Corporate governance is a system in which companies are controlled and managed by the managing people.
It basically control and direct the relationship between the company directors, its shareholders and other stakeholders. An overall structure is built between these three parties and this structure is maintained under the good corporate governance rules and codes.
In companies, we know that ownership structure is separate from its management structure but there may exist a strong relationship between two. Shareholders are the actual owners of the company and they appoint directors to manage and deal the company affairs.
Now the relationship between the directors and shareholders called ‘’agency relationship’’ under which shareholders are the principals and they appoint agents (directors) to carry out functions in the company.
So day to day running of the business is the responsibility of directors and other managers. The shareholders have to rely on their agents (management). At this point there may be conflicts of interest between management and the shareholders if there is a breach of trust by management.
To resolve this above problem there must be an alignment of interests and objectives between these two parties. And it can also be possible if companies follow the corporate governance rules and codes. It creates level of trust and integrity on the management by the shareholders.
Features of good corporate governance
A good corporate governance system must have following features;
Corporate governance system specifies some rights and responsibilities towards the participants of the corporation. And these participants may be the overall board and the stakeholders.
Stakeholders are the persons, group or non human entity with an interest or concern in something (usually business here). So all the connected people with the corporations are the stakeholders which may be as follows;
- Directors and managers
- Other employees
- The public
- Pressure groups
- Trade union
Shareholders are the key stakeholders of the company. They invest in the company by taking shares so their interest is to secure their stake (investment).
They are not involved in day to day running of the business but there approval is necessary before taking any decision.
They are the owners so corporate governance is developed for them if they are separate from the people who are responsible to manage the company.
Directors and managers
They are the people who are managing the company at the behalf of shareholders. They involved in routine decision making and their implementation after approval.
There interest is to secure their position in the company and other financial interests (remuneration, allowances ad bonuses).
They use the investment of shareholders that’s why shareholders want to be assured that their investment is using correctly.
As we know that shareholders are not involved in day to day running of the business so they lack information about the company’s position and performance.
This knowledge gap may be removed by following ways by the companies.
- Making financial statements
- Hold annual general meeting
- Following corporate governance rules and codes
From the above points a topic of corporate governance codes will be discussed in detail as we know much more about the financial statements and general meetings. But here we illustrate that how financial statements and general meetings used to remove the knowledge.
Preparation of financial statements
Financial statements are the statements which show that how company is performing and making profits. Through these statements shareholders can access the business position and came to know that their investment is using correctly.
These all statements must be audited to enhance the credibility of these statements. These financial statements are as follows;
- Statement of comprehensive income
- Statement of financial position
- Statement of cash flows
- Statement of changes in equity and other notes
These above financial statements are prepared and audited under the corporate governance rules and other reporting framework.
Annual general meeting
AGM held annually by the directors and shareholders exercise their control at the meetings.
In this meeting shareholders communicate with directors and mangers directly and discuss the issues and other matters. Financial statements are also presented to shareholders and they can ask questions about the company’s performance, its growth and further strategies and policies.
Despite the financial matters other decisions like amendment of company objects and authorization of share capital also discussed on AGM.
So it is concluded by this AGM a knowledge gap removed because shareholders communicate directly and know all whatever they want to know and get all the information through a prescribed way.
Corporate governance codes
Under the corporate governance structure, codes of best practice were developed in many jurisdictions. These codes provide all the companies to comply with higher standard of behavior than local legislation requires.
Major corporate governance codes are as follows;
- UK corporate governance codes
- Combined codes of corporate governance
- South African king report under corporate governance
- Singapore code of corporate governance
- OECD principals international
Combined codes of corporate governance
First of all combined codes of corporate governance were developed which includes three reports.
- Cadbury report
- Greenbury report
- Hampel report
According to Cadbury report the post of chairman and CEO held by separate people with clear rights and responsibilities. In the same way directors must be executive and non executive directors with independent judgment and there must be three independent non executive directors.
An audit committee must be developed to review the relevant functions and disclosures of director’s remuneration in separate reports.
Greenbury report went beyond the Cadbury report and also recommends a remuneration committee which must determine the remuneration of executive and non executive directors.
Greenbury report also includes the principals of directors pay and other disclosures which should be given in annual accounts and reports.
Hampel report includes the matters raised in Cadbury and greenbury report and its main objective is to restrict the burden of rules on companies and changing it to follow the principals. As we that principals based approach is more demanded as compared to rules based approach which contains strict and unchanging rules under the legal framework and companies must have to follow them.
UK corporate governance codes
After the combined code, in UK various other reports developed like;
- Turnbull report
- Smith report
- Higgs report
So after some revision a combined code changed into UK corporate governance codes with three other reports.
Turnbull report focused on the management of risk and various other internal controls.
Smith report focused on the roles and responsibilities of audit committee.
Higgs reports focused on the roles of non-executive directors.