What is corporate governance? V3

 What is the purpose of this article?

The purpose of this document is to enable founders, CEOs, management, investors, shareholders, boards of directors, 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 coporate governance V3

 What are the critical learnings in this article?

• Corporate governance is focused on the board of directors.
• There can be many difference views regarding the definition of corporate governance, the purpose of corporate governance, ad the purpose of the corporation.

What is corporate governance?

Corporate governance is focused on the board of directors. Governance exists throughout the company, at all levels, and should be aligned with corporate governance.

A definition of 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

Based on the above definition, there are four aspects to corporate governance:

• The focus is on relationships among different types of people.
• Setting objectives. People set objectives.  The board directors, company management, shareholders, stakeholders and third parties all have different interests and personal objectives.  The conflicts of interest need to be understood and managed to agree upon objectives for the board and for management.
• Determining how to meet objectives. People have to develop plans which reflect what they will do to achieve the objectives.  Both the board and management have objectives and plans.
• Monitoring performance. The performance of people (the board and management) is monitored. Everyone needs to understand the personal consequences of not achieving objectives.

Also implied in the above definition:

• Who can make decisions and how are those decisions made?
• What are the consequences for decision makers who make poor decisions?
• Who has the authority to act on behalf of the corporation and in what specific situations?
• Who is accountable for behaviour and outcomes?
• How are those people who are accountable for execution involved in decision making?

 What is the board’s decision-making model?

There are several types of decision-making models, including:

• The jury – 12 non-experts make a decision.
• The parliamentary or congressional model – non-experts make decisions, which may be based in whole or in part on advice.
• The judge model – a expert in making decisions based upon rules & principles.
• The meritocracy model – an expert making decisions based on personal experience and skills.

Or some combination of the above.

What are some of the challenges in company decision-making?

• Group decision making does not require 100% of the decision makers to be in agreement.
• The decision making process and enabling technology may hinder decision making.
• Not everyone’s input can be reflected in a decision.
• Those not supporting the decision make hinder the successful execution of the decision.

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, ethics, company purpose and culture 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.

Sometime there is confusion between a fiduciary(i.e. decision-making board vs an advisory board. 

• The decision-making board has the authority to make decisions and is accountable for the results of those decisions.
• The advisory board has no authority to make decision and is not accountable for the actions of the board of directors, C-Suite and others in the company.

 What is the purpose of the corporation?

What is the purpose of your corporation?  Is it solely to make money for shareholders and the C-Suite?

Why have societies and governments put in place the legal and regulatory framework for corporations?  Is it to enable the creation of financial wealth for shareholders and the C-Suite?  Is it so a “business can thrive and sustain growth while enhancing the wealth of its stakeholders and the well-being of societies in which it operates?”²

The U.S. perspective on the relationship between the corporation and society has changed radically since 1981

 In 1981: “Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy.” “Business and society have a symbiotic relationship: The long-term viability of the corporation depends upon its responsibility to the society of which it is a part.  The well-being of society also depends upon profitable and responsible business enterprises.”³

In 2016: “Core guiding principles: The board approves corporate strategies that are intended to build sustainable long-term value.”⁵ There is no mention of responsibility to society.

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”⁴

 The purpose remains fixed while operating practices, cultural norms, strategies, tactics, processes, structures, and methods continually change in response to changing realities. ⁵

 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

#1 Survey the board of directors, C-Suite, advisory board(s), and key other members of your company’s ecosystem to determine what they perceive to be:

• The purpose of your corporation.

#2 Survey the board of directors, C-Suite, and advisory board(s) to determine what they perceive to be:

• Your company’s corporate governance.
• The purpose of your company’s corporate governance.
• Your board of directors decision making model.

#3 Analyze the surveys to identify the implication on value creation.

#4 Agree upon: the purpose of your corporation, your definition of corporate governance, the purpose of corporate governance, and the board’s decision making model.

#5 Review and revise corporate governance documents, processes, and technology to align with #4

#6 Review other governance within your company, to align with #4 and #5 above,

 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 Dr. Didier Cossin, Boon Hwee Ong, Sophie Coughla, “Stewardship fostering responsible long-term wealth creation”, IMD, Global Board Center 2015, https://www.imd.org/globalassets/board-center/docs/stewardship_2015.pdf

3 Ralph Gomory and Richard Sylla, “The American Corporation”, April 2013, page 6, The Wall Street Journal http://online.wsj.com/public/resources/documents/50b74ca9c91e6TheAmericanCorporation11292012.doc.pdf

⁴  https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter

⁵ 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/

How can the board of directors create value?

https://koorandassociates.org/corporate-governance/how-can-the-board-of-directors-create-value/

Is your company planning to fail?

https://koorandassociates.org/avoiding-business-failure/is-your-company-planning-to-fail/