COMPANY LAW – I
IS GOOD CORPORATE GOVERNANCE IMPORTANT?
This research paper deals with the meaning of the term corporate governance and the importance of good corporate governance where it says the if good corporate governance adds value to the company, further, it says that real economic benefits in following good corporate governance practices, by doing so, managers can potentially add significant shareholder value and investors are prepared to pay a premium for investments in companies where good governance practices are followed.
- What is corporate governance?
- Is good corporate governance important and does it add value?
WHAT IS CORPORATE GOVERNANCE ?
MEANING OF CORPORATE GOVERNANCE
There is no set definition of concept of corporate governance. Several recent reports dealing with corporate governance have attempted to clarify the concept. For example, corporate governance refers generally to the legal and organizational framework within which, and the principles and processes by which, corporations are governed. It refers in particular to powers, accountability and relationships of those who participate in direction and control of a company. Chief among these participants are the board of directors, an management. There are aspects of the corporate governance regime that have an impact on the relationship between shareholders and the company.
Justice Owen considered the meaning of the term ‘corporate governance’ in two different places in the report of the royal commission set up to investigate the collapse of HIH insurance Ltd, one of Australia’s largest corporate collapses. 1
DEFINITION OF ‘CORPORATE GOVERNANCE’
Corporate governance has also been defined as “a system of law and sound approaches by which corporations are directed and controlled focusing on the internal and external corporate structures with the intention of monitoring the actions of management and directors and thereby mitigating agency risks which may stem from the misdeeds of corporate officers.2
IS ‘GOOD CORPORATE GOVERNANCE IMPORTANT AND DOES IT ADD VALUE?
When corporate governance is raised in conversation and commentaries, there is an often reference to the need for corporations to implement and maintain ‘good governance practices’. There is an ongoing debate, however, as to whether a focus on governance practices comes at the expense of focusing on what is really important to the company and shareholders
Does providing attention to ‘conformance’, in terms of adhering to corporate governances rules and principles, come at the expense of ‘performance’? Is implementing good corporate governance practices a necessary ingredient for corporate success, or merely a distraction from the real business of the company? Naturally, given that there is debate and uncertainty as to what ‘corporate governance’ means, there are varying perspectives on what constitutes good governance practices, and whether good governance is indeed important to the company.
In the report of the HIH royal commission, justice Owen opined that to achieve good governance practices in Australia’s companies , corporate governance must not succumb to a ‘ one size fit all’ approach which involves heavy regulation of companies and does not give companies much opportunity to implement practices which are best for the company. Rather, good governance naturally develops within companies by setting down voluntary guidelines which can be used by companies to develop a model which best suits their particular circumstances. Justice Owen stated that:
For me, the key to good governance lies in substance, not form. It is about the way the directors of a company create and develop a model to fit the circumstances of the company and then tests it periodically for its practical effectiveness.
One thing is clear though. Whatever the model, the public must know about it and how it is operating in practice. Disclosure should be a central feature of any corporate governance regime.3
Given that some of the companies involved in the recent international spate of corporate collapses (such as world.com in USA and Ansett, Pasminco, HIH and one.tel in Australia) actually had In place generally good governance practices, the question has also been raised as to whether good governance practices are important in terms of ensuring company success . In Australia the adherence to corporate governance principles was, in the late 1990s, considered to put unnecessary burden Australian businesses. Strict corporate governance rules have been blamed for the under- performance of Australian companies. 4
Nowadays the general consensus, at least in Australia , appears to be that while heavy regulation and ‘one size fits all’ approaches to corporate governance should be avoided, it is at the very least important that companies are good corporate governance citizens. In an article entitled’ the changing face of corporate governance’, which appeared in a special symposium edition of the university of new south Wales law journal 5 dedicated to corporate governance , former chairman of the national companies and securities commission, Henry Bosch, made the following useful remark about the importance of good corporate governance:
Good corporate governance is desirable and important for two reasons. First, in a well governed company, the risks of fraud and corporate collapse are reduced, and there are mechanisms which reduce the likelihood of company controllers enriching themselves at the expense of investors. Considerable evidence has emerged in the hearing of the HIH royal commission, and from the court cases involving one. Tel and Harris scare, that government practices in those companies were poor and accountability lax… good governance is desirable and important for a second reason : it can increase the creation of wealthy by improving the performance of honesty managed and financially sound companies. 6
Similarly, Justice Owen noted, in the report of the HIH royal commission, the economic benefits which come from good corporate governance:
There is continuing debate about the existence or otherwise of a correlation between good corporate governance and successful performance. Good governance processes are likely in my view to create an environment that is conductive to success. It does not follow that those who have good governance processes will perform well or be immune from failure. Risk exists to some extent at the heart of any business. Risks are taken in the search for rewards. No system of corporate governance can prevent mistakes or shield companies and their stakeholders from the consequences of error. 7
These sentiments are also echoed internationally. The south African king report(2202) relies on an investment opinion survey by McKinsey& co (June 2000) and a study by Stanford university (march 2001) to illustrate the profound implications of adhering to good governance practices. By developing good governance practices managers can add significant shareholder value; institutional investors are willing to pay a premium for shares in well governed companies; and good governance practices are now widely recognized as part of international architecture and make countries, especially in the emerging markets, a magnet for global capital.8 The contrary, bad corporate governance practices, combined with some other factors, have exactly the opposite effect, as was illustrated by the East Asia experience in the late 1990s. 9
The most recent evidence of the significance of good corporate governance practices comes from the OECD principles of corporate governance (April 2004). The OECD found that corporate governance was a key element in improving economic efficiency and growth, as well as in enhancing investor confidence.10it also observed that if countries are to reap the full benefits of the global market, and attract long term ‘patient’ capital, corporate governance arrangements must be credible, well understood across borders and adhere to internationally accepted principles. Even if corporations do not rely primarily on foreign sources of capital, adherence to good corporate governance practices will help improve the confidence of domestic investors, reduce the cost of capital. Underpin the good functioning of financial markets, and ultimately induce more stable sources of financing. The OECD pointed out that companies with a good corporate governance record are often able to borrow larger sums and on more favorable terms than those which have poor records or which operate in non transparent markets.11
It will be apparent that there are various definitions of corporate governance. At the end of the day corporate governance deals with ways to control management, balancing the interests of all internal stakeholders and other parties who can be affected by the corporation’s conduct in order to ensure responsible behavior by corporations and to achieve the maximum level of efficiency and profitability for a corporation. There is ample evidence that there are real economic benefits in following good corporate governance practices, by d\doing so, managers can potentially add significant shareholder value and investors are prepared to pay a premium for investments in companies where good governance practices are followed.
- Cambridge university press, jean Jacques du Plessis, James McConvill, Mirko Bagaric, Principles of contemporary corporate governance.
I would like to thank Mrs. Spandana Reddy, Christ School of Law for giving me an opportunity to do a research paper on good corporate governance. This research gave me a vivid idea about the importance of good corporate governance in companies and that they add value to it. It was a very interesting and I have learnt a lot regarding this topic.