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CORPORATION AND CORPORATE GOVERNANCE

Corporation is a separate legal entity that has been incorporated through a legislative or
registration process established through legislation. Incorporated entities have legal rights and
liabilities that are distinct from their employees and shareholders, and may conduct business as
either a profit-seeking business or not for profit business. Early incorporated entities were
established by charter. Most jurisdictions now allow the creation of new corporations through
registration. In addition to legal personality, registered corporations tend to have limited liability,
be owned by shareholders who can transfer their shares to others, and controlled by a board of
directors who are normally elected or appointed by the shareholders.
In American English the word corporation is widely used to describe large incorporated
businesses. In British English and in the commonwealth countries, the term limited company is
more widely used to describe the same sort of entity while the word corporation encompasses
all incorporated entities. In American English, the word company can include entities such as
partnerships that would not be referred to as companies in British English as they are not a
separate legal entity.
Despite not being human beings, corporations, as far as the law is concerned, are legal
persons, and have many of the same rights and responsibilities as natural people do.
Corporations can exercise human rights against real individuals and the state, and they can
themselves be responsible for human rights violations. Corporations can be "dissolved" either
by statutory operation, order of court, or voluntary action on the part of shareholders. Insolvency
may result in a form of corporate failure, when creditors force the liquidation and dissolution of
the corporation under court order, but it most often results in a restructuring of corporate
holdings. Corporations can even be convicted of criminal offenses, such as fraud and

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manslaughter. However corporations are not considered living entities in the way that humans
are.
Ownership and Control
A corporation is, at least in theory, owned and controlled by its members. In a joint-stock
company the members are known as shareholders and each of their shares in the ownership,
control and profits of the corporation is determined by the portion of shares in the company that
they own. Thus a person who owns a quarter of the shares of a joint-stock company owns a
quarter of the company, is entitled to a quarter of the profit (or at least a quarter of the profit
given to shareholders as dividends) and has a quarter of the votes capable of being cast at
general meetings.
In another kind of corporation the legal document which established the corporation or
which contains its current rules will determine whom the corporation's members are. Who is a
member depends on what kind of corporation is involved. In a worker cooperative the members
are people who work for the cooperative. In a credit union the members are people who have
accounts with the credit union.
The day-to-day activities of a corporation are typically controlled by individuals appointed
by the members. In some cases this will be a single individual but more commonly corporations
are controlled by a committee or by committees. Broadly speaking there are two kinds of
committee structure.
A single committee known as a board of directors is the method favored in most
common law countries. Under this model the board of directors is composed of both executive
and non-executive directors, the latter being meant to supervise the former's management of
the company.
A two-tiered committee structure with a supervisory board and a managing board is
common in civil law countries.

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Formation
Historically, corporations were created by a charter granted by government. Today,
corporations are usually registered with the state, province, or national government and
regulated by the laws enacted by that government. Registration is the main prerequisite to the
corporation's assumption of limited liability. The law sometimes requires the corporation to
designate its principal address, as well as a registered agent (a person or company designated
to receive legal service of process). It may also be required to designate an agent or other legal
representative of the corporation.
Generally, a corporation files articles of incorporation with the government, laying out the
general nature of the corporation, the amount of stock it is authorized to issue, and the names
and addresses of directors. Once the articles are approved, the corporation's directors meet to
create bylaws that govern the internal functions of the corporation, such as meeting procedures
and officer positions.
The law of the jurisdiction in which a corporation operates will regulate most of its
internal activities, as well as its finances. If a corporation operates outside its home state, it is
often required to register with other governments as a foreign corporation, and is almost always
subject to laws of its host state pertaining to employment, crimes, contracts, civil actions, and
the like.

