As publicly traded companies have ownership distributed among shareholders, the board of directors has a responsibility to operate the business in a faithful and ethical manner. In order to effectively carry out this responsibility, they use a framework of rules, practices and processes, which is known as corporate governance.
Corporate governance ensures the long-term success of the business, protects shareholder rights, and balances the interests of all stakeholders. However, corporate governance is not only beneficial for public companies, but private companies as well. Therefore, for anyone starting their own business corporate governance will be a key component of success.
In this article, we’ll dive into what corporate governance is, how it works, and the importance of effective corporate governance in business.
What is corporate governance?
Corporate governance is essentially a blueprint that companies use to manage the business in a way that ensures accountability to stakeholders, protects business integrity, and maximizes profitability. Depending on the individual company, corporate governance includes various components, such as policies, responsibilities, decision-making processes, principles, action plans and financial disclosures.
The main individuals within a company who are responsible for achieving good corporate governance are the members of the board of directors. Each publicly traded company is required by law to have a board of directors who are elected by shareholders to oversee the company. The board of directors are primarily responsible for making high-level decisions, providing strategic guidance and mitigating risk — which are all activities that fall under corporate governance.
As the board of directors has a responsibility to practice good corporate governance, they are also expected to balance the interests of not only shareholders, but other stakeholders as well. These include employees, vendors, clients and the general public.
How it works
At the core of good corporate governance are four key principles, which are accountability, transparency, fairness and responsibility. Companies that build their corporate governance around these principles are more likely to maintain a good reputation among investors and achieve long-term success.
Accountability
Good corporate governance relies on accountability, which refers to clearly defined roles and responsibilities within those roles. Each board member should at any time be prepared to provide their shareholders with rationale behind any decisions made or actions taken. This accountability serves to prevent negligence, fraud and corruption, which could be detrimental to the success of the company.
One example of poor accountability in corporate governance is the Volkswagen AG scandal in 2015. After senior leaders deliberately installed defective parts into cars to circumvent emissions standards, the company was viewed as lacking accountability to both their customers and the environment. This scandal led to disastrous financial and reputational damage for the company.
Transparency
The principle of transparency refers to stakeholders being informed about all matters of the business. Therefore, in order to ensure transparency, companies must provide shareholders with access to financial statements, performance reports, strategies, future risks and any other key business information.
To demonstrate transparency, some companies, such as Goldman Sachs even publicly share their corporate governance principles and practices on their website. Transparency around corporate governance is a key component of investor relations and attracting funding.
Fairness
In order to be viewed as an ethical company that treats shareholders equally, corporate governance relies on the principle of fairness. Fairness involves outlining how the shareholders will be treated based on their holdings in the company. As investors want to ensure they will receive fair treatment, operating fairly can help secure future investments.
For many companies, the principle of fairness does not only apply to shareholders, but all stakeholders. For example, companies with exceptional corporate governance will seek to apply fairness to employee relations through implementing equal hiring practices and fair wages.
Responsibility
Corporate governance means that the board of directors has a responsibility to act in the best interest of the company and stakeholders. However, responsibility doesn’t only mean ensuring the company stays profitable for the shareholders, but also means that the board of directors has responsibilities to the wider society as well.
It is the responsibility of companies to consider the social and environmental impacts of business decisions and practices, which is known as corporate social responsibility (CSR). Some examples of CSR are reducing a company’s carbon footprint, promoting diversity and paying fair wages.
The importance of corporate governance
The role that corporate governance plays in enabling companies to achieve long-term success is instrumental. Below are ten benefits of corporate governance that every entrepreneur or business owner should be aware of:
1. It creates smoother operations
Smooth operations are key to running any successful business, as they improve the efficiency and profitability of the company. Although the board of directors typically does not take part in a company’s daily operations, corporate governance can still play a role in facilitating smoother business operations.
Through policies, procedures and processes, corporate governance helps to ensure that internal mechanisms are monitored and functioning as effectively and efficiently as possible. As good corporate governance is the foundation of a company, it has an influence on all business operations and activities.
2. It builds a positive brand reputation
One of the most important benefits of good corporate governance is that it can safeguard a company’s brand reputation — among both consumers and potential investors. Since consumers prefer to support ethical companies that have high corporate social responsibility, this can lead to higher sales and profitability.
However, corporate governance does not only ensure a positive brand reputation among consumers, but also investors, as they are interested in funding reliable and safe companies. So, in order to achieve long-term business success, maintaining a positive brand reputation through corporate governance is key.
