A series of events over the last two decades served to place the issues and the nature and

evolution of corporate governance and its corollary the stewardship of assets at the center of the
policy agenda. In a corporate context, the board serves as a ‘guardian of assets. Proper corporate
governance and stewardship impose a duty to exercise due diligence, rigor, and attention, in the
management and disposal of all those assets for which the officer is given responsibility. In this
module, we define corporate structure & corporate governance and integrate the concept with
other elements of social responsibility. We also examine primary issues that should be considered
in the development and improvement of corporate governance systems.

After successful completion of this module, you should be able to:

➢ Understand the definition and importance of corporate governance.
➢ Know the relationship between corporate governance and social responsibility.
➢ Identify different issues concerning corporate governance.

Corporate Structure
Before we define corporate governance, we must understand first the organizational structure of
corporations. Corporations have many structures, but the most typical corporation organizational
structure consists of the (1) shareholders or owners, (2) board of directors, (3) officers, and (4)
employees.
Shareholders or Owners
The shareholders are the owners of the corporation. Corporations issue shares or stocks that
might be sold to private investors or the general public in the case of publicly listed corporations.
Normally, the ownership of a corporation is divided into many individuals ranging from
hundreds to thousands, depending on the corporation’s size. Shareholders do not usually
participate in the day-to-day management of a corporation, but they ultimately hold the power to
vote on the appointment and removal of the board of directors and other major corporate changes
that can only be affected with shareholders’ approval.
Board of Directors
The primary responsibility of the board of directors is to protect the shareholders’ investment.
The board is elected by the shareholders for this reason. The board of directors reports on the

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business’ success and progress to the shareholders regularly. The board appoints the officers. The
officers are the President or CEO (Chief Executive Officer), one or more Vice Presidents, the
Treasurer, and the Secretary.
Officers
The officers report to the board of directors. They are responsible for the everyday business
operations. Their main responsibility is to act in the best interest of the corporation. This may or
may not always align with the board of directors’ wishes.
Employees
Employees make the business run. They carry out the various tasks associated with the
company’s mission. Employees report to the officers of the company.

Corporate Governance Defined

We define corporate governance as the formal system of oversight, accountability, and control
for organizational decisions and resources.

• Oversight relates to a system of checks and balances that limit employees’ and managers’
opportunities to deviate from policies and codes of conduct.
• Accountability relates to how well the content of workplace decisions is aligned with a
firm's stated strategic direction.
• Control involves the process of auditing and improving organizational decisions and
actions.
The philosophy that is embraced by a board or affirmed regarding oversight accountability and
control directly affects how corporate governance works. Both directors and officers of
corporations are fiduciaries to the shareholders. Fiduciaries are persons placed in positions of
trust who use due care and loyalty in acting on behalf of the best interests of the organization.
There is a duty of due care, also called a duty of diligence, to make informed and prudent
decisions. Corporate governance establishes fundamental systems and processes for oversight,
accountability, and control. This requires investigating, disciplining, and planning for recovery
and continuous improvement. Effective corporate governance creates compliance and values so
that employees feel that integrity is at the core of competitiveness. Governance also provides
mechanisms for identifying risks and planning for recovery when mistakes or problems occur.

