This article has been written by Riya Puthran, pursuing a Diploma in Corporate Law & Practice: Transactions, Governance and Disputes course from LawSikho.

This article has been edited and published by Shashwat Kaushik.

Introduction 

In its Corporate Governance Review 2020, Grant Thornton concluded: “The best-performing companies are embracing governance activities, not as separate compliance needs but as business essentials that are fundamentally linked; risks to strategy, strategy to purpose, reward to what really matters to all.” A company or an organisation is said to be directed or managed by some rules or regulations laid down by its Board of Directors. Such a process of controlling a company’s overall activities is called corporate governance. The concept of corporate governance also pushes the narrative of ethical business practices. Companies that follow corporate governance can be said to have a good and trustworthy image in the market.

Importance of corporate governance

Companies that follow such practices become successful in creating a reputation for their company in the market. With their ethical business practices and transparency in transactions, they gain the trust of their shareholders, investors, employees, and customers. When a company has well-built corporate governance, it means that the interests of employees and shareholders are aligned with each other.

Benefits of corporate governance

There are numerous benefits to corporate governance. They are:

Risk identification

Corporate governance helps to identify and reduce risks by appointing personnel who keep a close eye on the transactions of the company and implement policies that identify the risks and take measures to minimise them.

Long-term sustainability

Corporate governance ensures the smooth functioning of the organisation. It helps to minimise financial losses that are likely to happen in the future and also promotes product efficiency. This results in the orderly working of the organisation in the long term.

Investor confidence

Corporate governance asks the board of directors to conduct meetings regularly, frame policies, and maintain transparency in transactions. This transparency helps investors understand what is happening in the company. Due to the lack of any secrets between the investors and the company, there is a high amount of trust between them.

Improved brand image

A company that discloses all of its transactions in front of its investors without any hesitation is bound to have a good reputation or brand image in the market. Such practices also lead to increased share prices for the company.

Corporate governance models

Anglo-American model

The Anglo-American model, also known as Anglo-Saxon, is usually practiced in the United States, the United Kingdom, Australia, and Canada. Variations of the above model can be seen in India, Malaysia, and China. It focuses more on the shareholders of the company by giving them various rights. The Board of Directors also plays a crucial role in framing policies and strategies. Usually, the Chief Executive Officer and Chairman of the Board are one single individual, but not in the case of the Anglo-American model, as it does not promote the concentration of all the power within a single individual. This model promotes transparency in the affairs of the company. Companies are required to provide proper information about their financial standing and everyday work to their shareholders so that they can make fair and practical decisions in the annual general meeting.

Continental-European model

This type of model is focused on stakeholder satisfaction rather than the satisfaction of just shareholders. The term stakeholders consists of employees, creditors, customers, etc. This model consists of two boards: a management board, which includes the insiders, i.e., the executives, and a supervisory board, which includes the shareholders. Any bank that holds a stake in the company can be a part of the supervisory board. The supervisory board directs or guides the management board. Countries like Germany or the Netherlands can be good examples of countries that follow the continental European model.

Japanese model

Similar to the Continental-European model, the Japanese model also focuses on the stakeholder approach. The fulfilment of stakeholders, including the local community, employees, creditors, etc., along with those of the shareholders, is the primary goal of this model. Companies provide lifetime employment to their employees, which gives them job security and creates a sense of loyalty in the minds of employees. Japanese companies have always insisted on undertaking Corporate Social Responsibility (CSR) activities. Conducting an activity that results in the betterment of the environment or people or an improved overall image of the nation is one of the goals of the Japanese model. The interests of individual investors or small businesses are less likely to be taken into consideration. The Japanese model lacks transparency.