Naming
Corporations generally have a distinct name. Historically, some corporations were
named after their membership: for instance, "The President and Fellows of Harvard College."
Nowadays, corporations in most jurisdictions have a distinct name that does not need to make
reference to their membership. In Canada, this possibility is taken to its logical extreme: many
smaller Canadian corporations have no names at all, merely numbers based on a registration

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number (for example, "12345678 Ontario Limited"), which is assigned by the provincial or
territorial government where the corporation incorporates.
In most countries, corporate names include a term or an abbreviation that denotes the
corporate status of the entity (for example, "Incorporated" or "Inc." in the United States) or the
limited liability of its members (for example, "Limited" or "Ltd."). These terms vary by jurisdiction
and language. In some jurisdictions they are mandatory, and in others they are not. Their use
puts everybody on constructive notice that they are dealing with an entity whose liability is
limited: one can only collect from whatever assets the entity still controls when one obtains a
judgment against it.
Some jurisdictions do not allow the use of the word "company" alone to denote corporate
status, since the word "company" may refer to a partnership or some other form of collective
ownership (in the United States it can be used by a sole proprietorship but this is not generally
the case elsewhere).

Unresolved Issues
The nature of the corporation continues to evolve in response to new situations as
existing corporations promote new ideas and structures, the courts respond, and governments
issue new regulations. A question of long standing is that of diffused responsibility. For example,
if a corporation is found liable for a death, how should culpability and punishment for it be
allocated among shareholders, directors, management and staff, and the corporation itself? See
corporate liability, and specifically, corporate manslaughter.

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Introduction
The concept of governance is not a new one but nowadays we hear words as corporate
governance, organizational governance or good governance frequently. Actually corporate
governance or, as defined in ISO FDIS 26000, organizational governance is the system by
which an organization makes and implements decisions in pursuit of its objectives. Simply put
governance means: the process of decisions making and the process by which decisions are
implemented (or not implemented). And according to ISO FDIS 26000, it is the most crucial
factor in enabling an organization to take responsibility throughout the organization and its
relationship.
Good governance is fundamental to the successfully continuing operating of any
company; hence much attention has been paid to the procedures of such governance. It is
concerned with how the company conducts its annual meeting, deals with auditors etc. It is also
been extended into more general concern with the management or investor relationships. In
reality of course it affects all of the operations of a business and its relation with all of its
stakeholders a much wider ranging concern than is sometimes appreciated.
It is being recognized everywhere that good governance is important for corporate
performance. Indeed firms are being expected to make statements about their governance as
part of their annual reporting and every corporate website makes a statement about the
companys governance procedures.
Corporate governance is therefore currently an important concept the world over. It has
gained tremendous importance in the recent years. Two of main reasons for this upsurge in
interest are the economic liberalization and deregulation of industry and business brought about
through globalization and demand for new corporate ethos and stricter compliance with the law
of the land. One more factor that has been responsible for the sudden exposure of the corporate

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sectors to a new concern for corporate governance is that times have changed and there is a
demand for greater accountability of companies to their shareholder and customers.
Communities and their environment are increasingly impacted by any kind of
organization including small, medium, and large size, domestic or multinational, private or
governmental enterprises. Some people tend to relate the prominence and importance of social
responsibility to issue raised by international organizations although social responsibility has
ever been important for the world business long before the emergence of multinational
companies.
One factor which is significantly affected by such governance is that of risk assessment
and management of risk.

Governance
The concept of governance has existed as long as any form of human organization has
existed. The concept itself is merely one to encapsulate the means by which that organization
conducts itself. Recently however the term has come to the forefront of public attention and this
is probably because of the problems of governance which have been revealed at both a national
level and in the economic sphere at the level of the corporation. These problems have caused
there to be a concern with a re- examination of what exactly is meant by governance, and more
specifically just what are the features of good governance. It is here therefore that we must start
our examination.
When considering national governance then this has been defined by the World Bank as
the exercise of political authority and the use of institutional resources to manage societys
problems and affairs. This is a view of governance which prevails in the present, with its
assumption that governance is a top down process decided by those in power and passed to

