Corporate Governance

Corporate Governance?

Corporations’ boards of directors and executives utilize a combination of rules, processes, and policies to carry out their responsibilities on behalf of their shareholders. This is referred to as corporate governance in the business world.

Definition and Origins:

As a general rule, corporate governance refers to the combination of rules, practices, procedures, and policies that a company’s board of directors (who represent the shareholders) and its executives (who manage on behalf of the board of directors) use to carry out their responsibilities on behalf of the shareholders.

Not only does the concept address how boards of directors deal with the agency problem, but it also raises questions about the legal position of businesses in the marketplace. Examples include the 1886 Santa Clara County v. Southern Pacific Railroad case, in which the United States Supreme Court established corporations as “persons” entitled to equal protection under the 14th Amendment of the United States Constitution, which made significant changes to the legal status of corporations in the United States of America.

Consequently, companies have the same legal standing and due process rights as individuals: they can file petitions with the government and use their right to free expression, for example, by purchasing television commercials to promote a particular political candidate. In addition, corporations are believed to be entities with civic responsibilities due to their legal standing in society (Dodd, 1932).

According to current thinking, the corporation is a political actor who participates in political discourse and is subject to the discipline of democratic institutions – just like private individuals (Scherer and Palazzo, 2007).

According to Bakan (2004), the Dodge v. Ford 1919 case, in which the Supreme Court held that corporate executives have a legal obligation to serve the ‘best interests of shareholders,’ established what is now known as shareholder primacy and contributed to the further definition of corporate governance in the United States (Bakan, 2004: 36–37).

It wasn’t long before the notion that shareholders are the legal property owners of organizations and that the primary purpose of corporate executives is to grow shareholder wealth was accepted as a fundamental part of both organizational theory and organizational practice (Bearle and Means, 1932; Coase, 1937; Friedman, 1962). Wallman (1999) added to this concept by asserting that corporate executives must support the corporation’s principal aim (shareholder primacy) and be accountable for investor protection.

To maximize long-term wealth generation capacity rather than simply current shareholder interests, a firm must be managed in such a way that long-term wealth generation capacity is increased (p. 817). Fairfax (2006) argues that while shareholder primacy continues to be the dominant driving concept for corporate executives today, they must simultaneously contend with stakeholder demands and balance and integrate opposing interests (see Stakeholder Theory) (Freeman, 1984).

Corporate social responsibility advocates define stakeholders as including society, and businesses exist within communities and the environment. Therefore, they are responsible for understanding the social and environmental consequences of their decisions and actions and planning for and building a more sustainable future.

To accomplish this, companies must develop and implement environmental, human rights, public health and safety, and community relations policies that allow them to be successful without jeopardizing the environment, human rights, public health and safety, community relations, or the dignity of their employees (Hinkley, 2002: 19).

This perspective is reinforced by a large body of research on corporate social responsibility (see Scherer and Palazzo, 2007 for an excellent synthesis) and the moral duties of management (e.g., Windsor, 2001).

Comments from scholars about this concept

By using various organizational governance methods, boards of directors can ensure that the interests of managers are aligned with their own. As stated by several authors (Rutherford et al. 2007: 417), boards of directors have two choices: first, they can increase their monitoring activities to increase the amount of information available on performance; second, they can change executive compensation to better align administrative interests with those of shareholders’ interests.

Pettigrew (1992) argues that, despite the ease with which monitoring activities and incentive systems for CEOs can be imagined, the whole processes and behaviors of the board of directors as they attempt to govern are still poorly understood.

First and foremost, consideration should be given to the ownership and leadership structure, as well as to the composition and stock ownership of the board of directors, as well as to the term and remuneration of the CEO, as well as to the CEO’s compensation package (Coles, McWilliams and Sen, 2001). Coles and colleagues investigated the relationship between these qualities and market and industry performance indicators in their examination of the performance records of 144 firms between 1974 and 1994, which was carried out between 1974 and 1994.

In economics, Market Value Added (MVA) is defined as the difference between a firm’s total market value minus its cumulative book value of the capital invested. In contrast, Economic Value Added (EVA) is defined as the difference between a firm’s after-tax operating profit and the product of the weighted average cost of capital multiplied by the amount of money invested.

If you’re looking for a way to measure business success over the long haul, MVA is generally considered superior to EVA. However, the researchers discovered that a firm’s governance structure (including board membership and CEO tenure) had a considerable impact on Market Value Added, but not on Economic Value Added, contrary to predictions. 

According to the paper, a ‘positive correlation between MVA and the firm’s governance structure, which is targeted at lowering the agency costs that result from the separation of ownership and control,’ according to the paper, appears to have been discovered in the research (Coles et al., 2001: 47).

According to Tuggle et al. (2010), a significant assumption in agency theory is that “by monitoring, corporate board members may oversee and control senior managers’ interests in such a way that they do not vary materially from those of the owners” (p. 946). However, the bulk of studies employs board composition and structure as proxy measures for the concepts of monitoring and accountability, although this has been a significant issue of corporate governance study.

