What is corporate governance? V2

What is the purpose of this article?

The purpose of this document is to enable founders, CEOs, management, investors, shareholders, board of directors, and advisory boards to create a shared understand of their company’s corporate governance.

This article does not provide legal advice.

You can download a PDF of this article from: What is corporate governance V2

 What are the critical learnings in this article?

The value growth of your company will be hindered if decisions and actions are based on conflicting perspectives regarding: the definition of corporate governance, the purpose of corporate governance, and the company’s values, morals, and ethics.

What is corporate governance?

“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and members of the company’s ecosystem.  Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. “1

This definition has 4 components:

  • Relationships among the company’s ecosystem members.
  • Decision making i.e. setting objectives and approving action plans.
  • Action plans i.e. means of attaining those objectives.
  • Performance monitoring of the objectives, action plans, relationships.

The members of the corporation’s ecosystem make assumptions regarding the corporation’s purpose, values, morals, and ethics based upon observations of: the nature of their relationships, decisions made, and impact of the action plans.

What are the challenges of understanding corporate governance.

Discussion around governance is often very silo based and depends upon the specific background of the governance advisor e.g.

  • Lawyers often start with the Business Corporations Act. Sometimes the legal framework is a social purpose corporation, such as a B Corp., a partnership or a joint venture.
  • Regulators often start with financial risk management guidelines.
  • Accountants often start with quality of financial statements.
  • Consultants have a variety of different points of view.
  • IT (Information Technology) governance advisors have an IT-centric perspective.
  • Private corporations may have unanimous shareholder agreements, which limit the decision making and accountability of the board of directors by reserving certain decisions for the shareholders.
  • Any corporation could have a voting trust comprised of some or all of the shareholders.
  • Financing agreements may have terms and conditions which constrain the company’s decision making and may even provide the financers with decision making authority in certain situations.
  • Values, morals, and ethics may not be seen as a critical part of corporate governance.

Etc.

Often there this is a legal perspective of acting in the best interests of the corporation or the shareholders or other members of the company’s ecosystem.  What does this actually mean? Two example questions, for which I don’t have the answer:

  • If climate change is real, should the company reduce or eliminate it’s impact on global warming, even if that reduces company profits, shareholder dividends, and compensation for the board of directors and C-Suite?
  • Should the company lobby governments to reduce or eliminate environmental laws and standards in order to increase company profits?

After company management, its board, and its shareholders have heard from several different advisors, there is a confusing and disjoint picture of governance with limited shared understanding.

What is the purpose of the corporation?

Is the purpose of the corporation to maximize money for shareholders? Is the purpose to make as much profit as possible?

Larry Fink, in his 2018 letter to CEOs, said “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate…..Without a sense of purpose, no company, either public or private, can achieve its full potential…..And ultimately, that company will provide subpar returns to the investors.”2

 The purpose remains fixed while operating practices, cultural norms, strategies, tactics, processes, structures, and methods continually change in response to changing realities. 3

 What is the purpose of corporate governance?

The purpose of corporate governance is to enable the achievement of the purpose of the corporation, consistent with the corporations values, morals, and ethics.

Corporate governance manages the broad set of conflicts of interests which arise. The OECD governance definition starts with relationships: within corporate leadership, as well as stakeholders and third parties.  Any relationship has the potential for conflict of interest, because company ecosystem members may have different or conflicting interests.  For example, how should both profits and costs be allocated among the ecosystem members, including: CEO, C-Suite, shareholders, employees, and society. This conflict become acute in cases of poor profits or losses.

Perhaps the greatest conflict of interest is deciding the degree to which the corporation extracts value from society versus creating value for society. An example is the decision on whether to whether to replace local community employees with lower-cost offshore staff which may benefit the off-shore communities or retain the employees in order to sustain local communities.

What are your next steps

The following next steps should be time boxed in a short time frame by limiting scope and using assumptions when necessary.

  • Agree upon the potential value, if any, is of a common understanding of the company’s purpose and the purpose of corporate governance. If there is little or no value, don’t proceed.
  • Document the company’s current ecosystem members and relationships among them.
  • Document the company’s current process for major decision making.
  • Document the company’s current process for monitoring objectives, action plans, and ecosystem relationships.
  • Review the process for making major decisions and revise if necessary in order to make decisions regarding the purpose of corporate governance and the definition of corporate governance. For example, does the CEO make a single recommendation to the board of directors (or does the CEO provide alternatives) based upon analysis?
  • Ask your major shareholders, board of directors, and C-Suite how they would define corporate governance.
  • Ask your major shareholders, board of directors, C-Suite, employees, and other members of the corporation’s ecosystem how they perceive the corporation’s current purpose and its current values, morals, and ethics. Also ask them why they say that i.e. what is the perceived evidence.
  • Ask your major shareholders, board of directors, C-Suite, employees, and other members of the corporation’s ecosystem what changes, if any, should be made to the currently observed purpose and values, morals, and ethics. Also ask why these changes should be made and the impact of these changes.
  • Get the perspective of difference advisors as to the purpose of corporate governance and the definition of corporate governance.
  • Make the decisions regarding: the definition of corporate governance, the purpose of corporate governance, and the company’s values, morals, and ethics.
  • Identify the implications of the above decisions. The impact includes: talent management, value creation plans, board of directors and committee mandates, company policies, etc.

 Footnotes:

1 Based on “G20/OECD Principles of Corporate Governance”, 2015  I added the concept of third parties, https://www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf

2 https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter

 3 Page 17 The five most important questions you will ever ask about your organization (2008)   by Peter F. Drucker,  Jim Collins et al, I adapted.

Further reading

What is the purpose of your company?

https://koorandassociates.org/corporate-governance/what-is-the-purpose-of-your-company/

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s