While management is about directing activities, governance is about setting the conditions within which activities can be directed. Formally defined, corporate governance is about management and the board of directors enforcing policy that:
- Balances the interests of shareholders
- Forces responsibility, accountability, and transparency
- Challenges management to achieve high performance
Agency Theory
Agency theory is one way of looking at the problem of controlling the performance and ethics that a business’s influence carries. In agency theory, there are two actors. One actor is a principal, which is thought of as a stakeholder (someone who is affected by an entity). The other actor is an agent, or someone managing the entity. It is often the case that the principal and the agent do not have the same goals. For example, although the principal may have a monetary stake in the entity and the agent is an employee of the entity, the principal and agent may not share the same work ethic for company success or the same notion of what appropriate risk is.
Given these differences in how the principal and agent think about an entity, it may be difficult for a principal to monitor the actions of the agent. When active monitoring does not take place, it is easy for the gap between a principal’s and an agent’s desires to grow wider and conflict. Corporate governance can help close this gap.
Who is Involved?
Although everyone should act responsibly, the board of directors has the explicit responsibility for overseeing corporate governance. The board is usually broken up into several committees who each have one or two main objectives. The responsibilities of the board of directors and its committees include:
- Nominating other board members
- Auditing and determining who performs the audits
- Setting the tone for ethical behavior and high performance
- Approving budgets
- Ensuring availability of financial resources
- Setting salaries and compensation for executives
- Watches out for a “if it is legal, it is okay” attitude
- Questions executive decisions
- Allows the outside to see success
- Looks out for shareholder equity
- Balances stakeholder interests
Stakeholder Analysis
Being aware of all stakeholders that are affected by the company and balancing their needs can cover much of what corporate responsibility is meant to do. The following list outlines basic stakeholder analysis steps:
- Identify all stakeholders and their relationship to the company
- All stakeholder needs must be identified (time, quality, cost)
- An organization must understand how well stakeholder needs are being met
- Gaps in providing for needs must then be weighed and necessary changes made
Independence
The executives of a company are responsible for following guidelines and rules, but it is the board of directors that should have the last say in questionable matters. Given all the decision making and analytical power that the board possesses, an important caveat in structuring a board of directors is the degree to which they are independent. Independence in a board of directors will determine how easy it is for a company to become unethical or underperform.
The degree to which a board of directors is independent directly affects how equitable it is with shareholders as well as how it balances stakeholder needs. When a board is independent, it can act without bias. When a board is not independent, conflicts of interest arise. To help ensure the independence of board members, they must:
- Not have any conflicts of interest
- Not be afraid to speak out
- Be trained to ask the right questions
Making sure that an annual meeting calendar with topics exists, and making a distinction about what decisions the board should make can help the board operate effectively.
Companies must pay the price to help ensure that conflicts of interest do not exist, that boards are independent, decisions are transparent, and that auditing is done correctly. If they do not, more regulations will be put in place and fewer overall benefits will be garnered by stakeholders.
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