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society at large. In actual fact the concept is originally democratic and consensual, being the
process by which any group of people decide to manage their affairs and relate to each other.
Such a consensual approach is however problematic for any but the smallest of groups and no
nation has actually managed to institute governance as a consensual process. With the current
trend for supra-national organization then this seems even more of a remote possibility; nor is it
necessarily desirable. Thus a coercive top down form of governance enables a society to accept
leadership and to make some difficult decisions which would not otherwise be made. Equally of
course it enables power to be usurped and used dictatorially- possibly beneficially but most
probably in a way in which most members of that society do not wish.
This top down, hierarchical form of governance is the form of governance which normally
takes place in large monolithic organization such as the nation state. Conversely the consensual
form tends to be the norm in small organizations such as local clubs. There are however other
forms of governance which are commonly found. One of these is governance through the
market (see Williamson 1975). The free market is the dominant ideology of economic activity,
and the argument of course is that transaction costs are lowered through this form of
organization. From a governance perspective however this is problematic as there is no
automatic mechanism and negotiation is therefore used. The effect of this is that governance is
decided according to power relationships, which tend to be coercive for less powerful (eg
consumers). Consequently there is a need to impose some form of regulation through
governments, or supra-national organizations such as the World Trade Organization, which
thereby re-imposes the eliminated transaction costs. The argument therefore resolves into an
ideological argument rather than an economic one.
An increasing number of firms rely upon informal social systems to govern their
relationship with each other, and this is the final form of governance. This form is normally

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known as network governance (Jones, Hesterly & Borgatti, 1997). With this form of governance
there is no formal rules certainly none which are legally binding. Instead social obligations are
recognized and governance exist within the networks because the different organizations
continue to engage with each other, most probably in the economic arena. This form of
governance can therefore be considered to be predicated in mutual self interest. Of course, just
as with market governance, power relationships are important and this form of governance is
most satisfactory when there are no significant power imbalances to distort the governance
relationships.
Although in some respects these different forms of governance are interchangeably they
are, in reality, suited to different circumstances. Whichever form of governance is in existence,
however, the most important thing is that it can be regarded as good governance by all parties
involved in other words all stakeholders must be satisfied. For this to be so then it is important
that the basic principles of good governance are adhered to.
Corporate Governance
Corporate governance can be considered as an environment of trust, ethics, moral
values and confidence as a synergic effort of all the constituent parts that is the
stakeholders, including government, the general etc., professional, service providers, and the
corporate sector. One of the consequences of a concern with the actions of an organization, and
the consequences of that actions, has been an increasing concern with corporate governance.
Corporate governance is therefore a current buzzword the world over. It has gained tremendous
importance in recent years. There is a considerable body of literature which considers the
components of a good system of governance and a variety of frameworks exist or have been
proposed.

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One of the main issues, therefore, which has been exercising the minds of business
managers, accountants, and auditors, investment managers and government officials again all
over the world is that of corporate governance. Often companys main target is to become
global while at the same time remaining sustainable as a means to get competitive power.
But the most important question is concerned with what will be a firms route to becoming global
and what will be necessary in order to get global competitive power. There is more than one
answer to this question and there are a variety of routes for a company to achieve this.

Principles of Governance by Crowther and Seifi

Crowther and Seifi, 2011 enumerated and discussed the principles which underpin every
system of governance. There are eight (8) principles which are the following: transparency, rule
of law, participation, responsiveness, equity, efficiency and effectiveness, sustainability, and
accountability.

Transparency. Transparency, as a principle, necessitates that the information is freely

available and directly accessible to those who will be affected by such decisions and their
enforcement. Transparency is of particularly important to external users of such information as
these users lack the background details and knowledge available to internal users of such
information. Transparency can therefore be seen to be part of the process of recognition of
responsibility on the part of the organization for external effects of its action and equally part of
the process of redistributing power more equitably to all stakeholders.

