The Importance Of Corporate Governance
With this simple definition, we assume that directors and managers are motivated to serve the interests of the corporation by incentive pay, by their own shareholdings and reputational concerns, and by the threat of takeover.
The operation of the board and the remuneration of the Executive Directors are vital in maintaining and protecting the interests of the different stakeholder groups. If we accept that the shareholders collectively own the business and they have invested in it to maximise their wealth, then their main aim is to grow the overall value of their share capital and maximise returns in the form of dividends.
However, there are potential conflicts of interest between this ambition and the managers/employees of the group who are looking to maximise their own wealth. Managers are appointed as agents on behalf of the shareholders of the company who have delegated this responsibility to them.
In the UK and the US, corporate governance mechanisms emphasise the relationship between shareholder and management. In countries such as France, Germany and the Netherland, the corporate governance mechanisms take a stakeholders’ approach to governance, aiming to balance the interests of owners, managers, major creditors and employees.
The main mechanisms for understanding corporate governance are the following:
1. The market for corporate control (i.e. a hostile takeover market and the market for partial control).
2. Large shareholder and creditor monitoring.
3. Internal control mechanisms, i.e. the board of directors, non-executive committees and the design of executive compensation contracts.
4. External mechanisms, i.e. product-market competition, external auditors and the regulatory framework of the corporate-law regime and stock exchan
How governance affects firm performance? Do firms perform better when shareholders’ interests are likely to be dominant? Answering these questions, will lead us to evaluate the folowing points:
*Corporate control
Changes in control due to takeover or insolvency bring dramatic changes in firm personnel and strategy. CEO and board member turnover increases radically in the event the firm goes into financial distress. Managers will avoid being taking over by either increasing the firm’s cash flows or by some less productive avenue.
*Board, Remuneration Committee, Pay and incentives
A research has found that the appointment of non-executives directors is associated to a company stock price increases. An Executive that wants to take the company in a direction that might be more in its personal interests could be sacked. Another research has found a positive relationship between the percentage of shares owned by managers and board members and firms’ market-to-book values.
The remuneration committee is made up of non-execs, so this creates a natural control to stop the executive directors awarding themselves unjustifiable salaries and benefits. The remuneration of the Directors should be in line with other similar companies, to remain competitive and retain its top executives.
The remuneration packages are intended to align the interests of Director and Shareholders by linking cash and share incentives to performance.
However, some argue that the increase in share price was also associated with a decline in the value of the firm’s outstanding debt. And corporate performance cannot be reliably increased simply by adding outsiders to the board of directors or by increasing the CEO’s stockholdings.
*Recent Corporate Scandals Corporate governance failures can lead to disastrous consequences beyond anyone expectations. Parmalat- a world leader in the dairy food business, entered bankruptcy protection in 2003 when investors least expected it. How the Italian group so much praised siphoned away billions of euros without its shareholders, nor its top managers suspecting it?
One of the problem at Parmalat was due to its ownership and control structures-There was a limited presence of shareholders and mainly linked by family ties. Parmala was a holding company with all the other companies within the group controlled by the Tanzani family. The family had the majority if not ‘all’ of the voting rights. As this happens, other shareholders had limited control over the activities of the group-hence limited power to block any decisions. Managers had also limited power to influence decisions taken by the family shareholders.
In that case, the family managed to siphoned away almost millions of euros to other companies owned by the family.
In summary, the demise of Parmalat was a failure to fully implement the corporate governance mechanisms listed above.
*Statutory auditors
Some thought that the Parmalat case was country-specific, however, Enron the giant American Energy failed victim to corporate governance problems with the help of Arthur Andersen -the US accounting firm.
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Tags: Corporate, Governance, Importance