3. It improves cost efficiencies
Companies with good corporate governance have clearer processes and efficient operations in place, which can improve cost efficiencies. With good corporate governance, the board of directors maintains a broader overview of business practices and are better able to detect opportunities to reduce costs and improve profitability.
For example, as good corporate governance includes having internal control activities, there will be a mechanism for completing audits. These audits can then, in turn, improve cost efficiencies by uncovering any wastes in energy or resources.
4. It attracts investor funding
When buying a share in a company, investors want to be certain that their funds are safe and that the company is trustworthy. For this reason, corporate governance is a crucial aspect in securing investor funding.
Companies that demonstrate that they have stable, ethical, and transparent business practices will be attractive to investors. And staying attractive to investors through corporate governance will help the company grow and overcome any potential financial challenges.
5. It ensures objectives are reached
Good corporate governance is purpose-driven and includes aligning procedures, processes and practices around company objectives. Therefore, corporate governance plays an instrumental role in ensuring businesses reach their goals.
Implementing strategies and road maps helps to increase the likelihood that a company will reach their set objectives. If a company is consistently not reaching their goals, or doesn’t have any plans to reach them, this may be a red flag for investors and make it difficult to obtain funding.
6. It minimizes corruption and fraud
One of the most important benefits of good corporate governance is that it prevents corruption and fraud — two types of conduct that can lead to business failure. Through adhering to principles of accountability and transparency, the risks of corruption and fraud are greatly reduced.
As we’ve seen from the Volkswagen AG scandal, corruption can have disastrous consequences; and corporate governance plays an important role in reducing the risk of impropriety. Therefore, companies that want to avoid any bad press — or legal trouble — should have good corporate governance in place.
7. It improves compliance
Businesses are responsible for acting within the confines of certain local, state, and federal laws and regulations. This is referred to as compliance; and it is an important aspect of corporate governance.
Because non-compliance can lead to fines, penalties and even legal action, it is in the best interest of companies to ensure they are adhering to all laws and regulations. So, good corporate governance includes compliance, which minimizes financial, legal or reputational risks.
8. It improves company culture
The behavior, practices and norms of the board of directors trickle down through the rest of the company. Therefore, in order to ensure a positive and ethical company culture, it is important to have good corporate governance in place at the top.
For example, if the board of directors embeds the principles of transparency, fairness, accountability and responsibility into the governance structure, they have controls in place to ensure ethical behavior and workplace norms are adhered to throughout the whole company.
9. It considers the interests of everyone
A further benefit of corporate governance is that the interests of all stakeholders are considered and balanced. Stakeholders do not only include shareholders, but also employees, customers and the wider society.
For example, when employees’ interests are considered, they tend to be more satisfied at work. When shareholder interests are considered, they retain their stocks. And when the interests of the wider society are considered, the company is more likely to be viewed as ethical. This is why balancing the interests of all stakeholders is beneficial for all.
10. It expedites decision-making
It is crucial for companies to be nimble when it comes to decision-making. However, businesses shouldn’t focus so much on the speed of decision-making that they sacrifice adequate consideration or group consensus. This is why good corporate governance can be such an asset.
For example, instead of using valuable time to decide which stakeholders will be responsible for important decisions, the decision-making processes will be established in advance. Therefore, corporate governance helps to ensure decisions are made as quickly and thoroughly as possible when the time comes to act fast.
Key takeaways
It is indisputable that corporate governance is key to long-term business success. Through outlining clear business practices, processes and rules, companies can reap a myriad of benefits.
Good corporate governance can support the success of a company through:
- Building a positive brand reputation: Having clear accountability minimizes the risk of scandals, misconduct or poor management.
- Ensuring long-term financial stability: It demonstrates to investors that the company is reliable, well-managed and a safe investment.
- Improving company culture: The board of directors sets the tone of the company through their corporate governance.
- Considering the interests of all stakeholders: Corporate governance promotes fair practices that are more likely to keep stakeholders satisfied.
- Facilitating efficient decision-making: By having decision-making processes in place, decisions are made more quickly and effectively.
Corporate governance is a framework that provides companies the highest chance of success. It doesn’t only lead to higher profitability for the company, but also to transparent, fair and ethical practices that are less likely to have negative impacts on society. For these reasons, corporate governance is an invaluable aspect of any successful business.
Did you know what corporate governance was? How are you going to bring these practices into your business? Let us know in the comments!
This is an updated version of an article originally published on 10 July 2015.