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Rule of Law. This is the consequence of the transparency principle. It is apparent that
good governance requires a fair framework of rules of operation. These rules must then be
imposed impartially, without regard for power relationships where rights of the minorities must
be protected. In addition, there must be appeal to an independent body as a means of conflict
resolution, and this right of appeal must be known to all stakeholders.
Participation. The ability of everyone to participate is an essential principle. Participation
includes freedom of association and of expression that goes along with this. Participation can be
either direct or through legitimate intermediate institutions or representatives, as in the case of
national government. Participation would involve everyone, or at least all adults both male and
female.
Responsiveness. This is a consequence of the participation principle and the
transparency principle. Responsiveness implies that the government regulations enable the
institutions and processes of governance to be able to serve all stakeholders within a
reasonable timeframe.
Equity. This involves that all the members of society feel that they have a stake in it and
do not feel excluded from the mainstream. This particularly applies to ensuring that the views of
minorities are taken into account and the voices of the most vulnerable in society are heard in
decision-making. This requires the mechanisms to ensure that all stakeholder groups have the
opportunity to maintain or improve their well-being.
Efficiency and Effectiveness. Efficiency implies transaction cost minimization-a focus of
accounting and cost management- whereas effectiveness must be interpreted in the context of
achievement of the desired purpose. Thus for effectiveness it is necessary that the processes
and institutions produce results that meet the needs of the organization while making the best

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use of resources at their disposal. This also means sustainable use of natural resources and the
protection of the environment.
Sustainability. This requires a long perspective for sustainable human development and
how to achieve the goals of such development. This term sustainability has become universal
both within the discourse of globalization and within the discourse of corporate performance.
Sustainability is a controversial issue and there are many definitions of what is meant by the
term.
At the broadest definition, sustainability is concerned with the effect which action taken
in the present has upon the options available in the future (Crowther, 2002). Sustainability
implies that society must use no more of a resource than can be regenerated (Aras and
Crowther, 2007).

Sustainability, Sustainable Development and the Triple Bottom Line

One of the developments from the notion of sustainability has been that of Triple Bottom
Line Reporting. This is based on the assumption that there are 3 aspects of performanceeconomic, social, and environmental- and that addressing them is all necessary to ensure not
just sustainability but also enable sustainable development. The implicit assumption is one of
business- add some information about environmental performance and social performance to
conventional financial reporting(the economic performance) and that equates to triple bottom
line reporting.
Accountability. Accountability is concerned with an organization recognizing that its
actions affect the external environment, and therefore assuming responsibility for the effects of
its actions. This concept implies recognition that the organization is part of a wider societal
network and has responsibilities to all of those networks rather than just to the owners of the

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organization. Alongside this acceptance of responsibility therefore must be a recognition that

those external stakeholders have the power to affect the way in which those actions of the
organization are taken and a role in deciding whether or not such actions can be justified, and if
so at what cost to the organization and to other stakeholders.
This accountability must extend to all organizations- both governmental institutions as well those
in the private sector and also to civil society organizations- which must all recognize that they
are accountable to the public and to their various stakeholders. One of the significant purposes
of this is to ensure that any corruption is eliminated, or at the very least minimized.

Principles of Corporate Governance

Good governance is important in every sphere of society whether it be the corporate
environment or general society or the political environment. When the sources are too limited to
meet the minimum expectations of the people, the level of good governance can help to
promote the welfare of society. Good governance is essential for good corporate performancemanagement stewardship of financial resources of the organization and environmental
resources.

Four Principles of Corporate Governance

Transparency
It needs to be apparent to all the governance procedures.
Accountability
The reporting structures must be clear.
Responsibility
Someone must be accountable for all parts of the effect.
Fairness
The system must operate impartially and without prejudice.
These principles are related with the firms corporate social responsibility.