Corporate Governance and Social Responsibility

To understand the role of corporate governance in business today, it is also important to consider
how it relates to fundamental beliefs about the purpose of business organizations. Some people
believe that as long as a company is maximizing shareholder wealth and profitability, it is
fulfilling its core responsibility. Although this must be accomplished by legal and ethical
standards, the primary focus is on the economic dimension of social responsibility. Thus, this
belief places the philanthropic dimension beyond the scope of business. Other people, however,
take the view that a business is an important member, or citizen, of society and must assume
broad responsibilities. This view assumes that business performance both affects and is
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influenced by internal and external factors. In this case, performance is often considered from a
financial, social, and ethical perspective. From these assumptions, we can derive two major
conceptualizations of corporate governance: the shareholder model and the stakeholder model.
The shareholder model.
The shareholder model of corporate governance bases management decisions on what is in the
best interests of investors, including the maximization of wealth for investors and owners. It has
long been the view that shareholders are a company’s most important stakeholder. If a business’s
goal is to make a profit, and if the firm’s owners and investors have the most to lose when a firm
closes, then businesses must create value to survive and provide returns for owners. Managers
who adopt the view of maximizing shareholder value advocate for a shareholder model of
corporate governance. From an economic perspective, such a viewpoint makes sense. Businesses
cannot survive without making a profit. However, there is a significant downside to the
shareholder model. Due to the pressures to meet performance expectations, managers are often
tempted to take a short-term perspective of the organization. In other words, managers might
focus on maximizing value in the short term rather than in the long term. This can have negative
repercussions on the firm.
The stakeholder model.
In the stakeholder model of corporate governance, the purpose of business is conceived more
broadly. Although a company has a responsibility for economic success and viability, it must also
answer to other parties including employees, suppliers, government agencies, communities, and
groups with which it interacts. However, while managers with this viewpoint acknowledge the
importance of all stakeholders, they also recognize that firms must prioritize these stakeholders.
For instance, some firms may choose to prioritize employees, while others could choose to focus
on customers. This allows the firm to tailor its goals to best meet the needs of its chosen
stakeholder rather than trying to meet the needs of every stakeholder. When satisfying the interest
of the chosen stakeholder, benefits to other stakeholders, including shareholders, followed. The
stakeholder model has received widespread support from many successful managers over the
years. Adopting the stakeholder model will be able to manage both short-term results— creating
wealth for shareholders—while considering the long-term well-being of the firm.

Issues in Corporate Governance Systems

Organizations that strive to develop effective corporate governance systems consider several
internal and external issues. In this section, we look at four areas that need to be addressed in the
design and improvement of governance mechanisms. We begin with the board of directors,
which has the ultimate responsibility for ensuring a governance focus. Then, we discuss the role
of shareholders and investors, internal control and risk management, and executive compensation
within the governance systems. These issues affect most organizations, although individual
businesses may face unique factors that create additional governance questions.

Internal
Board of Shareholders Control and Executive
Risk

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 Directors and Investors Management Compensation
Board of Directors
Members of a company's board of directors assume responsibility for the firm's resources and
legal and ethical compliance. The board appoints top executive officers and is responsible for
providing oversight of their performance. Thus, board membership is not designed as a vehicle
for personal financial gain; rather, it provides the intangible benefits of ensuring the success of
the organization and the stakeholders affected and involved in the fiduciary arrangement. Several
issues concerning the board of directors are as follows:
• Independence. A key attribute of an effective board is that it is comprised of a majority of
independent outsiders. An outsider is someone who has never worked at the company, is
not related to any of the key employees, and has never worked for a major supplier,
customer, or service provider of the firm, such as lawyers, accountants, consultants,
investment bankers, etc. The outside directors are thought to bring more independence to
the monitoring function because they are not bound by past allegiances, friendships, a
current role in the company, or some other matter that may create a conflict of interest.
• Quality. Finding board members who have similar expertise in the firm's industry or who
have served as chief executives at similar-sized organizations is a good strategy for
improving the board’s overall quality. Directors with competence and experiences that
reflect some of the firm's core issu

• es should bring valuable insights to bear on discussions and decisions.

