CHAPTER 3

Corporate GovernanceCorporate Governance

Chapter Objectives

• To define corporate governance• To describe the history and practice of corporate

governance• To examine key issues to consider in designing

corporate governance systems• To describe the application of corporate governance

principles around the world• To provide information on the future of corporate

governance

Corporate Governance

Corporate governance is the formal system of oversight, accountability, and control for organizational decisions and resources

History of Corporate Governance

• 1932—U.S. Securities & Exchange Commission (SEC) is formed, requiring corporations to allow shareholder resolutions to be brought to a vote of all shareholders.

• Mid-1900s—The goal of business is to align the interests of principals and agents so that organizational value and viability are maintained.

History of Corporate Governance (cont.)

• Mid-1990’s—Boards of directors play a greater role in strategy formulation, andthere is movement toward corporate governance committees.

• 2002—Sarbanes-Oxley Act brought sweeping changes in corporate governance.

• 2008-2009 – Collapse of U.S. financial system discloses corruption and need for greater oversight and control.

Models of Corporate Governance

• Shareholder model

• Stakeholder model

Issues in Corporate Governance Systems

• Boards of directors

• Shareholders and investors

• Internal control and risk management

• Financial misconduct

• Executive compensation

General Issues in Social Investing

• Environmental

• Workplace equity and safety

• Product safety and testing

• Global operations

• Human rights

Internal Control and Risk Management

Controls are used to safeguard corporate assets and resources, protect the reliability of organizational information, and ensure compliance with regulations, laws and contracts.

Financial Misconduct

• The failure to understand and manage ethical risks played a key role in the financial crisis of 2008-2009.

• Complex financial schemes, inappropriate risk levels, opportunity for personal gain, financial incentives, and a lack of effective corporate governance led to the financial crisis.

• Subprime lending created thousands of mortgage foreclosures and delinquencies.

• Derivatives, a financial trading instrument, have been called “financial weapons of mass destruction.”

OECD Principles of Corporate Governance

1. Basis for an effective corporate governance framework

2. Rights of shareholders and key owners

3. Equitable treatment of shareholders

4. Role of stakeholders in corporate governance

5. Disclosure and transparency

6. Responsibilities of the board

Implementing OECD Principles of Corporate Governance• Create systems that articulate divisions of responsibilities

and are consistent with the rule of law.

• Ensure the rights of shareholders to vote and influence corporate strategy.

• Recruit greater number of skilled, independent members on boards of directors.

• Eliminate techniques that protect failing management and strategy.

• Promote wider use of international accounting standards.

• Promote better disclosure of executive pay and remuneration.