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Corporate Governance

A system of direction and control within an organization

What is Corporate Governance?

Corporate governance is a system that guides the conduct of the people within an organization, as well as the direction of the organization itself.

Corporate governance is altogether different from the daily operational decisions and activities that are executed by the management of an organization. Corporate governance is the domain of the Board of Directors, as opposed to its management team (such as the CEO and other C-suite executives).

Key Highlights

  • Corporate governance is a system (or a function); it’s not a job title or a specific role.
  • Some of the many domains for which the corporate governance function is responsible include risk management, strategic planning, talent management, and succession planning.
  • Evolving market dynamics and economic realities are putting pressure on the corporate governance functions at organizations around how stakeholder needs are identified and managed.
  • A healthy corporate governance function requires a clear and formal separation of duties between management and the Board.

Corporate Governance Deployment

The corporate governance function must steer the direction of an organization across a variety of important dimensions. These dimensions include, but are not limited to:

  • Enterprise Risk Management – This includes identifying and mitigating strategic, operational, reputational, and even financial risks within an organization.
  • Strategic Planning – This is all about identifying and capturing opportunities today in order to position for (and to create) enduring competitive advantages and future value.
  • Accounting & Disclosure – The corporate governance function must support financial recordkeeping, as well as approve public stakeholder reporting (including financial statements, 10Ks, and sustainability and/or ESG disclosures).
  • Talent Management – This requires that leaders understand how to attract, retain, and improve human resources within the organization. This area is often referred to as Human Capital Management (or HCM).
  • Succession Planning – This is effectively talent management but with the intention of “future-proofing,” particularly at the leadership levels. This helps to ensure that a strong leadership “pipeline” exists within the organization.

More broadly, an organization’s ability to demonstrate compliance with all legal and regulatory requirements, as well as its ability to operate ethically (meaning behavior that is governed by moral principles), all fall within the scope of the corporate governance function.

Understanding Organizational Hierarchy

A relatively standard organizational structure typically looks like this:

Corporate Governance

The C-suite is operational decision makers within the organization, with the CEO being the senior-most person. The CEO reports to the Board of Directors (BOD).

The BOD (led by the Chair of the Board) is responsible for the direction and execution of the corporate governance function.

All appointments to the Board must be voted upon by the shareholders of the company. In many respects, this makes the BOD beholden to shareholders. Historically, most BODs have operated under this line of thinking. 

The concept is referred to as shareholder primacy; it’s an implicit understanding that all decisions within an organization must be made with the best interest(s) of shareholders in mind. 

More recently, however, the growing popularity of Environmental, Social & Governance (ESG) as an analysis framework has put pressure on organizations (and their corporate governance functions) to consider the concept of stakeholder primacy more rigorously.

Shareholder Primacy vs. Stakeholder Primacy

Shareholder primacy is a management and governance philosophy under which the leadership’s core responsibility is to make decisions that are aligned with the needs and wants of investors.

While many shareholders indeed want optimal returns on their investments, shareholder primacy tends to force leadership teams into short-term thinking. An example is doing whatever is necessary to meet quarterly targets set by the analyst community, under constant fear that the firm’s stock price could be punished for falling short.

Opponents of purified shareholder primacy are also quick to point out that short-term thinking and profit-maximizing forms of governance lead to generally “bad” corporate behavior, which can create negative externalities like environmental degradation and social inequality.

The concept of stakeholder primacy (sometimes called stakeholder capitalism) is thought to have evolved from the term shared stakeholder value, coined by Michael Porter and Mark Kramer in 2011[1]

Stakeholder primacy purports that the needs and outcomes of all stakeholders – including employees, customers, supply chain partners, and members of the communities in which an organization operates (not just shareholders) – should be considered in all strategic and operational decisions.

Beyond the expansion in scope from shareholder to stakeholder primacy, there are some interesting, current trends that are putting significant pressures on the corporate governance functions within organizations of all sizes.

Some examples are:

The “Great Resignation”

The so-called “Great Resignation” has created an environment where the very nature of work (as we once knew it) has changed. Firms must consider remote and hybrid working arrangements when planning to hire. 

While this presents challenges, it has also opened the door to a much broader talent pool since companies are no longer required to hire people that live within commuting distance of the nearest office.

Climate change

Leadership at many organizations is realizing that climate change presents more than just environmental risks – it can present existential risks to business operations (due to physical climate impacts, regulatory-driven “transition risks,” and potential reputational damage).

With so many organizations making pledges to meet “Net Zero” or even carbon neutral emissions targets, having BOD representation with some ESG experience has become paramount in order to navigate the ESG disclosure landscape and to avoid the perception of greenwashing

Geopolitical and Economic Uncertainty

Russia’s invasion of Ukraine in 2022, coupled with strained relations between two of the world’s economic superpowers (the US and China), are a few of many factors that have converged to create chaos in supply chains, as well as subsequent economic uncertainty on a global scale.

A strong leadership team and effective corporate governance function must identify and seize upon opportunities while simultaneously identifying and mitigating risks accordingly.

Technology & Data

In an increasingly digital world (and economy), technological advancements have changed the landscape of virtually every business. Employees, customers, and other stakeholders are increasingly concerned about privacy; therefore, it’s incumbent upon organizations to take these issues seriously.

Secure warehousing of sensitive information, deployment of communication tools, and general data protection and integrity are all major topics of discussion in boardrooms around the world. 

Board vs. Management Responsibilities

Broadly speaking, the BOD is responsible for dictating policies within the organization and determining plans and objectives (while also overseeing their implementation). 

Management is responsible for executing against these objectives by steering the day-to-day operations of the company.

The BOD is also responsible for designing the management team’s compensation structure and overseeing their performance. 

Corporate Governance – The Bottom Line

A healthy corporate governance function requires a clear and formal separation of duties between management and the BOD. It also requires a healthy working relationship between the Board and the CEO.

Similarly, having at least some independent Directors (meaning arms’ length from the company) generally lends itself well to conflict resolution and objectivity when it comes to other strategic and executive considerations that are material to a business.

A Director is generally considered to be independent if they have no direct relationship with the business or with any of its subsidiaries. This includes cash compensation or material shareholdings. 

This article was written in collaboration with Rho Impact.

More Resources

Thank you for reading CFI’s guide to Corporate Governance. Through financial modeling courses, training, and exercises, anyone in the world can become a great analyst. To keep advancing your career, the additional CFI resources below will be useful:

Article Sources

  1. Creating Shared Value
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