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The OECD Principles of Corporate Governance

The Organization for Economic Co-operation and Development (OECD) Principles of
Corporate Governance were originally developed in response to a call by the OECD Council
Meeting at Ministerial level on 27-28 April 1998, to develop, in conjunction with national
governments, other relevant international organizations and the private sector, a set of
corporate governance standards and guidelines. Since the Principles were agreed in 1999, they
have formed the basis for corporate governance initiatives in both OECD and non-OECD
countries alike. Moreover, they have been adopted as one of the Twelve Key Standards for
Sound Financial Systems by the Financial Stability Forum. Accordingly, they form the basis of
the corporate governance component of the World Bank/IMF Reports on the Observance of
Standards and Codes (ROSC).
The Principles are intended to assist OECD and non-OECD governments in their efforts
to evaluate and improve the legal, institutional and regulatory framework for corporate
governance in their countries and to provide guidance and suggestions for stock exchanges,
investors, corporations, and other parties that have a role in the process of developing good
corporate governance. The Principles focus on publicly traded companies, both financial and
non-financial. However, to the extent they are deemed applicable, they might also be a useful
tool to improve corporate governance in non-traded companies, for example, privately held and
state-owned enterprises. The Principles represent a common basis that OECD member
countries consider essential for the development of good governance practices. They are
intended to be concise, understandable and accessible to the international community. They are
not intended to substitute for government, semi-government or private sector initiatives to
develop more detailed best practice in corporate governance.

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This supra-national authorities like OECD and the World Bank did not remain passive
and developed their own set of standard principle and recommendation. This type was chosen
above a set of legal standards (Van den Barghe, 2001). This is important to understand the
content of these principles which are the following:

Ensuring the Basis for an Effective Corporate Governance Framework

The corporate governance framework should 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 authorities.
The Rights of Shareholders and Key Ownership Functions
The corporate governance framework should protect and facilitate the exercise of
shareholders rights.

The Equitable Treatment of Shareholders

The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should have the
opportunity to obtain effective redress for violation of their rights.

The Role of Stakeholders in Corporate Governance

The corporate governance framework should recognize the rights of stakeholders
established by law or through mutual agreements and encourage active co-operation between
corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound
enterprises.
Disclosure and Transparency

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The corporate governance framework should 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 company.
The Responsibilities of the Board
The corporate governance framework should ensure the strategic guidance of the
company, the effective monitoring of management by the board, and the boards accountability
to the company and the shareholders.

Guiding Principles in Corporate Governance

(Presented by Business Roundtable, an association of chief executive officers of leading U.S
companies)
1. The paramount duty of the board of directors of public corporations to select a chief
executive office and to oversee the CEO and senior management in the competent and
ethical operation of the corporation on day-to-day basis.
2. It is the responsibility of the management, under the oversight of the board, to operate
the corporation in an effective and ethical manner to produce long-term value for
shareholders.
3. It is the responsibility of the management, under the oversight of the board, to develop
and implement the corporations strategic plans, and to identify, evaluate and manage
the risks inherent in the corporations strategy.
4. It is the responsibility of the management, under the oversight of the audit committee
and the board, to produce financial statements that fairly present the financial condition
and results operations of the corporation and to make timely disclosures investor needs
to assess the financial and business soundness and risks of the corporation.

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5. It is the responsibility of the board, through its audit committee, to engage an

independent accounting firm to audit the financial statements prepared by management
and issue an opinion that those statements are fairly in accordance with GAAP.
6. It is the responsibility of the board, through its governance committee, to play a
leadership role in shaping the corporate governance if the corporation and the
composition and leadership of the board.
7. It is the responsibility of the board, through its compensation committee, to adopt and
oversee the implementation of compensation policies, establish goals for performancebased compensation.
8. It is the responsibility of the corporation to engage with long-term shareholders in a
meaningful way on issues and concerns that are of widespread interest to long-term
shareholders, with appropriate involvement from the board and management.
9. It is the responsibility of the corporation to deal with its employees, customers, suppliers
and other constituents in a fair and equitable manner and to exemplify the highest
standards of corporate citizenship.
Corporate governance procedures determine every aspect of the role of the management of
the firm and try to keep in balance and to develop control mechanisms in order to increase both
shareholder value and the satisfaction of other stakeholders. In other words, it is concerned with
creating a balance between the economic and social goals of a company (efficient use of
resources, accountability in the use of its power, behavior of corporation in its social
environment).

