Corporate governance refers to policies and processes that run corporations. A company’s corporate governance is of particular concern to investors. It often reflects a company’s direction and health. Learn the basics of this important business principle, why it matters, and how to achieve best practices.
Corporate Governance: The Basics
Putting it simply, corporate governance is the system of processes, rules, and regulations that runs a company. It affects a company’s board of directors, executives, shareholders, and even customers. Examples of strong corporate governance include risk management, transparency, accountability, clear corporate strategies and processes, ethical business practices, and fairness.
A company’s board of directors plays a key role in implementing and enacting corporate governance policies. The board ensures that a company’s processes, decision-making, and other factors align with the interest of the stakeholders.
For example, key tenets of a company’s mission may address transparency or environmentally-conscious manufacturing processes. Through the principles of corporate governance, the board of directors can help ensure that these beliefs are being upheld. Meanwhile, it keeps in mind the interests of the stakeholders and company. The board can also utilize corporate governance when resolving issues or conflicts of interest between competing parties within the company.
Why It Matters
Corporate governance is important to a company and its overall health for a few key reasons. First, just about any company has conflicts of interest. Corporate governance helps avoid conflicts of interest between competing parties, such as a stakeholder and a chief executive, for example. It also helps set out processes for dealing with these conflicts when they inevitably pop up.
Corporate governance also helps ensure that a company carries out its primary objectives. Those objectives may be economic, environmental, or ethical. They likely vary between different stakeholders within the company. For shareholders, they may include earnings and returns. For employees and customers, they may involve ethical business practices and labor practices.
Strong corporate governance can help bolster a company’s reputation, customer loyalty, and, eventually, its bottom line. It can also help avoid a scandal or PR disaster. By setting out processes and rules for how things should be done, a company essentially monitors itself. This increases corporate accountability and can negate questionable business practices or “bad apples” within a company.
Governance and Investment
Corporate governance is of particular concern to investors. That’s because it can reveal a lot about a company. For example, it can show the strength of its board of directors or whether it has a clear business strategy. It can also tell investors how well a company is governed, As a result, it can affect its bottom line and an investor’s returns.
Bad corporate governance can take many forms. For instance, a company may not audit to management or executives who don’t adhere to corporate governance guidelines. Meanwhile, companies may lack corporate governance structures altogether..
A prime example of bad corporate governance is 2001’s Enron scandal, which essentially resulted from bad corporate governance. More specifically, Enron failed to audit. As a result, shareholders brought a $40 billion lawsuit against the company. Enron declared bankruptcy that same year.
Achieving Best Practices
While establishing a solid foundation for corporate governance may not be at the top of a company’s to-do list, it should be. After all, bad corporate governance and the potential fallout can affect customers’ faith in and loyalty to your company. Meanwhile, it can also have a disastrous effect on a company’s bottom line.
Businesses may achieve best practices for corporate governance by putting into place a solid board of directors that will act in the company’s best interests. The board will not only play a major role in putting corporate governance policies into place but also enforce those policies.
There are other means of attaining best corporate governance practices. First, set clear guidelines and role expectations. Secondly, emphasize both ethical behavior and business practices. Finally, creating an atmosphere of transparency and fairness within the company.
Meanwhile, ensuring that the company’s business goals coincide with its ethics is another key factor. For example, if a company’s lofty production goal won’t allow ethical working conditions, these two will eventually be at odds. Consequently, that creates conflict throughout the production process. It also, potentially, builds conflict between competing stakeholders.
The Bottom Line
Corporate governance is the system of processes, rules, and regulations that run a business. The board of directors plays a major role in a company’s corporate governance since they play a key role in implementing and enacting corporate governance policies.
Key tenets of corporate governance commonly include accountability, transparency, listening to shareholders and acting in their best interest, ethical business practices, and fairness. Good corporate governance can help a company avoid a scandal or PR disaster since it’s essentially a way for a company to police itself. Bad corporate governance can include things like failure to audit to management or executives who don’t adhere to corporate governance guidelines.
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- What is your threshold for risk if a company has poor corporate governance? How will it affect your investment’s growth? SmartAsset’s investing guide can help you answer some of these initial questions.
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