Many people ask us “what is corporate governance?” Investopedia defines corporate governance as, “…the system of rules, practices, and processes by which a firm is directed and controlled. Corporate governance essentially involves balancing the interests of a company’s many stakeholders, such as shareholders, senior management executives, customers, suppliers, financiers, the government, and the community.” What is corporate governance? It’s the framework which enables organisations to gain financial success through governance excellence. Governance is the mechanism which the board of directors can effectively make better decisions. The company, through its board of directors and senior executive team set corporate governance as part of the strategy by aligning business objectives. The company and its employees need to understand what corporate governance is and how it benefits the sustainable success of its business. Understanding what governance is will help employees operate ethically and in the best interests of the company. The board of directors provide the strategic leadership and ‘tone from the top’ for better corporate governance practices. The CEO and their executive team are pivotal in implementing good governance across all areas of the company. The most successful and sustainable companies are able to embed governance as part of their culture. When governance becomes apart of the corporate DNA, it is the means which employees and the board look to for effective decision making. It is the board of an organisation which sets the tone, and the CEO is the means by which good culture and governance are rolled out.
Culture and corporate governance – what is corporate governance?
Good governance and corporate culture should go hand in hand for the sustainable growth of the company. Furthermore, they create transparency and foster trust and openness with shareholders, directors, and employees. This ensures that everyone’s goals and incentives are aligned with good cultural behaviours by which it is governed. When a company acts honestly and is a good corporate citizenship the risk to shareholders is minimised. Shareholders and stakeholders feel assured that the right risk management is in place when companies are transparent. A company which is sustainable and understands what governance is will increase shareholder value, dividends and stakeholder engagement.
What is the S&P 500 ESG Index and what does corporate governance have to do with it?
The S&P 500 ESG Index integrates environmental, social, and governance values to rate the corporate governance of an organisation. Moreover, it serves as a governance framework upon which companies can build. The Index excludes companies related to tobacco and controversial weapons. Also excluding companies that are not in compliance with the UN Global Compact (UNGC). Companies that have a low ESG (Environmental, Social, and Governance) score are also excluded. This index ensures that a company aligns with that of the shareholders’ investment goals as well as their personal code of conduct. The S&P 500 ESG Index was designed to provide a similar risk/return profile to the S&P 500 and also to help shareholders avoid companies that are not in line with the ESG principles. An organisation which articulates what corporate governance is and how it is applied, will get the higher ESG scores. Investors want businesses to apply good corporate governance that embraces social and environmental strategies. Furthermore, large institutional investors only invest in businesses whose board of directors effectively implement good corporate governance polices.
Interpreting the S&P 500 ESG Index
The entire ESG score of the S&P 500 ESG Index is 71.57, which is a 9.32 increase from the composite S&P 500’s score. These scores are meant to be read as percentiles, therefore, a score of 60 means that the company being indexed has a stronger score than 60% of the companies in that industry. The S&P 500 ESG Index was designed for the investors who wanted to integrate ESG elements into their core investments. Many institutional investors and fund managers have an investment mandate. Usually this mandate requires them to only invest in the businesses which adopt high standards of corporate governance. A board of directors which incorporates a framework for effective governance and robust internal control is more likely to attract the larger investors.
Poor Corporate Governance
Corporate governance is more than just policies and procedures, its a vital part of good culture. Unfortunately, many organisations do not invest adequately in establishing an effective governance model which becomes part of their corporate DNA. Usually it takes a major corporate governance failure to get an organisation to understand what the value of corporate governance is. The board then sets governance and compliance as part of their core strategy to work towards remediation to tighten internal controls and governance policies. Siemens was involved in corrupt practices which involved more than $1.4 billion in bribes to government officials in Asia, Africa, Europe, the Middle East and the Americas. At the time, Siemens received the largest fine issued by the US authorities for corrupt practices, fraud and bribery. Siemens plea bargained and put forward a governance and compliance remediation plan with the authorities which reduced the magnitude of fines they had to pay. Since that time, there have been many other corporate scandals; Toshiba, Wells Fargo, Rolls Royce, HSBC and the more recent Airbus bribery scandal.
Poor internal controls, governance frameworks and culture
Poor governance practices can profoundly impact a company’s reliability. Shareholders are looking for companies who have integrity and are sustainable. When an company successfully applies a corporate governance framework it safeguards the financial health of the business. There have been many scandals among corporations that have negatively impacted their public perception and trust. This in turn affects sales and to the stock value. It also impacts stakeholders, namely employees, suppliers and customers. There may also be criminal penalties for those organisations and individuals who break securities and other laws. Other poor governance practices include companies that do not comply with auditors, poor executive compensation packages, and poorly structured boards. Also, in a study performed on Ugandan banks with poor corporate governance, it was found that “Openness and Reliability are measures of trust … It is obvious that trust has a significant impact on financial performance; given that transparency and disclosure boost the trustworthiness of commercial banks. Banks both local and international should enforce full disclosure practices and transparency practices thereby enhancing trust in order to survive in the competitive financial landscape.”
