Corporate Governance: 15 Reasons for Effective Management

Understanding the importance of corporate governance is critical for all companies, even small—to medium-sized companies. Good corporate governance can help companies build business integrity and play a role in risk management.

While public companies typically need to have corporate governance in place, it can benefit all companies looking to create a stronger foundation. Consider what the corporate governance of a company is and why it matters.

What is corporate governance besides a set of rules that companies must follow? Though it may seem like rules to follow (and can even be a bit of a complex process to set up), it’s a must for most of today’s companies, especially in social responsibility.

Like it or not, your company’s customers have opinions, and meeting their objectives (or at least not going directly against them) can help with your branding or hurt it if you’re not careful.

What Is Corporate Governance?

Corporate governance is a set of guidelines or a system of rules and processes that a company follows. This system of practices aids in the direction and control of the company. Ultimately, it is a framework that outlines how a company will work to reach its goal.

Types of Corporate Governance

Timeline of Key Milestones for Corporate Governance

• 1992: Cadbury Report (UK)
  • Published in response to major corporate scandals, this report recommended best practices in corporate governance, including the role of board members and accounting systems.
• 2002: Sarbanes-Oxley Act (US)
  • Passed after major accounting scandals like Enron and WorldCom, this act introduced stringent reforms to improve financial disclosures and prevent accounting fraud.
• 2003: NYSE and NASDAQ Listing Requirements
  • New rules required listed companies to have a majority of independent directors and fully independent audit, compensation, and nominating committees.
• 2004: OECD Principles of Corporate Governance
  • These principles guided policymakers to improve legal, institutional, and regulatory frameworks for corporate governance.
• 2010: Dodd-Frank Wall Street Reform and Consumer Protection Act (US)
  • Introduced in response to the 2008 financial crisis, this act implemented significant changes to financial regulation and corporate governance practices.
• 2013: EU Action Plan on Company Law and Corporate Governance
  • This plan aimed to enhance transparency, engage shareholders, and support companies’ growth and competitiveness.
• 2018: UK Corporate Governance Code
  • This updated code emphasized the importance of corporate culture, stakeholder engagement, and board diversity in effective governance.
• 2020-2022: ESG and Stakeholder Capitalism Focus
  • Increased emphasis on Environmental, Social, and Governance (ESG) factors in corporate governance, reflecting a shift towards stakeholder-centric models.

Who Creates a Company’s Corporate Governance Rules?

A core component of corporate governance is balancing the company’s stakeholders’ goals and best interests. That typically includes the company’s shareholders, customers, financiers, suppliers, executives, senior management, government, and community.

While not all parties play a role in creating corporate governance objectives, those that do do so for the betterment of the entire organization and all stakeholders. The board of directors is a company’s primary influencing group for creating corporate governance.

Their influence and decision-making affect the company’s achievement of its long-term goals. Corporate governance also involves a wide range of the company’s objectives.

As a result, it incorporates all components of its management. That includes all the internal controls established for the company, its action plans, the way it measures performance, and all corporate disclosures created.

See Related: What is the Pyramid of Corporate Social Responsibility?

What Are the Principles of Corporate Governance?

The principles of corporate governance are customized to meet the company’s needs. Some of the most common include:

• Fairness: The board of directors must establish an objective of treating all stakeholders, including shareholders, employees, and vendors, with equal and fair consideration. That often extends to the community as well.
• Transparency: Another core component of corporate guidance is transparency in providing accurate, timely, and clear information about important topics. This typically includes risks to shareholders, conflicts of interest, and financial performance.
• Responsibility: The board is also responsible for overseeing various corporate matters. This includes being aware of and supporting the company’s successful performance. It may also include recruiting management leaders, including the CEO.
• Accountability: This area often focuses on the company’s activities and the results of its conduct. The board and the other company leadership members must be accountable for performance, potential, and the company’s capacity. It is accountable to all stakeholders when matters of importance occur.
• Risk Mitigation: Nearly all corporate governance plans incorporate defined risk. That includes learning what risks a company faces and developing a plan for controlling them. The board is responsible for recognizing risk, gathering risk information, and then taking steps to manage that risk.