Main points addressed by good corporate governance:

Creating sustainable value

Ways of achieving the firms goal
Increasing shareholders satisfaction
Efficient and effective management
Increase credibility

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Ensuring efficient risk management

Providing an early warning system against all risk
Ensuring a responsive and accountable corporation
Describing the role of the firms units
Developing control and internal auditing
Keeping a balance between economic and social benefit
Ensuring efficient use of resources
Controlling performance
Distributing responsibility fairly
Producing all necessary information for stakeholders
Keeping the board sufficiently independent from management
Facilitating sustainable performance
Long term benefits for firms from corporate governance:

Increasing the firms market value, rating and competitive power

Attracting new investors, shareholders and more equity
Higher credibility
Enhancing flexible borrowing condition/facilities from financial institutions
Decreasing credit interest rate and cost of capital
New investment opportunities
Attracting better personnel/employees
Reaching new markets
These long-term benefits are directly related to the sustainability of a firm and firms
success.
Sustainability is focused on the future and is concerned with ensuring that the choices
of resource utilization in the future are not constrained by decisions taken in the present.

We can evaluate corporate governance from different perspective:

General Economy
Quality of corporate governance system may be an important determinant of its
competitive conditions (Fulghieri and Suominen, 2005)
The company itself
Installing proper governance mechanisms may provide a company with a competitive
advantage in attracting investors.
Private and institutional investors

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Corporate governance is recognized to have an impact on the financial risks of the firms
portfolios.
Banking and other financial institutions
There is a plea for increased attention for corporate governance in banks risk
measurement methods.
Corporate governance evolves and improves over time: Globally, organizations in
different sectors operate in diverse environments. Culture, regulation, legislation and
enforcement are all different. Governance-wise, what is appropriate for one type of organization
will not be appropriate for all. Further research and open debate is needed in this area.
Corporate governance and risk management will never be fully evolved and may always be
improved: It is vital that requirements do not create a straightjacket that prevents innovation and
improvements in the way organizations conduct themselves in the future.

Development of Codes of Governance

Every organization has its own decision making processes and structures according to
its structure and objectives which may range from formal and sophisticated ones subject to laws
and regulations, to informal ones rooted in its organizational culture and values. The world has
realize the importance of harmonized codes of governance and considerable effort has been put
into developing such codes.

Codes of Governance for Best Practice

Codes of best practice for generic business activities
Applicable to all categories of business activity
One country that uses codes for generic business activities is South Africa.
Codes of best practice for listed companies
Typically used by countries with a developed, active capital market Codes are targeted
at listed companies
Codes of best practice for specific types of companies

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Codes focus on specific types of companies such as banks, state-owned enterprises

(SOEs) or small and medium-size enterprises.
More operational and cover issues that are not typically dealt with in existing principlebased codes.
Specific Codes can prove especially relevant for low-income countries or where few
companies are listed.

Codes focusing on specific aspects of corporate governance

Some codes of best practice focus upon specific aspects of corporate governance such
as board practices or disclosure. These codes of best practice should not be confused
with professional codes of conduct adopted by the members of professional bodies such
as accounting federations or institutes of directors.
Professional Codes vs. Codes of Best Practice
Professional codes are typically developed and implemented by professional, selfregulated organizations to ensure that high-quality service is provided by their members and
that high levels of public trust are maintained in particular professions.
Codes of best practice addressing specific aspects of corporate governance are
geared toward improving corporate governance by addressing specific issues that are not
otherwise dealt with. These codes tend to be more detail oriented and can prove very useful
when reviewing and improving more comprehensive codes of best practice.

The Environment of Codes of Best Practice

The legal environment in which corporations operate is typically quite complex.
Corporate governance practices are typically affected by a myriad of government laws and
regulations, industry standards and guidelines, and the individual companys own by-laws and
rules. Corporate governance codes must therefore be developed with the knowledge that they
will be part of a large body of existing laws, regulations, principles, and best practices.