Examples of corporate governance

Good corporate governance

1. Tata Group is one of India’s largest and oldest conglomerates. It is known for its corporate social responsibility and ethical business practices. Tata Group is often used as a prime example of good corporate governance. Chairpersons such as J.R.D. Tata and Ratan Tata inculcated the concept of ethical business practices and the welfare of the people. The group has always maintained transparency in its actions and always made sure that the stakeholders were aware of the company’s direction. The group has always communicated with its employees, shareholders, creditors, etc., and made sure that their interests are considered by the board of directors while making decisions. The group also contributes a good part of its profits towards CSR activities.
2. Unilever is a British-Dutch multinational consumer goods company operating in a variety of products, including beverages, personal care products, etc. Unilever has undertaken many social responsibilities, including environmental protection, community welfare, etc. This company involves a diverse but balanced board of directors. The board includes executive, non-executive, and independent directors. The company has framed various policies to ensure fair labour practices and ethical business practices. Unilever earned the respect and trust of its shareholders because of its transparency.

Bad corporate governance

1. Enron Corporation was an American energy, commodities, and services company. As a result of its accounting fraud, Enron ceased its operations in 2007. In the year 2000, the company started collapsing due to high financial losses. However, to hide these losses from the shareholders, the top management engaged in accounting fraud. The company also discovered flaws in the existing law and used it in its favour to undertake unlawful activities. This led to the enactment of new regulations, such as the Sarbanes-Oxley Act, to prevent such corporate governance failures in the upcoming future.
2. Satyam Computer Services, popularly known as the Satyam scandal, can be a good example of bad corporate governance. It was one of the largest IT companies in India, founded by Ramalinga Raju. Later, he admitted to having falsely altered the financial statements of the company and even produced the false statements in front of the shareholders. This fraudulent act led to great financial losses for investors.

Does corporate governance affect a company

Good corporate governance results in an increased company reputation and long-term sustainability. It bridges a gap between stakeholders and the company, as a result of which stakeholders begin to have faith in the company and extend their support towards the company, which is what happened with Tata Group and Unilever. On the other hand, the fall of Enron and Satyam Computer Services can be a good example of what happens in the case of poor corporate governance. Not only was the company shut down, but also the investors lost their confidence, employees lost their jobs, etc. Hence, it is necessary to maintain good corporate governance by maintaining transparency, communicating with stakeholders, and conducting CSR activities.

How to achieve effective corporate governance

Stakeholder management

The company should maintain communication with its stakeholders and make decisions in their interests. Shareholders can also participate in the decision-making process by voting.

Transparency

Companies should maintain transparency in their actions at all costs to achieve effective corporate governance. Timely financial statements shall be produced before investors to help them understand the financial standing of the company.

Ethical business practices

A company should follow ethical standards to achieve effective corporate governance. No company shall produce any false records or statements to hide the real financial standing of the company. It should comply with all the rules and regulations. A part of the profit should be spent on CSR activities for the welfare of society.

Board diversity

Shareholders should appoint directors with different experiences, different approaches to problem-solving, and different skills; this way, there will be diversity on the board. Board directors shall be responsible for conducting meetings, recording minutes, and producing them in front of shareholders. The board should also frame policies and procedures that will be followed by the employees in the day-to-day operations of the company.

Mitigate risks

Mitigate risk means to identify and reduce the risk. The board should appoint such personnel who will keep a close eye on the transactions of the company and mitigate the risks involved in or resulting from such transactions. It enables a company to enjoy long-term sustainability.

Conclusion

It can be said that good corporate governance plays a significant role in the success story of a company. Companies that adopt corporate governance stay in the market for a long time; however, companies that take this concept lightly may gain short-term profits, but in the long run, the reputation of the company will suffer. Hence, every company should adopt the process of corporate governance.

References

• https://www.investopedia.com/terms/c/corporategovernance.asp
• https://sprigghr.com/blog/board-management/the-importance-of-corporate-governance/
• https://uk.indeed.com/career-advice/career-development/benefits-of-corporate-governance#:~:text=Risk%20mitigation%20is%20identifying%20and,as%20soon%20as%20they%20arise
• https://boardclic.com/corporate-governance/how-to-ensure-good-corporate-governance/
• https://blog.ipleaders.in/all-you-need-to-know-about-corporate-governance/#:~:text=Corporate%20Governance%20essentially%20involves%20the,challenges%20of%20running%20an%20organization.
• https://www.investopedia.com/updates/enron-scandal-summary/#:~:text=By%20the%20fall%20of%202000,the%20company%20using%20MTM%20accounting