Shareholders and Investors

Because they have allocated scarce resources to the organization, shareholders and investors
expect to grow and reap rewards from their investments. This type of financial exchange
represents a formal contractual arrangement and provides the capital necessary to fund all types
of organizational initiatives. Investments include financial, human, and intellectual capital.
Several issues concerning shareholders and investors include:
• Shareholder Activism. This is a way that shareholders can influence a corporation's
behavior by exercising their rights as partial owners. Several ways exist for them to
influence a company’s board of directors and executive management actions. These
methods can range from dialogue with managers to formal proposals, which are voted on
by all shareholders at a company's annual meeting. Shareholder activists also employ a
variety of offensive tactics to force changes. They may also threaten companies with
lawsuits if they are not allowed to have their say.
• Social Investing. Many investors assume the stakeholder model of corporate governance,
which carries into a strategy of social investing, “the integration of social and ethical
criteria into the investment decision-making process”. There are two inherent goals of
socially responsible investing: social impact and financial gain. A social investor assesses
the financial outlook of the investment while trying to gauge its social value.

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 • Investor Confidence. This is the investors’ willingness to engage in the investment
opportunities and associated intermediation channels available to them based on their
perception of risk and return. Shareholders and other investors must have assurance that
their money is being placed in the care of capable and trustworthy organizations. These
primary stakeholders are expecting a solid return for their investment, but they also have
additional concerns about social responsibility. When these fundamental expectations are
not met, the confidence that investors and shareholders have in corporations can be
severely tested. Part of this trust relates to the perceived efficacy of corporate governance,
which is now considered an investment criterion for most investors.

Internal Control and Risk Management

Controls and strong risk management systems are fundamental to effective operations, as they
allow for comparisons between the actual performance and the planned performance and goals of
the organization. Controls are used to safeguard corporate assets and resources, protect the
reliability of organizational information, and ensure compliance with regulations, laws, and
contracts. Risk management is the process used to anticipate and shield the organization from
unnecessary or overwhelming circumstances while ensuring that executive leadership is taking
the appropriate steps to move the organization and its strategy forward. The following are the
several issues under internal control and risk management:
• Internal and External Audit. Auditing, both internal and external, is vital between risk and
controls and corporate governance. The purpose of internal auditing is to provide insight
into an organization’s culture, policies, and procedures and aids board and management
oversight by verifying internal controls such as operating effectiveness, risk mitigation
controls, and compliance with any relevant laws or regulations. Boards of directors must
ensure that the internal auditing function of the company is provided with adequate
funding, up-to-date technology, and restricted access, independence, and authority to
carry out its audit plan. External audits, on the other hand, provide credibility, improve
shareholders’ and investors’ confidence, and improve internal systems and controls.
• Control Systems. The area of internal control covers a wide range of company decisions
and actions, not just the accuracy of financial statements and accounting records.
Controls also foster understanding when discrepancies exist between corporate
expectations and shareholder interests and issues. Internal controls effectively limit
employee or management opportunism or the use of corporate assets for individualistic or
non-strategic purposes. Controls also ensure the board of directors has access to timely
and quality information that can be used to determine strategic options and effectiveness.
For these reasons, the board of directors is responsible for ensuring that an effective
internal control system exists and they should have ultimate oversight for the integrity of
the internal control system.

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 • Risk Management. A strong internal control system alerts decision-makers to
possible problems or risks, that may threaten business operations, including
worker safety, company solvency, vendor relationships, proprietary information,
environmental impact, and other concerns. Having a strong crisis management
plan is part of the process for managing risk. The board of directors is accountable
for discovering risks associated with a firm’s specific industry and assessing the
firm's ethics program to ensure that it is capable of uncovering misconduct.

Executive Compensation
Executive compensation, also known as executive pay, refers to remuneration packages
specifically designed for business leaders, senior management, and executive-level
employees of a company. Executive compensation includes benefits such as salaries,
perks, incentives, insurance, etc. Senior management and executive-level employees play
a crucial role in the company as they're the ones making the strategies, making importance
decisions, etc. To keep them motivated and satisfied it's important to set the right benefits
package. Executive compensation is such an important topic that many boards spend more
time deciding how much to compensate top executives than they do ensuring the integrity
of the company's financial reporting systems. How executives are compensated for their
leadership, organizational service, and performance has become a controversial topic.

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