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Following are the kinds of norms that can have a direct impact on corporate governance
practices:

International laws (treaties, agreements, directives)

National laws (legal codes)
Subnational legislation (state laws)
Regulations
Listing rules
Standards, guidelines, and codes of best practice
Organic documents of the corporation (company charter)
Corporate rules and provisions (company by-laws)

Things to Consider in Developing a Governance Framework

Structure of the organization for example, federal or highly centralized

Nature of the organizations business such as policy work or operations

Range of business functions undertaken, and the commonalities between them

Requirements for communication and data sharing across the business functions of the
organization and its partners

Distribution of authority and the extent of central or local autonomy

Procedures and responsibilities for business planning and defining business strategy

Geographic distribution of organizational units, business functions and facilities such as

IT

Existence of corporate-wide policies, such as for purchasing and procurement

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Role and authority of cross-divisional structures (for example, steering groups) in the
organization and its partners

Extent to which standards are enforced across the organization

Extent to which work processes are common across the organization

Internal control & security policies

Elements of Corporate Governance Framework

1. General Corporate Governance - obligations refer to the tapestry of legislation and
case law reflected largely in the act that encompasses the statutory directors duties and
the relationships between the holders of equity and others.
Obligations are contained in:
governance documents
he statutory duties that apply to Enterprise Controllers
2. Operational Governance of the Enterprise - refers to its compliance with a range of

statutory obligations. These fall into two categories:

compliance with a range of industry specific legislation; and
compliance with general statutes that impose obligations on all Enterprises.

Code of Good Governance Process

1. Initiating the Process: The parties involved in the initial stages of developing a
corporate governance code; the formation of the crafting committee; The appointment and
functions of the key individual members.
2. Managing the Process: Developing a master schedule; Setting the terms of reference
for the committees work; Dealing with internal and external challenges.

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3. Consulting Stakeholders: Key stakeholders and their level of involvement; Methods of

consultation.
4. Researching and Drafting the Code: Researching existing international best practice
and models; Assessing the countrys legal framework and reform needs; Integrating consultation
feedback; Adopting the right style and format; Agreeing on the final code.
5. Implementing and Monitoring: Launching and disseminating the code; Adopting and
implementing the code; Measuring the impact of the code; Updating the code.
Systems of Governance
It is probably true to say that there is a considerable degree of convergence on a global
scale as far as systems of governance are concerned, and this convergence is based on the
dominance of Anglo Saxon Model of the State, the market and civil of society. As a
consequence there tends to be an unquestioning assumption that discussions concerning
governance can assume the Anglo Saxon Model as the norm and then consider, if necessary,
variations from that norm. It is important however to recognize that there are other models. The
three models of governance are the Anglo Saxon Model, Latin Model, and the Ottoman Model.

Anglo Saxon Model

Anglo-Saxon model is characterized by the dominance in the company of independent
persons and individual shareholders. The manager is responsible to the Board of Directors and
shareholders, the latter being especially interested in profitable activities and received
dividends. It ensures the mobility of investments and their placement from the inefficient to the
developed areas, but it however feels a lack of strategic development.

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It is founded on rules which must be codified and can therefore be a subject to a

standard interpretation by the appropriate adjudicating body. It has a tendency to be hierarchical
and must be imposed from above and along with this imposition is an assumption of its efficacy
and a lack therefore of considerations of alternatives.
In countries with an Anglo-Saxon legal tradition, such as the United States, United
Kingdom, Canada and Australia, corporate governance typically focuses on the firm's outside
investors, mainly shareholders. In those countries, top managers tend to be monitored by
means of market-based rewards and penalties. For instance, in the United States, where
compensation is often tied to the level of profitability, most firms would opt to cut back on labor
in order to sustain current profitability. The Anglo-Saxon countries are characterized by the
emergence of financial markets and strong banking restrictions, especially regarding the holding
of shares in companies outside the banking sector.
Under this system, employees often find it difficult to trust top management, as their
behavior is subject to constant market scrutiny. In countries such as Germany or Japan, where
stakeholder claims are typically taken into account in top management decisions, job security
becomes a main corporate objective. Canon, for example, has never laid off employees in its
entire history, despite all the ups and downs in profitability.
In Germany, employees are influential stakeholders whose welfare is internalized to a
certain extent by top managers through co-determination systems of governance, having small
percentages of the firm's total stock in free-float, and making the managers' compensation not
so focused on current profitability.
It is assumed that corporate governance is determined by a set of mutually reinforcing
institutional elements: disclosure, the board of directors, hostile takeovers, legal systems,
transparency, accountability, separation of CEO and chair, stock in capital markets, personnel

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turnover, unionization, flexibility of labor markets and so on. And it is the existence of
complementarities between configurations that determines the economic success of different
corporate governance arrangements at an individual country level.

