Understanding the importance of corporate governance is critical for all companies, even small- to medium-companies. Good corporate governance can help companies to build business integrity and plays a role in risk management.
While public companies typically need to have corporate governance in place, it can be beneficial to all companies looking to create a stronger foundation. Consider what the corporate governance of a company is and why it matters.
Exactly what is corporate governance aside from what seems like a set of rules that companies have to follow? Though it may seem like just 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 the area of 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 type of framework that outlines how a company will work to reach its goal.
Who Creates a Company’s Corporate Governance Rules?
A core component of corporate governance is balancing the goals and best interests of all of the company’s stakeholders. That typically includes all of the company’s shareholders, customers, financiers, suppliers, executives, senior management, government, as well as the community itself. While not all parties play a role in the creation of corporate governance, those that do create these objectives do so for the betterment of the entire organization for all stakeholders.
The primary influencing group for the creation of corporate governance for a company is the board of directors. It is their influence and decision-making that makes a difference, in the long term, in how well the company achieves these goals.
Corporate governance also involves a wide range of the company’s objectives. As a result of this, it incorporates all components of its management. That includes all of 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 have an established objective to treat 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 the oversight of various corporate matters. This includes being aware of as well as supporting the successful performance of the company. This may 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 will incorporate some level of defined risk. That includes learning what risks a company faces and then a plan for controlling them. The board is responsible for recognizing risk, getting information on risk, and then taking steps to manage that risk.
What Is the Importance of Corporate Governance?
The significance of corporate governance can be multiple things. Who needs corporate governance? 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 own way. Why then, do you need to alter your business operations to practice good corporate governance? Consider these important reasons to incorporate corporate governance in business.
#1: Create Transparent Rules and Controls
Corporate governance ensures there are 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 what the expectations are.
Consider the importance of 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. Senior leaders may be responsible for establishing those rules.
#2: Give Your Leaders Guidance
Effective corporate governance often requires the board to provide leaders with a clear explanation of the company’s goals and objectives. While a lot of the direction and decision-making remains left to the leadership structure, the board is expected to provide leaders with guidance on expectations in all areas.
For example, the corporate governance guidelines outline what the expectations are of leaders. It further defines the expected corporate behavior of leaders and what each professional is tasked with. This helps to improve communication while also ensuring all parties are following the established corporate governance structures put into place.
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 in the fair and equal treatment of all people but also within the community through all connections the company has with customers and the community as a whole.
#4: Build Trust with Your Investors
Private companies nearly always need help from investors. This could be private investors, or it could be financial institutions.
Having a strong corporate governance model in place enables investors to understand the company’s objectives, the responsibilities of corporate officers, and the expectations of where and how the company will remain profitable. It does not require the company’s operations and strategies to be fully revealed but often incorporates responsibilities for communicating with investors.
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.
With bad corporate governance, secrets and poor transparency often lead to complicated outcomes. An audit committee could find poor business decisions being made as well as corruption present. That’s going to sour the company’s investor relations even more so.
#5: Align the Company with Your Shareholder’s Interests
Major shareholders contribute significantly to the business’s objectives and goals. Without a doubt, they are invested in the company and want to see a strong profit margin and good, long-term success. By creating a corporate governance model, there’s clear communication between all shareholders.
In this way, all of the corporate decisions made can follow the basic principles outlined in the governance model. The structure of the framework itself is specific to the objectives of those shareholders. Decisions are made to support all shareholders, not just the goals of the executive leadership or one leader.
#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 that includes a focus on creating a strong, healthy support system for management and employees as well.
For example, many times, these guidelines will define what ethical behavior is to the employees of the company. It can outline how people will be treated (and often how they should never be treated). It also helps with the establishment of 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 having clearly defined guidelines for how people should be treated.
For example, the company may be facing the need to improve employee morale. There’s more to that than just increasing pay.
Corporate officers and board members should define what the problem is, communicate with employees, and establish a plan for achieving the desired outcome. By having a plan for how to do this, companies can tackle problems quickly and maintain their positive company culture.
This can also play a role in career development and advancement for employees. The management team may have expectations on how to lead to not just manage existing teams but also to 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 financial health of the organization. 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 long-term development of the company. With a lack of clear insight into these areas, investors are less likely to view the company favorably or with trust. Objectives to raise funds then 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 turn to their loyal investors and even other financial institutions in difficult times with confidence, knowing they will be respected and supported.
#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 rely on company management to handle financial needs, board members can constantly see the company’s books and are kept up to date on the financial health of the company.
That creates an opportunity for spotting problems early on. For example, companies are then able to see that they are losing money in specific areas, or they may be better able to spot fraud or corruption.
With rules in place like this, there is a clear step-by-step process outlined for how to report financial health, what the limitations of risk are, and what should be done when there are losses. This, too, helps to create and maintain long term value creation within the organization.
#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 within compliance. This could include factors related to energy consumption, employee social responsibility, diversity within the workplace, and protection of personal and health information.
The governance structure lays the foundation for how to do this, outlining what the expectations are in this area. That way, there is a clear and concise path for ensuring every aspect of the laws and regulations are 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 is aware of all such regulatory requirements and has a plan in place to follow them. This may impact the company’s daily operations as well as long-term objectives.
#10: Create Long-Term Financial Stability
Corporate governance covers a wide range of factors that could impact the viability and longevity of a company. Good corporate governance is flexible enough to change over time as needed, such as when culturally or socially appropriate changes in workplace culture or environmental strategies develop.
