Corporate Governance: Principles, Roles And Mechanisms

By Indeed Editorial Team

Published 12 October 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Corporate governance is a mechanism for governing a company based on certain systems and principles. It directs and controls the company to achieve its goals and objectives, which add value and include long-term benefits to stakeholders, such as shareholders, employees, suppliers, customers and society. Learning about effective governance can help you incorporate important principles into a company's governance strategies. In this article, we define corporate governance, describe its importance, outline the major principles and roles and explore the mechanisms and controls for effective governance.

What Is Corporate Governance?

Corporate governance is the framework of regulations and procedures that determines how the board of directors manages a company. It includes balancing the interests of the stakeholders in a company, including shareholders, senior executives, customers, suppliers, financial intermediaries, government and community. It helps establish who has power and accountability and who makes decisions. The goal of governance is to facilitate effective, entrepreneurial and prudent management that helps the company achieve long-term success.

Importance Of Governance

Governance helps businesses operate under a system of transparency and responsibility. It can help businesses comply with various financial and legal regulations. It can also help a company maintain a positive reputation. Effective governance also benefits its shareholders and community because it can help a business form trust and show integrity. Governance helps a company show the shareholders the strength of its operations through standard reporting. By using governance to establish a transparent relationship with its stakeholders, a company can put itself in a positive position for financial growth.

Related: What Is A Shareholder? (With Rights And Responsibilities)

Principles Of Corporate Governance

The following are some of the critical principles for effective governance:

  • Transparency: Transparency is an important component of governance, as it helps to promote trust among a business's shareholders. A board of directors can include transparency in its governance policies by conducting audits, releasing earnings reports and providing details about its activities at regular and predefined intervals.

  • Security: Information security is growing as an increasingly important principle of company governance in today's digital environment. The board of directors of a business can ensure shareholders that their confidential information is safe while also reporting regularly on security.

  • Rules of law: This principle focuses on preparing rules, showing them and documenting when someone violates the rules. The rules of law for a business can help promote accountability and transparency in its governance.

  • Responsibility: A company's governance can both explain and define the level of accountability for its board of directors. For example, if a board of directors has the power to appoint the chief executives, its governance can define this power and explain the conditions of the authority in its bylaws.

  • Risk management: When risk management is part of a business's governance, it increases the trust of its external shareholders and stakeholders. Regular risk review and reporting can help a board of directors make better decisions about how to run a business.

  • Fairness: A business's governance may require including elements of fairness throughout its policies. This means that a company requires treating all its shareholders the same.

  • Integrity: Including integrity in every element of governance may allow a company to gain a favourable reputation and remain competitive in its market. Integrity also benefits shareholders by demonstrating a company's values and strengths.

  • Accountability: Accountability makes sure that the administration of a business is accountable to the board members of the business who are answerable to the shareholders.

  • Control environment: Internal control procedures, such as disaster management systems, risk management frameworks, independent internal audit committees and media management techniques, are the focus of the control environment.

  • Shareholder recognition: Letting shareholders select a board of directors can assist companies in recognising the importance of shareholders in company governance. This can demonstrate to shareholders that a company values them and also gives them direct control over business operations.

  • Reputation: A company's reputation is very important. The share price of a company is often strongly correlated with its reputation.

  • Independence: It is important for management to make independent decisions, so it is beneficial to avoid any conflicts of interest.

  • Sustainability: Sustainability refers to progress that meets the necessities of the current stakeholders without risking the ability of future generations to meet their requirements.

Related: What Is A Compliance Audit? (With Definition And Benefits)

Roles In Governing An Organisation

The following are some of the key roles in governing an organisation effectively:

Board of directors

The board of directors are a group of elected professionals that represent shareholders who plan and manage the direction and activities of a company. The board's role is to manage and enforce a company's rules while making decisions for it. They can both set and follow the governance rules. This group has the authority to appoint the chief executive officer (CEO) and general manager of a company. There are a few types of members on a board of directors:

Member types

The following are the two types of members of the board of directors:

  • Executive director: These members are employees of the company. An executive director has two separate jobs as a director and as an employee.

  • Non-executive director: Non-executive directors do not work for the company. They can assist a company in reducing conflicts of interest.

Related: What Is A Non-Executive Director? (What They Do And FAQs)

Key positions

The following are a few of the key positions on the board of directors:

  • CEO: The CEO manages a firm's operations. They can observe and implement a company's internal governance rules.

  • Chairperson: The chairperson is usually a non-executive director who is accountable for leading the board of directors. A chairperson can organise a board's accountability in governance.

  • Secretary: The secretary creates meeting plans and organises a board's administrative support. The secretary also records minutes for board meetings.

Related: What Is A CEO? Definition And Career Advice

Audit committee

People from the board of directors can assemble an audit committee. This committee regularly handles the reporting of a company's financial state. The audit committee may ensure a company's transparency, accountability and risk management. They help in protecting shareholders and the company by regularly reviewing its compliance with financial regulations and laws.

Related: What Does An Auditor Do? Duties And Responsibilities

Shareholders

A shareholder is someone who owns a minimum of one share of a company's stock. Shareholders of a company may also vote on company activities and share accountability for the company's key decisions with the board of directors. They can also appoint members of the board to represent their concerns. By evaluating risks and promoting integrity, shareholders can help to promote governance.

Related: What Is A Shareholder? (With Rights And Responsibilities)

Mechanisms And Controls For Effective Governance

The mechanisms and controls of company governance intend to reduce the inefficiencies caused by adverse selection and moral hazards. The following are the three major types of mechanisms and controls:

Internal governance controls

Internal company governance controls review activities. It then takes action to accomplish organisational goals. The following are a few examples:

  • Internal control procedures and internal auditors: These procedures are policies by an audit committee, board of directors, executives, management and other personnel to deliver suitable assurance that the entity may meet its goals for reliable fiscal reporting, operational efficiency and compliance with regulations and laws. Internal auditors are employees who test the design and execution of an organisation's internal control procedures and the accuracy of its fiscal reporting.

  • Observation by the board of directors: The board of directors protects invested capital through its authority to appoint and compensate the higher authority. Regular committee meetings allow for the identification, discussion and avoidance of potential issues, and it suits different board structures for different businesses.

  • Balance of power: The most basic balance of power requires the president and treasurer to be different individuals, and the split of power also develops in businesses where separate units check and balance each other's activities. For example, one group may suggest company-wide organisational modifications, another group analyses and rejects the modifications and a third group ensures the meeting of interests for the people outside of these groups.

  • Remuneration: Performance-based remuneration may link a portion of one's salary to one's performance. This can be as cash or non-cash payments, such as shares and stock choices or other benefits.

Related: What Is Salary Breakup? Why It Is Important To Know

External governance controls

External company governance regulates the external shareholder's exercise over the organisation. The following are a few examples:

  • Demand for and review of performance data

  • Mergers and acquisitions

  • Government regulations

  • Obligation covenants

  • Media pressure

  • Competition

  • Proxy firms

  • Takeovers

Related: Governance, Risk And Compliance Tools (With Benefits)

Fiscal reporting and the independent auditor

The board of directors oversees the company's external and internal financial reporting functions. The CEO and chief financial officers are important roles, and boards typically have a high level of trust in them for the accuracy and timely delivery of accounting information. They oversee the internal accounting systems and rely on the corporation's accountants and internal auditors.

Fiscal reporting fraud, which includes nondisclosure and intentional falsification of values, also increases the risk of users' information. To mitigate the risk and improve the perceived integrity of fiscal reports, corporations require having their fiscal statements audited by a personal external auditor who issues a report along with the fiscal statements.

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