See Related: Unum Group ESG Profile (UNM): Is It Sustainable?

What Is the Importance of Corporate Governance?

Corporate governance can be significant in multiple ways. Who needs it? Why should you even care about defining these rules?

Many business owners feel they know their customers well enough. They certainly want to run their company in their way. Why must you alter your business operations to practice good corporate governance? Consider these important reasons for incorporating corporate governance into a business.

#1: Create Transparent Rules and Controls

Corporate governance ensures clear and transparent rules for all stakeholders to follow. The rules and controls are created based on shareholder interest. Once laid out, every member fully understands the expectations.

Consider how that may help ensure the company’s objectives are met. If someone does not meet his or her responsibilities, corporate boards have clear insight into the steps to take, whether that is to adjust objectives, hold the management board responsible, or remove the problem otherwise.

Controls also guide decision-making. For example, the company may have specific career development goals for its employees, and senior leaders may be responsible for establishing those rules.

#2: Give Your Leaders Guidance

Effective corporate governance often requires the board to clearly explain the company’s goals and objectives to the leaders. While much of the direction and decision-making remains left to the leadership structure, the board is expected to guide expectations in all areas.

For example, the corporate governance guidelines outline leaders’ expectations. It further defines the expected corporate behavior of leaders and what each professional is tasked with. This helps improve communication while ensuring all parties follow the established corporate governance structures.

See Related: What is International Development? Definition & Meaning

#3: Ensure the Community Continues to Back You

Corporate governance guidelines are not simply focused on internal operations. Rather, the goal is to create a plan for managing and leading a company that treats its community with respect and meets the expectations of that community. For example, company executives should not do anything that would cause damage to the local community.

Many corporate governance principles focus at least somewhat on creating sustainability. This could include, for example, supporting environmental protections for the community to reduce carbon emissions and waste.

Social responsibility is also a core component of the corporate governance framework. Corporate social responsibility extends not just to employees, ensuring the fair and equal treatment of all people, but also within the community through all company connections with customers and the community.

See Related: Chevron Corporation ESG Profile (CVX): Is It Sustainable?

#4: Build Trust with Your Investors

Private companies typically require investor support from private individuals or financial institutions. A robust corporate governance model helps investors grasp the company’s goals, corporate officers’ roles, and profitability expectations. While it doesn’t necessitate complete transparency of operations and strategies, it usually includes responsibilities for investor communication.

Good investor relations are critical to all companies. Imagine if a company needs to borrow money to expand. With poor investor relations or limited information on things like executive compensation or the financial viability of the company plan, investors are less likely to be willing to participate and extend financial support.

Bad corporate governance, secrets, and poor transparency often lead to complicated outcomes. An audit committee could find poor business decisions and corruption, which will further sour the company’s investor relations.

#5: Align the Company with Your Shareholder’s Interests

Major shareholders contribute significantly to the business’s objectives and goals. They are undoubtedly invested in the company and want a strong profit margin and long-term success. Creating a corporate governance model creates clear communication between all shareholders.

In this way, all corporate decisions can follow the basic principles outlined in the governance model. The framework’s structure is specific to those shareholders’ objectives. Decisions are made to support all shareholders, not just the goals of the executive leadership or one leader.

See Related: Chubb Limited ESG Profile (CB): Is It Sustainable?

#6: Meet the Goals and Needs of Management and Employees

While much of the focus is on defined responsibilities for the company’s board and management team, there’s much to the process, including creating a strong, healthy support system for management and employees.

For example, these guidelines often define ethical behavior toward the company’s employees. They can outline how people will be treated (and often how they should never be treated) and help establish the company’s expected culture.

Defining the company culture is vital to many employees, especially top talent that could be valuable to any other company in the industry. Private companies can build loyal employees and a strong employer brand by clearly defining guidelines for treating people.

For example, the company may need to improve employee morale. There’s more to that than just increasing pay. Corporate officers and board members should define the problem, communicate with employees, and establish a plan for achieving the desired outcome. By having a plan for doing this, companies can tackle problems quickly and maintain their positive company culture.

