ensure accountability, transparency, and integrity across the organization.
  3. To define and achieve strategic business objectives aligned with the interests of corporate stakeholders.

In most organizations, corporate governance is at least partially managed by a Board of Directors. Members of the board are elected by corporate shareholders and bound by fiduciary duty to act in their best interests and in accordance with corporate bylaws. 

A board of directors may be responsible for staffing the corporation with senior executives, establishing compensation, stock option, and dividend policies, setting strategic objectives for the organization, and other high-level governance tasks.

Why is Corporate Governance Important?

Corporate governance is vital to overall business success and sustainability. Effective governance seeks to set high-impact strategic aims, balance short-term and long-term objectives, and ensure transparency, integrity, and ethical conduct across the organization.

Corporate governance also provides a framework for making decisions, resolving conflicts, and implementing new policies and working methods that maximize shareholder value.

What are Key Principles for Corporate Governance?

Each corporation establishes its own unique governance framework, but we can point to five principles of effective corporate governance that leading organizations tend to follow:

  • Shareholder Primacy – The shareholders are the owners of the corporation. An effective corporate governance framework recognizes the right of shareholders in this capacity and may allow shareholders to participate in corporate decision-making.
  • Duties and Obligations – While the corporation’s primary duty is to its shareholders, an effective governance framework also accounts for the obligations that corporations have to their creditors, investors, employees, customers, vendors, regulators, and the community. 
  • Ethics – An effective corporate governance framework includes an ethical code of conduct that establishes clear behavior and decision-making standards for executives and directors.
  • Accountability – Effective corporate governance establishes roles and responsibilities within the board of directors, executive management team, and employees. It also establishes a framework for measuring and evaluating organizational performance. 
  • Transparency – Corporations who wish to maintain the confidence and trust of their shareholders must operate with transparency. This includes best practices like releasing financial results to investors and shareholders in a timely fashion and advising shareholders on the duties and responsibilities of key personnel.

What are the Consequences of Ineffective Corporate Governance?

Ineffective corporate governance can result in poor business decision-making that damages public perception of an organization’s competence or integrity and negatively impacts shareholder value. 

Enron is an example of what happens when corporations are governed without the principles of shareholder primacy, duty and responsibility to stakeholders, ethics, accountability, transparency.

Inadequate oversight from Enron’s board of directors allowed the corporation’s CFO and other executives to exploit accounting loopholes, inflating Enron’s earnings reports and driving up share prices. When it was eventually discovered that Enron was unprofitable and hiding its losses, its stock value plummeted and shareholders lost millions of dollars.

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