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Corporate Governance can essentially be described as a system by which business corporations are directed and controlled. Being a subject of multiple characteristics, business studies have generally defined it from different theoretical perspectives1. Some authors present a regulatory view of corporate governance focussing on the set of laws that control operations within a company while others tend to focus on the accountability by defining it as the means by which individuals providing the finance to a company can be assured of a return to their investment1,2. Still other authors believe there is more to corporate governance than merely the relationship between the company and the finance suppliers and extent its effect to the stakeholders of the company-thereby encompassing everyone from owners/shareholders, managerial and non-managerial staff, customers, government and the community as a whole3.. Perhaps a fitting definition is provided by noted business author Gabrielle O'Donovan, who defines corporate governance as "an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity, accountability and integrity"4. This definition thus presents an integrated approach to corporate governance by taking all perspectives into account.
Corporate Governance has been a subject under immense scrutiny in the 21st century following the high profile corporate scandals in the late 1990s and early 2000s, such as that of Enron Corporation and WorldCom. Not only did these scandals cause a loss of billions in market capitalisations (due to the collapse of share prices of the affected companies), it also had an adverse effect on the confidence of investors in the capital markets3. The US government in 2002 responded to these scandals by initiating reforms by means of a legislation called the Sarbanes-Oxley (SOX) Act5. The Act consisted of eleven titles and set enhanced standards describing specific mandates and requisites for financial reporting for all public companies within the US6. Other countries such as Germany, France, Canada, Australia and South Africa too launched their own equivalents of SOX to allow for greater investor protection and high market capitalisations resulting from high shareholder value3. Corporate Governance has thus in contemporary times evolved from being merely a compliance requirement to an indispensable component of a company's strategy.
The salient features of contemporary corporate governance are said to be based on three interrelated parts of corporate governance- principles, functions and mechanisms3. The correct functioning of these components can lead to an effective structure of corporate governance within a company in the post SOX era.
Corporate Governance Principles: Although there is no single set of corporate governance principles accepted worldwide, many economists and academics have in recent times proposed codes under the subject of corporate governance which cover a broad range of topics. The Organisation for Economic Cooperation and Development (OECD), for example, released what it calls the "Principles of Corporate Governance" in 20047. This set consists of a series of six principles and their associated sub-principles which can be applied to all business practices and any legal, political and economic environments. The set of principles is described as follows:
Promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities7. This would lay the foundation based on which an effective framework for Corporate Governance can be achieved.
Protect and facilitate the exercise of shareholders' rights7.
Ensure the equitable treatment of all shareholders, including minority and foreign shareholders, thereby ensuring that all shareholders have the opportunity to obtain effective redress for violation of their rights7.
Recognise the rights of stakeholders established by law or through mutual agreements and encourage active cooperation between corporations and stakeholders in creating wealth, jobs and sustainability of financially sound enterprises7.
Ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership and governance of the company7.
Ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board's accountability to the company and the shareholders7.
The subject of transparency in corporate governance has been the focus of many other studies. The European Community (EC), for example, in 2004 suggested that a company's board of directors be held directly responsible for all its financial reports8. Also suggested was that information on the company's risk management system, internal controls, off-balance sheet arrangements etc. be made part of all annual financial reports8. Similarly, a report by the CFA Institute and the Business Roundtable Institute for Corporate Ethics suggest that companies must provide frequent and meaningful communication on their vision and long-term goals as well as performance metrics and financial statements in simplified language rather than the more complex legal and accounting language9.
Corporate Governance Functions: An important element of the corporate governance structure are its functions. There are seven interrelated corporate governance functions defined which when integrated with a company's company strategy produce responsible corporate governance, more transparent financial statements and credible auditing within the company3. The functions are described as follows:
Oversight Function: This function relates to the company's Board of Directors who must ensure that management acts in the best interests of the company and its shareholders by overseeing the management's plan, decisions and actions3. The primary responsibilities of the Board have been defined as to hire a capable and ethical CEO, ensure other top management positions and to monitor management's strategic, financial and operational goals3. A number of studies have tried to illustrate on how a Board can successfully implement this function. The National Association of Corporate Directors (NACD), in 2004 published a report that list a set of eleven roles of the Board within a company.10. Furthermore, fiduciary duties such as Duty of Loyalty and Duty of Care are now specified in the laws of the state of incorporation and are also contained in the company's charter which means that the company can face litigation should it violate any of them3.
Managerial Function: This function of corporate governance states that the responsibility to effectively manage a company's resources and operations rests with the management3. The success of this function thus depends on how the management aligns its interests with those of the company's shareholders. The management must ensure that it runs the company with the goal of creating sustainable shareholder value and hence must guard against possible roadblocks such as potential conflicts of interest among senior executives and motivational problems which could lead to the failure of this function3.
Compliance Function: The compliance function of corporate governance establishes the benchmark of minimum standards that must be followed by public companies. It is thus based on a set of laws, rules and regulations and standards defined by federal and state statutes, national stock exchanges, courts, regulators, professional organisations etc.
Internal Audit Function: The effect of the above mentioned principles and functions of corporate governance cannot be deemed favourable without professionals working within the company who can evaluate how the organisation is implementing them. This function thus refers to the presence of internal auditors who can offer evaluation and consultation services to the company3. Areas such as financial reporting, internal controls and risk management can thus be dealt with professionally leading to greater support for the company in its effort to comply with corporate governance principles. The skill, experience and independence of these auditors are therefore vital for the success of this function3.
Legal and Financial Advisory Function: This function refers to the role of legal counsel and financial advisers within the corporate governance framework of a company. Legal counsel offers legal advice to the company and all its personnel on complying with laws and regulations3. Financial advisers, on the other hand, offer advice on financial matters and financial planning activities3.. It is therefore evident that like the internal auditor function, the success of this function would depends on the independence, skill and experience of the counsel and advisers.
External Audit Function: While internal auditors offer assurance and consultation services to the company while it is in operation, independent external auditors must be hired by the company to evaluate whether the company's financial standing is fairly represented in its financial reports as well as to check for their compliance with general accounting norms3. A detailed and comprehensive external audit would enhance the reputation and credibility of the company's annual reports, thereby having a positive effect on its corporate governance.
Monitoring Function: This function is performed by the shareholders and other stakeholders of the company, who through their recommendations and nominations can influence the policies and practices and eventually the corporate governance of the company3. The active involvement of shareholders is crucial to the success of this function.
These functions when exercised cohesively lead to effective corporate governance within a company and lead to greater public trust and investor confidence.