Understanding ‘Corporate Governance’

Background

Humans are the only species of animals capable of creating complex structures for their growth and development. Such complex structures are a part of our life in the modern era and it is difficult to imagine a world without them. In reality, most of our life is occupied and somehow dependent on such structures. To take an example, government, universities, business entities, international organizations are very complex structures and even a nation is an amalgam of complex structures.

Business entities are very vital for any economy on the planet and most of the time incorporated in a corporate form. The word governance comes from the Latin word “gubanare” which means “to steer”. The ordinary meaning of governance is the manner of directing and controlling the actions and affairs of an entity.  Reduced to the basics, governance is the exercise of powers and actions to achieve the goals of an entity. The word ‘corporate’ generally stands for a united group of people coming together for a common objective in the form of an organized entity. This organized entity may be reflected in the form of a public or a private company, a Limited Liability Partnership, etc. All these entities are a legal fiction. It is a person defined by the law. Once formed, these entities get an independent existence separate from their founder, owner, promoter etc.

Though an entity is different from the persons associated with it, it can act only through human agency. The number of persons who have some interests in the functioning of the entity are many but the persons who actually control how the entity functions are only a few. who control. Every person directly associated with the entity has some interest involved in the entity.  The nature of interest may differ with the position of the person in the entity. The nature of duties towards the entity also differs with the said position. There are many rights and liabilities of persons from and towards the entity. It is extremely important to maintain the balance between the different types of interest and to keep a consistent and conscious check on the duties of a person towards the entity because mismanagements, conflicts and confusions are harmful to the growth and stability of any entity. To attract various investors, financers or to collaborate with any external agency, the entity must be credible, well understood and stable.

Meaning of Corporate Governance

Terminologies evolve with time and express themselves according to the need of time. Corporate governance is also an evolving terminology.

OECD, in its Principles of Corporate Governance, defines ‘Corporate Governance’ as:

“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.”

Corporate governance is a system through which powers are exercised and shared by different stakeholders and groups to ensure the achievement of the entity’s goals. The controlling management works for the benefit of the different stakeholders directly or indirectly involved in the entity. It involves the opportunity for stakeholders to enforce their rights in an effective and efficient manner and holding management accountable for such rights. On the other hand, most of the stakeholders are not involved in the day-to-day management of the entity. Control of management over the affairs of the entity also imposes a duty on the management to align with the pre-defined goals. Control of management is not absolute or undisputed.

Tools of corporate governance 

In the modern world, the law of the land is an effective tool to regulate and control any affair within the respective territory. The law of the land regarding corporate governance depends upon the economic conditions prevailing in the country and the institutional framework to administer justice. It is also important that any legislation or regulation is able to meet the expectation of changing economic conditions and the need of various business entities. Policymakers have the responsibility to put such a dynamic framework.

Today, laws in many domains such as company law, security laws, tax laws, competition laws directly enforce corporate governance or influence practices involved in corporate governance. Statutory requirements are also complemented with policies design by the entities, internal code of conducts, values and ethical practices.

The importance of the law of the land is significant because every entity is concerned only about the economical goal of a specific entity but policymakers have to take care of the balance between individual goals and social or community goals. Further, the single-minded pursuit of one’s own goals results in spillover costs on the others. Such costs are required to be balanced by the policymakers.

Structures of corporate governance  

There is no universal best choice for the structure of corporate governance. The best model depends upon the goal and nature of the entity, business contexts in the relevant market and the legal framework for the type of entity. Flexibility and smooth functioning are important aspects of a structure. Political and social aspects also influence such structure directly or indirectly. A company with limited liability is the most famous and used structure globally by many business houses for its inclusive nature, limited liability, division of power and more transparency over other entities. Hence, most of the corporate governance literature is focused on companies.

After discussing the basics of Corporate Governance in this article, we shall discuss the evolution of corporate governance in our next article.

• Team Efficax