This can also affect employee career development and advancement. The management team may have expectations regarding how to lead, manage existing teams, and maintain the company’s direction in developing improved talent.

See Related: Reasons Why Corporate Social Responsibility Is Important

#7: Help Support Your Efforts to Raise Capital

Companies with a reliable corporate governance model are also more likely to be able to raise funding, including that initial IPO. There’s clear, long-term value creation. Investors can see what the company is working to achieve, understand its culture, and back it up (or not).

There’s also the importance of clear and well-outlined transparency with financial terms. For example, board committees expect consistent communication about the organization’s financial health. When there are clear guidelines and constant communication like this, there’s a higher opportunity for investors to be confident in lending and supporting the company.

Depending on corporate strategy, this could be critical for the company’s long-term development. Without clear insight into these areas, investors are less likely to view the company favorably or with trust. Objectives to raise funds become complicated, if not impossible, to meet.

More so, investors are not just there for growth periods. With clearly established and maintained corporate governance, companies can confidently turn to their loyal investors and even other financial institutions in difficult times, knowing they will be respected and supported.

See Related: The Interpublic Group of Companies, Inc. ESG Profile (IPG): Is It Sustainable?

#8: Reduce the Risk of Financial Loss

Exceptional corporate governance outlines the company’s operations in terms of managing financials. This includes practices for proper auditing and verification of accurate data. Rather than relying on company management to handle financial needs, board members can constantly see the company’s books and are kept up to date on the company’s financial health.

That creates an opportunity to spot problems early on. For example, companies can see that they are losing money in specific areas or may be better able to spot fraud or corruption.

With rules like this, a clear step-by-step process is outlined for reporting financial health, the limitations of risk, and what should be done when losses occur. This also helps create and maintain long-term value within the organization.

See Related: The Boeing Company ESG Profile (BA): Is It Sustainable?

#9: Meeting Regulatory Obligations and Reduce Risk

One of the most pressing concerns for many organizations today is meeting regulatory objectives. Companies must be able to meet all regulatory obligations in all sectors, whether that includes meeting state or federal guidelines for communicating financials, reporting taxes, meeting employee regulations, or protecting customer information.

With compliance measures increasing across most aspects of the industry, it has become increasingly challenging for companies to remain compliant. This could include energy consumption, employee social responsibility, workplace diversity, and personal and health information protection.

The governance structure lays the foundation for this, outlining the expectations in this area. That way, there is a clear and concise path for ensuring every aspect of the laws and regulations is followed, reducing the company’s risk of financial loss or complicated legal matters related to the matter.

Often, the board of directors is responsible for ensuring the company knows all such regulatory requirements and has a plan to follow them. This may impact the company’s daily operations and long-term objectives.

See Related: The Howard Hughes Corporation ESG Profile (HHC): Is It Sustainable?

#10: Create Long-Term Financial Stability

Corporate governance covers many factors that could impact a company’s viability and longevity. Good corporate governance is flexible enough to change over time, such as when culturally or socially appropriate changes in workplace culture or environmental strategies develop.

The tools help keep the company on track and moving forward. That means that board members and other stakeholders can monitor the company’s health through communications, financial statements, and other methods of measuring shareholder interest and objectives. The result is a clear path that can help create long-term financial stability for any business.

Improved risk management also maximizes this. In short, when a company has corporate strategies that help minimize risk, it’s less likely to falter in those areas, creating financial stability over the long term.

See Related: Sustainable Finance: Different Types of Green Financing

#11: Build Business Integrity

From key stakeholders to external stakeholders and the public in general, companies with a solid business foundation and company culture are more respected. Having a diverse board helps a company understand its community’s cultural and ethical differences. They can better move the company in a positive direction for changing times or better meet the stakeholders’ expectations.

Businesses with a clear level of corporate governance are also seen as a positive addition to the community and the industry itself. This can boost investor insight and confidence, support stock growth and stability, and help the company maintain its best reputation.

See Related: Crown Holdings, Inc. ESG Profile (CCK): Is It Sustainable?

