Corporate Governance Chapter 2 Part 1

Study Notes

Corporate Governance - Chapter 2 Part 1

Ineffective corporate governance at major bankrupt US companies (Enron, WorldCom) fueled fraudulent financial reporting and an unethical corporate culture. This led to the loss of billions to investors and paved the way for corporate governance reforms.
Reforms include the Sarbanes-Oxley Act of 2002 (SOX), SEC rules, listing standards, and best practices.
Corporate governance and business ethics are now considered crucial for the 21st century. They've shifted from a compliance requirement to a strategic business imperative and a focus on ethical corporate culture.
Colleges and universities are vital in training future ethical business leaders, given the volatility of global capital markets.
Erosion of investor confidence in recent years is linked to economic slowdowns, terrorism threats, equity bear markets and significant financial scandals.
Congress responded with SOX to make public companies more accountable for the information they release. This includes improved corporate governance, financial reporting, and auditing.
Effective corporate governance aids management in better running organizations. It promotes board oversight, shareholder engagement, and the duties of gatekeepers (auditors, legal counsel, etc.). It improves trust in an organization.
Organizations of any size (simple operations to multinational corporations) benefit from effective governance.
Corporate governance is ultimately about leadership and accountability, leading to efficient operations, transparent reporting, trust, and sustainable performance.
Corporate governance is a process by legislation, regulations, contracts, and market mechanisms to create value for stakeholders.
There are three aspects of corporate governance: stakeholder, shareholder, and an integrated approach.

Shareholder Aspect

The board of directors and executives are chosen to manage the business on behalf of shareholders.
As corporations grow, dispersed ownership and diminished investor control is created, potentially influencing decision making for the benefit of senior leadership.
Ensure management interests align with shareholder interests via accountability and effectiveness in creating shareholder value.

Principal-Agent Problem

The principal-agent problem arises from the separation of ownership and control. It's about the gap between information available to management and to shareholders.
Complete, enforceable contracts are extremely challenging to achieve due to imperfect information.
Management may act in a way that isn't in the best interests of shareholders, whether intentionally or due to various types of flaws in corporate governance structures.

Stakeholder Aspect

Stakeholder view examines the company as the nexus of contracts (relationships) among various groups including: contractual stakeholders such as shareholders, creditors, suppliers, customers and employees and societal stakeholders such as local communities and global partners.
Public companies are increasingly accountable for their social and environmental impact.
This extends to assessing how a company's behavior can impact performance in terms of financial indicators, social outcomes(employment & customer satisfaction/supplier relationships), ethical performance (proper business culture, conduct codes), and environmental responsibility (pollution, preservation of natural resources).