Current research on actual monitoring activities is lacking, particularly in terms of board members’ constant allocation of attention to the performance of their executives, which is a problem. However, by studying the transcripts of board meetings held between 1994 and 2000, Tuggle and colleagues (2010) conducted a study of 178 publicly traded businesses from 18 different industries, which they found particularly interesting.

According to the researchers, a study of actual transcripts from hundreds of board meetings suggests that directors pay attention to monitoring in different ways based on the firms’ deviation from historical performance and whether or not duality is present. (Page 961 of the Second Edition.) There is less monitoring when things are going well; conversely, there is even more monitoring when things are going badly. If something goes wrong, there is even greater surveillance. When the CEO also serves as the chairwoman of the board of directors, there is a degree of duality present, which may result in less monitoring being provided.

The second strategy, which matches the interests of the principals (shareholders) with the CEO’s goal of generating personal wealth through the use of incentive mechanisms such as performance-related bonuses and stock ownership, is referred to as “shareholder alignment.” When confronted with this agency quandary, boards of directors frequently respond by improving the quality of information, upgrading monitoring systems, or adopting an incentive structure to encourage better performance.

In their study, researchers Rutherford et al. (2007) discovered that proactive data collection, increased interaction with the CEO, formalizing the CEO’s performance review, establishing rules of conduct for the CEO, and developing policies on decision-making all contributed to improving the quality of information available to boards of directors. Specifically, the authors state that the results of their poll “suggest that when boards get more information, they increasingly connect pay to company performance and restrain CEO authority” (p. 427). As a result, board information and CEO controls work in tandem to provide a valuable complement to one another.

According to the findings of this research, corporate governance is substantially more complex than the structure/incentives model would indicate. A change away from the shareholder primacy paradigm toward the director primacy model, according to Lan and Heracleous (2010), will benefit the agency theory perspective on corporate governance and its application. As a mediating organization, the board of directors is considered to assist in bringing the goals of the various teams within a corporation into alignment. In this strategy, businesses are divided into sections (including shareholders).

Using agency theory and corporate governance as a connecting thread, North (2008) argues that to attain greater social responsibility, boards of directors must move beyond the practice of making utilitarian judgments based on shareholder profit. Instead, according to him, a new ethical framework known as strategic value should be established in which decisions are made not only on the long-term viability and survival of a company but also on stakeholder claims and the responsibility to leave a legacy of integrity that benefits both the organization and the greater good.

Specifically, it is contended by Aguilera et al. (2008a) that by concentrating primarily on the direct relationship between corporate governance standards and business performance, the significance of more outstanding context issues is missed. The second point of emphasis is an open systems approach, which considers environmental complexity while explaining diversity in practice patterns.

Costs (including the direct and opportunity fees of the board of directors and executives); contingencies (in terms of the structural characteristics and life-cycle stages); and complementarities (in terms of the complementary capabilities of the board and executives) are three essential interdependencies that must be considered (how these issues interact). 

Cohen et al. (2008) go a step further. They claim that to comprehend the agency theory perspective on corporate governance properly, it must be reinforced with the attitudes of resource dependence, managerial hegemony, and institutional theory, among others.

According to a resource dependence approach to corporate governance, ‘the primary task of the board is less that of a monitor and more that of a partner to management, one that supports creating effective policies and goals for the organization’ (DISCUSSION). When managers seek to ensure that their board of directors will be supportive and under their control, a managerial hegemony perspective considers the political processes that may evolve during the organization’s development.

The notion that boards of directors are primarily symbolic has been put forth, claiming that “top management chooses cronies and colleagues… who are willing to be passive participants in the governance process.” Based on institutional theory and, in particular, the issue of institutional isomorphism, it is hypothesized that boards of directors will become more similar over time as a result of regulatory changes, benchmarking, best practices, and the desire for a company to gain legitimacy by imitating other successful organizations. Government institutions may be mainly ceremonial and symbolic in their approach to obtaining uniformity and consistency (see Beasley et al., 2009, for further elaboration).

According to Vandewaerde and colleagues (2011), a focus on the demographic composition of boards has prevented onboard research leadership from paying adequate attention to the actual behavioral processes that take place during board meetings.

According to the authors, future research should be focused on what they refer to as a “dynamic process model of shared leadership in the board room” and that boards should be viewed as teams rather than as individuals (p. 415). According to the Harvard Business Review, “sharing leadership” refers to the distribution of influence among team members to help one another toward accomplishing common objectives.

Source:

Corporate governance. (2013). In A. L. Cunliffe, & J. T. Luhman, SAGE key concepts: Key concepts in organization theory. Sage UK. Credo Reference: https://go.openathens.net/redirector/adler.edu?url=https%3A%2F%2Fsearch.credoreference.com%2Fcontent%2Fentry%2Fsageukot%2Fcorporate_governance%2F0%3FinstitutionId%3D4074