More so, the tools in place aid in keeping the company on track and moving forward. That means that board members and other stakeholders can monitor the health of the company through communications, financial statements, and other methods of measuring shareholder interest and objectives. The result is a clear path, one that can help to create long-term financial stability for a business of any type.
This, too, is maximized by the use of improved risk management. In short, when a company has corporate strategies that help minimize risk, it’s less likely it will falter in those areas. This creates 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 contribute to a company’s ability to understand the cultural and ethical differences represented within its community. They are better able to move the company in a positive direction for changing times or better meet the expectations of stakeholders.
Businesses with a clear level of corporate governance are also seen as a positive addition to the community and the industry itself. That can boost investor insight and confidence, support stock growth and stability, and help the company to maintain the very best reputation.
#12: Carve Out a Path for Building the Future of the Company
Strategic planning, that is 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 in place to develop new talent and support employee development and growth. That helps build the employee component of the business.
In addition to this, it is able to build long term shareholder value that’s lasting for generations to come. With tools like succession planning, the company not only knows who will likely take over when the leadership leaves or retires or when the board of directors needs to change, but there is a path in place to help govern the selection process, the training, and the transition itself.
This helps to build the company not just today but well into the future as well. Consider the value of succession planning alone.
Often, companies struggle significantly when top leadership or the owner of the business leaves, especially if that is the founder and the brand of the company. When there is strong succession planning in place over a period of time, employees, key stakeholders, and external stakeholders know what is to come and have faith in that transition.
#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 when it comes to 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, but the independent directors have a clear understanding of expectations, and it’s far easier to make leadership decisions as a result.
#14: Plan for Long Term Resilience
Another area that showcases 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. That could include, for example, a team of professionals tasked with helping the company with the development of new products or services or implementing new technology. A good corporate governance system is always planning for the long-term resilience of the business in a wide range of areas like this.
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 any more pressing for organizations. Having a management board and corporate culture focused on future-proofing the company can be invaluable.
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#15: It Minimizes Corruption and Fraud
For public companies, corporate governance is a way to minimize the risk of fraud and corruption across the board. These are two of the most common reasons that companies fail. Companies often falter without a system in place to spot problems early on and ensure transparency.
Companies utilizing 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. That is good news for all stakeholders and shareholders of the organization.
What Are the Benefits of Good Corporate Governance, Then?
Building a strong corporate governance model is not a simple process. Any company leader that has been a part of this process knows it is a long and challenging process that makes each member of the company’s board of directors 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 to ensure repeatability and consistency within the business model and daily operations. The significance of corporate governance here is that it ensures proper establishment and maintenance of the company’s brand. It can also help ensure that businesses can better their products or services because of their keen eye on details.
Errors become clear and easy to spot
The needs of corporate governance may not be more clearly defined than when a crisis or difficult periods exist. This allows for the visibility of errors to become clear. When there is a task that 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 in business also helps to reduce costs in various ways. This could include reducing repetition and incorporating more efficiency into operations. It could mean reducing the 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 that 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, there’s less risk of such difficult situations playing out, and operations are simply smoother.
Expectations are understood. Processes and policies are laid out clearly.
Everyone knows where to go and what to do, as well as what their responsibilities are. That goes from the board of directors down to the latest hire. Companies run smoother as a result.
Compliance costs are minimized, and risks are mitigated
Regulator compliance in any sector is often viewed as something to reduce fines and minimize scrutiny of the operation. Yet, the other side of that coin is that when there are smooth processes in place, and a strong corporate governance system is clear, those compliance rules help others.
Having a culture that is designed to support corporate governance enables this. It ensures that products are able to reach the market and intended customer within desired timelines while meeting all expectations in protecting employees, customers, and data.
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 to develop, 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 as a whole. The board of directors cannot find stability and is tasked with putting out fires often.
- Poor corporate social responsibility could lead to claims made against the business, increasing liability risks and positioning the company directly opposite of what cultural norms and expectations are, making it harder to sell a product or hire employees.
- Corruption is more likely to include company insiders, often clearly evident when the leadership, including the board of directors, is about improving themselves individually rather than keeping the focus on the success of the company in the long term.
- The board of directors itself is weak. This often comes from a lack of ability to make decisions or to govern in a positive manner.
- Inefficient internal audits occur, which can often lead to costly mistakes and increasing financial risk over time. This often ends up 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 in place, shareholders no longer trust the board of directors or the company as a whole. For public companies, that can be disastrous in the long term.
Eroding confidence from shareholders often meals 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, there is often the need for the leadership to take on risky and sometimes bold steps to try to improve profits or minimize ongoing losses. This often leads to taking on significant risks, and that often means 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?
The first and most important step to achieving good corporate governance is to implement straightforward, clearly defined rules and controls. Once a solid and well-rounded plan is in place, it is then possible to see improvement.
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 also help companies to better achieve their goals. This process is not one without 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 better understand the board’s performance as well as all members of the management team.
Good corporate governance also happens when better risk management strategies are put into place. 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 when it comes to risk tolerance.
The board of directors is responsible for putting good corporate governance in place, but it is also necessary to have a way to police them within that realm. That often means completing effective corporate governance audits while also working to ensure the board of directors is a solid representation of the company.
The importance of corporate governance is hard to overestimate because it impacts every facet of the way a company operates. Yet, at any time, changes can be made to improve its reach and achieve better outcomes.