Chapter 5

Corporate
Governance

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 Learning Outcomes
• Explain the term corporate governance.
• Understand the responsibilities of the board of directors and
the major governance committees.
• Explain the significance of the “King One” and “King Two”
reports.
• Explain the differences between the following two
governance methodologies: “comply or explain” and “comply
or else.”
• Identify an appropriate corporate governance model for an
organization.

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 Corporate Governance
System by which business corporations are directed and
controlled.
• Good corporate governance: Plays a vital role in underpinning the integrity
and efficiency of financial markets.
• Poor corporate governance: Weakens a company’s potential and can lead
to financial difficulties and fraud.

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What Does Corporate Governance Look Like?
Owners: Supply equity or risk capital to the company by
purchasing shares in the corporation.

Board of directors: Group of individuals who oversee

governance of an organization.
• Elected by vote of the shareholders at the annual general meeting (AGM).

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 Audit and Compensation Committees
Operating committees staffed by members of the board of
directors plus independent or outside directors.
• Audit committees are responsible for monitoring the financial policies and
procedures of the organization.
• Compensation committees are responsible for setting the compensation
for the chief executive officer (CEO) and other senior executives.

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 Corporate Governance Committee
• Monitors the ethical performance of the corporation.
• Oversees compliance with the company’s internal code of
ethics as well as any federal and state regulations on
corporate conduct.

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 Figure 5.1: Governance of the Modern
Corporation

Source: Adapted from Fred R. Kaen, A Blueprint for Corporate Governance (New York: AMACOM, 2003).
Access the text alternative for slide images.

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 In Pursuit of Corporate Governance
King One report was recognized as advocating the highest
standards for corporate governance.
• Took a more integrated approach to the topic of corporate governance.
• By recognizing the involvement of all the corporation’s stakeholders in the
efficient and appropriate operation of the organization.

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 King Two Report 1

Formally recognized the need to:

• Move the stakeholder model forward.

• Consider a triple bottom line as opposed to the traditional single bottom
line of profitability.
• Triple bottom line recognizes the economic, environmental, and social aspects
of a company’s activities.

Successful governance in the world in the 21st century requires

companies to adopt an inclusive and not exclusive approach.

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 King Two Report 2

• Company must be open to institutional activism and should

emphasize the sustainable or nonfinancial aspects of its
performance.
• Boards must apply the tests of fairness, accountability,
responsibility, and transparency to all acts and be accountable
to the company and its stakeholders.
• Correct balance between conformance with governance
principles and performance in an entrepreneurial market
economy must be found.

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 Two Governance Methodologies
Comply or explain.
• Guidelines that require companies to abide by a set of operating standards
or explain why they choose not to.

Comply or else.
• Guidelines that require companies to abide by a set of operating standards
or face stiff financial penalties.

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 The Chairman and the CEO 1

Disregarding the corporate governance model involves merging

the roles of CEO and chairman of the board into one individual.
• Oversight provided by the board of directors is lost.
• Operational focus changes from long term to short term.
• Merging the two roles may lead to higher efficiency.

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 The Chairman and the CEO 2

Advantages of merging.
• Potential for conflict is minimized.
• Board is given the benefit of leadership from someone who is in touch
with the inner workings of the organization rather than an outsider.

Disadvantages of merging.
• Governance of the corporation is with one person, which eliminates the
checks and balances process that the board was created for in the first
place.
• Independence of the board is compromised, and the power of the
stockholders is minimized.

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 Effective Corporate Governance 1

INSEAD, the European business school, emphasizes corporate

governance as an organizational culture issue through CRAFTED
principles.
• Consistency, responsibility, accountability, fairness, transparency, and
effectiveness that is deployed throughout the organization.

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 Effective Corporate Governance 2

To serve the purpose in setting the operational tone for the

organization, the board should be:

• Comprised of members who represent professional conduct.

• Granted proper authority to fulfill their responsibilities of oversight,
guidance, and approval.
• Willing to work with the executive leadership to provide feedback and
guidance in a detailed and timely manner.

Electing to take strategic projects under advisement for

extended periods of time may serve to reinforce the power of
the board of directors.

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Dangers of a Corporate Governance Checklist
Effective corporate governance is more than just maintaining a
checklist of items to be monitored on a regular basis.
• Having mechanisms in place will not guarantee good governance.

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 A Fiduciary Responsibility
Corporate governance is about managers fulfilling a fiduciary
responsibility to the owners of their companies.

Based on trust, which is a difficult trait to test when hiring a

manager or enforcing it later.
• Enforcement only becomes an option when that trust has been broken.

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 Key Safeguards for Corporate Governance
• Properly constituted boards.
• Separation of the functions of chairperson and CEO.
• Audit committees.
• Vigilant shareholders.
• Financial reporting and auditing systems that provide full and
timely disclosure.

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