Definition of Corporate Governance

The definition of corporate governance most widely used is "the system by which companies are directed and controlled" (Cadbury Committee, 1992). More specifically it is the framework by which the various stakeholder interests are balanced, or, as the IFC states, "the relationships among the management, Board of Directors, controlling shareholders, minority shareholders and other stakeholders".

The OECD Principles of Corporate Governance states:

"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."

While the conventional definition of corporate governance and acknowledges the existence and importance of 'other stakeholders' they still focus on the traditional debate on the relationship between disconnected owners (shareholders) and often self-serving managers. Indeed it has been said, rather ponderously, that corporate governance consists of two elements:

  1. The long term relationship which has to deal with checks and balances, incentives for manager and communications between management and investors;
  2. The transactional relationship which involves dealing with disclosure and authority.

This implies an adversarial relationship between management and investors, and an attitude of mutual suspicion. This was the basis for much of the rationale of the Cadbury Report, and is one of the reasons why it prescribed in some detail the way in which the board should conduct itself: consistency and transparency towards shareholders are its watchwords.

As fundamentally important as these traits are, we prefer to take a rather broader view, which places the Cadbury Code and other codes developed since (Combined Code, Sarbanes-Oxley, King, etc) in a wider context and shows its recommendations emerging naturally in the course of a company’s evolution. In an early book on corporate governance, also published in 1992, one of the creators of this website developed a definition of corporate governance as consisting of five elements which the board must consider:

This definition was endorsed by Sir Adrian Cadbury in his foreword to another of the author’s books on the subject, directed at the smaller company. A few years later in a third book the definition was extended by describing Five Golden Rules by which a system of good corporate governance should be operated, and set out a practical methodology for implementing and monitoring (Real World Corporate Governance - a Programme for Profit Enhancing Stewardship, FT Pitman 1998). We now make this methodology, expert knowledge and research available using modern internet technologies via this website.

Separation of Ownership and Control
The corporation, in contrast, for example, to a partnership, separates ownership from operational control - this concept is, of course, fundamental to any definition of corporate governance and is commonly referred to as the agency issue, or Agency Theory. It is this separation which creates the need for systems of independent monitoring and control. Historically, it was the freedom that this separation created to take much bigger risks in order to expand that prevented for so long the permission of such organisations to exist, with the potential dangers it implied. And it is this freedom which has required mechanisms to be constructed to try and prevent it being abused.

Different Countries, Different Models
This has led to different systems in different countries, depending on which constituent or interested party in the company’s operations has been given the most importance. In the Anglo-Saxon world, for example, there has always been a single board of directors consisting of executive and non-executive, or independent directors. Elsewhere, a two tier structure exists to balance the executive board with representatives from other stakeholder groups like employees and bankers (like the Aufsichtsrat or Supervisory Board in Germany).

The Emperor has no clothes

Corporate Governance, is not - or should not be - about debate and discussion on executive compensation, shareholder protection, legislation and so on. In recent times, the issue has become not only a subject of fierce debate and public outcry, but also, as a result of this and arising legislation, a subject which wearies many company directors. Put in other words, therefore, the phrase coined above means that there is very little substance to modern corporate governance, in the view of the authors. What is behind all the fracas is to a great extent common sense, like many principles in business. Directors, for example, should naturally be responsible in their role as fiduciaries of other people’s money. This is rarely mentioned in the conventional, reporting-based definition of corporate governance.

To use another metaphor, there is so much smoke, that we have lost sight of the fire. This fire is the real message and definition of corporate governance, which is undoubtedly beneficial to all, that we should be good directors. The early Cadbury and Greenbury codes did not arise simply to produce legislation, but to encourage self-regulation, with the ultimate goal that in applying the recommendations, the company will become more efficient, gain shareholder value, and hopefully increase market value as a result.

This is the bottom line. We all want to increase our value, and ‘Corporate Governance’ is often seen as cost ineffective, bringing little or no benefits - the smoke gets in our eyes, as it were. What we need to do is to apply the principles of good governance to the whole corporation.

This could be described as: "looking at Management through Corporate Governance-tinted glasses"

i.e. taking a fresh look at management structure taking into account all interested parties and ensuring all the necessary monitoring and controls are in place to ensure that shareholder value is always at the forefront.

Compare this with the definition of corporate governance in Director’s Monthly: "Effective corporate governance ensures that long-term strategic objectives and plans are established, and that the proper management and management structure are in place to achieve those objectives, while at the same time making sure that the structure functions to maintain the corporation’s integrity, reputation, and accountability to its relevant constituencies."

Our definition of corporate governance

The discussion so far has illustrated that a proper definition of corporate governance should not just describe directors’ obligations towards shareholders. And we have mentioned that different countries have different ideas as to what constitutes good corporate governance. Therefore any satisfactory definition, to be applicable to a modern, global company, must synthesise best practice from the biggest economic powers into something which can be applied across all major countries. In essence we believe that good corporate governance consists of a system of structuring, operating and controlling a company such as to achieve the following:

  • a culture based on a foundation of sound business ethics
  • fulfilling the long-term strategic goal of the owners while taking into account the expectations of all the key stakeholders, and in particular:consider and care for the interests of employees, past, present and future
    work to maintain excellent relations with both customers and suppliers
    take account of the needs of the environment and the local community
  • maintaining proper compliance with all the applicable legal and regulatory requirements under which the company is carrying out its activities.

We believe that a well-run organisation must be structured in such a way that all the above requirements are catered for and can be seen to be operating effectively by all the interest groups concerned. We develop this further in our section on best corporate governance practice. Here we have set out our assessment of how corporate governance is usually discussed and introduced our own, which we hope you have found useful. This page serves as a hub to link to a range of issues related to the definition of corporate governance. For example we define business ethics and Corporate Social Responsibility, different country models and Codes of Conduct.

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