#12: Carve Out a Path for Building the Future of the Company

Strategic planning, a component of corporate governance, is also valuable for building on the company’s future. As noted, the company’s management can use the policies and controls to develop new talent and support employee development and growth. That helps build the employee component of the business.

In addition, it can build long-term shareholder value that will last generations. With tools like succession planning, the company knows who will likely take over when the leadership leaves or retires or when the board of directors needs to change. Still, there is also a path to help govern the selection process, training, and transition.

This helps to build the company not just today but well into the future. Consider the value of succession planning alone. Often, companies struggle significantly when top leadership or the business owner leaves, especially if that person is the company’s founder and brand.

When strong succession planning has been in place for some time, employees, key stakeholders, and external stakeholders know what is to come and have faith in that transition.

See Related: Perrigo Company plc ESG Profile (PRGO): Is It Sustainable?

#13: Tying Profits and Compensation Minimizes Loss

Another way to look at the value of corporate governance is that it creates a clear line in the sand regarding compensation. When the company meets the outlined metrics, avoids problems with government regulators, manages significant pressures, and can continue to work towards its corporate purpose, compensation should follow for that leadership team.

Not just profits, but when other objectives are met for the company, corporate governance can provide some clarity on how executive compensation should be managed. It can offer insight into when senior management executives should be rewarded or replaced.

It is up to the board to make those decisions. Still, the independent directors clearly understand expectations, and it’s far easier to make leadership decisions.

See Related: The Clorox Company ESG Profile (CLX): Is It Sustainable?

#14: Plan for Long Term Resilience

Another area showcasing the importance of corporate governance is the company’s long-term objectives and growth strategies. Shareholder interests change over time, without a doubt, and to remain competitive, companies need to be innovative and change with the public and the company’s customers or clients.

Corporate governance can create tools to manage this process. One such tool could be a team of professionals helping the company develop new products or services or implement new technology. A good corporate governance system always plans for the long-term resilience of the business in a wide range of areas.

By contrast, bad corporate governance often leads to strife and a process of playing “catch up” instead of leading the pack. The most successful companies take risks but do so with objectives and strategic planning set in place by governance objectives.

That matters especially in today’s society, where the need to compete may not be more pressing for organizations. A management board and corporate culture focused on future-proofing the company can be invaluable.

See Related: How to Save Money & Go Green; a Step-by-Step Guide

#15: It Minimizes Corruption and Fraud

Corporate governance is a way for public companies to minimize the risk of fraud and corruption, two of the most common reasons for company failure. Companies often falter without a system to spot problems early on and ensure transparency.

Companies that utilize corporate governance properly are likely to adhere to accountability and transparency. This means it is much harder for fraud or corruption to occur at any level of the company’s operations, which is good news for all stakeholders and shareholders of the organization.

See Related: Pinnacle West Capital Corporation ESG Profile (PNW): Is It Sustainable?

What are the benefits of good corporate governance?

Building a strong corporate governance model is not a simple process. Any company leader involved in this process knows it is long and challenging, requiring each member of the board of directors to think and define what the company stands for and how operations are run. Yet, there are some clear-cut benefits to utilizing corporate governance.

Corporate governance ensures processes are efficient

This can help ensure repeatability and consistency within the business model and daily operations. Corporate governance is significant here because it ensures the proper establishment and maintenance of the company’s brand. Its keen eye for detail can also help ensure businesses can improve their products or services.

Errors become clear and easy to spot

Corporate governance needs may not be more clearly defined than during a crisis or difficult period. This allows for the visibility of errors to become clear. When a task is completed the same way (in any sector of the company) every time and something fails, it is possible to pinpoint what’s occurred so that changes can be made.

Corporate governance helps reduce costs

Corporate governance also helps reduce costs in various ways. This could include reducing repetition and incorporating more efficiency into operations. This could mean reducing waste material in the production process.

It may include minimizing the need to rework development or product manufacturing because there’s less risk of failure. This, along with better employees committed to the company, can help to streamline the costs of running the company.