Good Corporate Governance and your bottom line
We see that international corporate governance models are used in many countries to maintain value to the shareholders and to the wider stakeholders of organisations. These codes or governance regulations are there to protect organisations from financial distress and maintain financial performance. A Polish study found that “…the level of corporate governance of companies in Poland is associated with their ability to cope with…financial distress, as expressed by the degree of liquidity, profitability and the financial leverage variables.” In addition, an Indian study found that, “…corporate governance and corporate financial performance are correlated and governance rating of [a] company has [a] significant positive impact on its financial performance…Companies should strive to improve its performance along indicators of good governance–Leadership Ethics, Board Composition & Independence, Executive Compensation, Transparency and Reporting, Stakeholder Engagement, and Compliance with [the] law in true letter and spirit.” In short, governance is about trust, accountability and transparency. When stakeholders trust your openness, transparency, and honesty they will want to be part of your company. Moreover, when the right internal controls are in place it leads to financial success through good corporate governance in your business. We see that international corporate governance models are used in many countries to maintain value to the shareholders and to the wider stakeholders of organisations. These codes or governance regulations are there to protect organisations from financial distress and maintain financial performance. A Polish study found that “…the level of corporate governance of companies in Poland is associated with their ability to cope with…financial distress, as expressed by the degree of liquidity, profitability and the financial leverage variables.” In addition, an Indian study found that, “…corporate governance and corporate financial performance are correlated and governance rating of [a] company has [a] significant positive impact on its financial performance…Companies should strive to improve its performance along indicators of good governance–Leadership Ethics, Board Composition & Independence, Executive Compensation, Transparency and Reporting, Stakeholder Engagement, and Compliance with [the] law in true letter and spirit.” In short, governance is about trust, accountability and transparency. When stakeholders trust your openness, transparency, and honesty they will want to be part of your company. Moreover, when the right internal controls are in place it leads to financial success through good corporate governance in your business.
What is the meaning of corporate governance?
The principles of corporate governance revolve around best practices for internal controls, accounting controls and responsibilities. These controls should safeguard the sustainability and long-term success of an organisation. Corporate governance relates to the relationship between the shareholders, board of directors and the senior management team. The shareholders (as principal) of a company, appoint board members (as agents) to manage shareholder interests. The board of directors in turn appoints the senior management team to run the day to day operation of the business. What is your governance definition? For many it is the governance structure, policies and procedures set by the board of directors and delegated to the chief executive officer (CEO) and management to implement and embed. The performance measurement of the CEO and management are through board oversight and the compensation committee or remuneration committee. Compensation committees review the performance of the senior management team and the key performance indicators set at an individual and organisational level. These KPIs are usually based on financial performance with an aspect of non-financial related performance. This process usually takes into account short-term and long-term incentives for the purpose of minimising conflicts of interests, whilst increasing shareholder value. An audit committee will monitor risks, internal controls and their effectiveness in achieving business objectives. The objectives should be achieved in alignment with the core values of the company. Audit Committees are responsible for the review of the financial reports and the correctness of the financial data from management. The audit committee should be made up of independent and non-executive directors with relevant and current accounting or audit experience. If their is an internal audit function then it should report into the audit committee. The internal audit function should be independent and enjoy the protection of the audit committee or the board of directors. This will help safeguard the independence if the internal audit reports. It will also make it more difficult for the CEO or the management to coerce them to filter or downgrade high risk internal audit observations. The UK Corporate Governance Code 2018 states “where there is no internal audit function, an explanation for the absence, how internal assurance is achieved, and how this affects the work of external audit” – Principle M, Provision 26. An audit committee provides assurance to the board on the integrity of the financial statements, the effectiveness of the company’s internal financial controls and internal control and risk management systems. The committee also reviews and monitors the internal audit function and external auditor’s independence and objectivity. Public companies in many countries are required to form an audit, remuneration and nomination committee. In some cases a risk committee is also required for public companies and banks. The board of directors is ultimately responsible for risk management and internal controls to mitigate risk and maximise upside opportunities. By law the board are required to report to shareholders, in an annual meeting, the financial and non-financial performance of the company. The financial statements and the annual reports should provide a true and fair view of the company’s financial position and its prospects as a going concern for at least 12 months.
Your corporate governance definition
The definition for an SME or listed company differs significantly. Most micro or small businesses understand corporate governance and have some policies and procedures and they may have an owner/manager structure. In the United States, a company which is listed has to meet the minimum compliance and governance regulations. The US obligations are rule based regulations under the SEC and Sarbanes–Oxley Act (SOX). In the UK, listed companies are controlled through a principles based code and expected to comply of explain.
Here is how Governance Gurus helps with governance
Governance Gurus work with businesses to ensure that their governance and policies are right. We also advise boards and senior executive teams on board charters, delegations of authority matrices and terms of references. We know the importance of designing policies and procedure that the business understands and can easily implement. The internal controls, policies and the procedures of the organisation should be able to be understood and aligned to the business. There are also benefits in organisations conducting in-house training on governance. We offer, face to face training and virtual classroom training courses or webinars. Our training is accredited and the participants receive a certificate for the continuing professional development (CDP) they received. The training is designed to the specification and requirements of your business. We have trained directors, the executive teams and the company secretary of many global organisations. The training areas we focus on are leadership, corporate governance, strategic thinking for business transformation and diversity. Call us on +971(0)4387 3554 for more information on corporate governance services or drop us a message to the team through contact us! Scan the below QR code if you want to receive our newsletters and invitations to free online training and webinars on leadership, strategic risk management, GRC and other interesting topics.