An overview of corporate governance
Both US and UK capital markets have widely dispersed share ownership in contrast to concentrated shareholdings predominant in Europe and many developing countries. Ownership patterns fundamentally influence the way in which policymakers approach corporate governance and the management of potential conflicts of interests between ownership and control – the ‘Principal / Agency’ problem.
Principal / Agency problem
In countries with widely dispersed shareholding the ‘Principal / Agency’ problem concerns potential conflicts arising between the owners of companies (as ‘Principals’) and boards of directors who have effective control over companies (as ‘Agents’) and may allow self-interest to influence decision making.
Majority shareholders vs minority shareholders
Countries with more concentrated ownership structures often have majority shareholders who significantly influence the board. Consequently, an ‘agency’ conflict arises between controlling ‘majority’ shareholders who may extract private benefits at the expense of minority owners.
Protecting shareholder rights
Corporate governance aims to protect shareholder rights, enhance disclosure and transparency, facilitate effective functioning of the board and provide an efficient legal and regulatory enforcement framework. It addresses the ‘Principal / Agency’ problem through a mix of company law, stock exchange listing rules and self-regulatory codes.
Corporate governance in Europe
There is no ‘one size fits all’ approach to corporate governance. A number of countries in continental Europe tend to adopt an inclusive ‘stakeholder’ approach. This is where companies are considered ‘social institutions’ with responsibilities and accountability – not just to shareholders – but to employees and the wider community in general.
Corporate governance in the UK and US
In the UK and US there is an emphasis on creating wealth for shareholders. That said, while approaches may differ, there is global appreciation of the OECD’s generic corporate governance principles of responsibility, accountability, transparency and fairness.
Responsibility
Responsibility of directors who approve the strategic direction of the organisation within a framework of prudent controls and who employ, monitor and reward management.
Accountability
Accountability of the board to shareholders who have the right to receive information on the financial stewardship of their investment and exercise power to reward or remove the directors entrusted to run the company.
Transparency
Transparency of clear information with which meaningful analysis of a company and its actions can be made. The disclosure of financial and operational information and internal processes of management oversight and control enable outsiders to understand the organisation.
Fairness
Fairness that all shareholders are treated equally and have the opportunity for redress for violation of their rights.
Why is corporate governance important?
Corporate governance is a key element in enhancing investor confidence, promoting competitiveness, and ultimately improving economic growth. It is at the top of the international development agenda as emphasised by James Wolfensohn, President of the World Bank:
‘The governance of companies is more important for world economic growth than the government of countries.’
Legislative and regulatory reform
Cultural, political and economic norms influence the way in which a society approaches corporate governance and its impact on board leadership, management oversight and accountability. The challenge for policy-makers is to reach an appropriate balance of legislative and regulatory reform, taking into consideration international best practice to promote enterprise, enhance competitiveness and stimulate investment.
Corporate scandals, globalisation and shareholder activism
Much of the recent emphasis on corporate governance has arisen from high-profile corporate scandals, globalisation and increased investor activism.
Corporate scandals
High profile corporate collapses due to a number of circumstances including financial reporting irregularities leading to a lack of investor confidence and public trust.
Globalisation
Improved technology and private sector development increasing capital flows to large developing economies such as China. Developing markets in particular need to demonstrate good corporate governance to instil investor confidence thereby encouraging access to the global capital necessary for job creation and economic growth.
Shareholder activism
Institutional investors pursue good corporate governance when managing long-term investments and often take an active role in bringing under-performing companies to task.
Global market confidence
Recent new legislative and self-regulatory corporate governance requirements have helped to instill global market confidence. This includes improved integrity and oversight of management, scrutiny over board composition and independence, effective use of internal and external audit functions, higher levels of disclosure and transparency and greater engagement with investors.
Investors
There is evidence that investors value companies with good corporate governance. McKinsey surveyed over 200 institutional investors and found that 80% of respondents would pay a premium for well-governed companies, from 11% in Canada to 40% in Egypt (Global Investor Opinion Survey, 2002).
New research from ABI (Association of British Insurers) shows that companies with the best corporate governance records produce returns higher than those with poor performance.