See Related: What is Shared Governance? What You Need to Know

Corporate governance builds smoother-running operations

Anyone who has walked into turmoil within a company knows how much it can cost that organization, including product waste, employee turnover, and company profits. When corporate governance models are in place, such difficult situations are less risky, and operations are smoother.

Expectations are understood. Processes and policies are laid out clearly. Everyone knows where to go and what to do, as well as their responsibilities. That goes from the board of directors down to the latest hire. As a result, companies run smoother.

Compliance costs are minimized, and risks are mitigated

Regulator compliance in any sector is often viewed as reducing fines and minimizing scrutiny of the operation. However, the other side is that when smooth processes are in place, and a strong corporate governance system is clear, those compliance rules help others.

Having a culture designed to support corporate governance enables this. It ensures that products reach the market and intended customer within the desired timelines while meeting all expectations regarding protecting employees, customers, and data.

See Related: FirstEnergy Corp. ESG Profile (FE): Is It Sustainable?

What Happens When Poor Corporate Governance Is In Place?

One way to see the value and essential benefit that corporate governance brings to a company is to consider what happens when it’s non-existent. A company that lacks good corporate governance is likely to see a number of complications. Consider what happens when corporate governance failure happens.

There is a higher risk for:

• Unethical leadership in developing, pulling down the company’s integrity, and creating risks in all transactions. This often leads to an untrusted company by investors and the general public. The board of directors cannot find stability and often puts out fires.
• Poor corporate social responsibility could lead to claims against the business, increasing liability risks and positioning the company directly opposite cultural norms and expectations, making it harder to sell a product or hire employees.
• Corruption is more likely to involve company insiders, and it is often clearly evident when the leadership, including the board of directors, is about improving themselves individually rather than keeping the focus on the long-term success of the company.
• The board of directors itself is weak. This often comes from a lack of ability to make decisions or to govern positively.
• Inefficient internal audits can often lead to costly mistakes and increase financial risk over time, ultimately costing the company its financial viability.

Over time, this can lead to failures within the company and leadership, often limiting the company’s ability to grow and develop and sometimes leading to failure.

Shareholder confidence and trust are vital but lost

With poor or ineffective corporate governance models, shareholders no longer trust the board of directors or the company. For public companies, that can be disastrous in the long term.

Eroding confidence from shareholders often makes people feel as though they have been misled and cheated, and from that point onward, they will feel as though the company is making bad decisions even as it tries to right the ship.

Too much risk positions the company for loss

When corporate governance becomes damaged or ineffective, the leadership often needs to take risky and sometimes bold steps to improve profits or minimize ongoing losses. This often leads to taking on significant risks, which often mean further losses. Poor strategies often lead to too much risk for the company, which risks its ability to remain effective.

See Related: What is Environmental, Social, and Governance (ESG)? Definition & Examples

How Can a Company Improve Corporate Governance?

Implementing straightforward, clearly defined rules and controls is the first and most important step to achieving good corporate governance. Improvement can be seen once a solid and well-rounded plan is in place.

For example, companies may find that increasing diversity within the board of directors can help to stabilize claims that the company may be biased or no longer in touch with their customers or the community. This could help to address the company’s lack of ability to grow into the future. Diversity in the boardroom can change the decision-making and culture of the entire company.

Appointing new and more competent board members can help companies achieve their goals better. This process requires skill—those who lack that skill and are left to try to learn it put the company at risk. There may be a need for a change of leadership.

There’s also the need to fall back on those corporate governance rules which typically focus on consistency, transparency, and accuracy. This can help to understand better the board’s performance as well as all members of the management team.

Good corporate governance also occurs when better risk management strategies are implemented. Organizations may find that reassessing risk tolerance can lead to better outcomes. Because corporate governance deals directly with decision-making and company operations, it is very important for all to be on the same page regarding risk tolerance.

The board of directors is responsible for establishing good corporate governance, but it is also necessary to have a way to police it within that realm. That often means completing effective corporate governance audits while also working to ensure the board is a solid representation of the company.

The importance of corporate governance is hard to overestimate because it impacts every facet of a company’s operation. Yet, changes can be made anytime to improve its reach and achieve better outcomes. 

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