The Latin Model of Governance

The Latin model of governance tends to be less codified than the Anglo Saxon model
and finds less need for procedures for adjudication. This is because it is founded in the context
of the family and the local community. In some respects therefore it is the opposite of the Anglo
Saxon model, being based on a bottom up philosophy rather than a hierarchical top down
approach. Thus this model is based on the fact that extended families are associated with all
other family members and therefore feel obligated. And older members of the family are
deemed to have more wisdom and therefore assume a leadership role because of the respect
accorded them by other family members. As a consequence there is no real need for formal
condification of governance procedures and the system of adjudication does not need to be
formalized it works very satisfatorily on an informal basis. Moreover this model is extended
from the family to the local community and works on the same basis.
The Latin model of governance is also known as Continental Model. The underlying
principle on which the Continental corporate governance system is based is embodied in the
stakeholder theory of the firm. The Continental capitalist model considers not only the interest of
shareholders but also inputs from the relevent stakeholders. Often, the most important
stakeholders who take an active part in strategic decision making at corporate level are
employees, through trade union representation and/or works councils.
Unlike the Anglo- Saxon model, many Continental Europian countries provide for a twotier board: executive board of directors and the supervisory board. The supervisory board is

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formed according to different procedures across Europe, but in many cases employees have
the right to appoint or recommend several members to the supervisory board.
From the schematic relationships depicted in figure below it can be seen that, unlike the
Anglo Saxon system, Continental corporate governance allows for multiple chanels to deal with
the shareholder-manager agency problem and ensure insiders supervision.

Capital-related aspects
Unlike the Anglo-Saxon system, the Continental model is based on the prominent role of
banks and on extensive cross-ownership links in corporate finance and control. It is common for
banks in this model to own significant proportions of shares in their portfolios as a way of
controlling their major clients economic activities. Banks representatives are also often found on
the boards of directors of the companies to which they offered large loans. These organizatonal
features and close banking-enterprise interaction create a more secure economic environment
that allows firm to seek higher profits in the long term, as opposed to the short-term view
imposed by stock market on Anglo-Saxon companies (Albert 1993; Smyser 1992). Further more
banks are allowed to conduct business in all branches of banking (Universal Banking), while
Anglo-Saxon countries strictly seperate certain banking activeties (Albert 1993). Both features

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make banks more attrative than stockmarket for companies in Continental Europe wishing to
raise capital for new investment.

Labor- related Aspects

With regard to many strategic corporate decisions, Continental-based companies often
involve works councils at an early stage. In such cases, better coordiantion and agreement
between works councils and trade union can strengthen the employees position in mergers,
acquisitions and corporate reorganization. In the German corporate model (and to a large extent
in the Netherlands and other Western Europian countries) works councils are engaged in
consultaion and participation in the corporate decision-making process, while trade unions are
mostly concerned with working conditions and which bargaining.
However, co-determination may also create disadvantages. If workers become to
influential they may pursue optimistic objectives. It may also slow down decision-making within
firms by requiring lengthy procedures before decisions can be taken (Hopt 1994). Moreover, codetermination may reduce the flexibility of employment accross firms and industries. Often
employers have to consult the works council not only on the social consequences of important
economic decisions, but on the economic and financial consequences as well, even though
works councils have not been given a say in how the company profits should be distributed.
Despite the institutionalized links between workers and management in the Continental
model, corporate governance and industrial relations are far from being a non-conflictual
environment. The board of directors maintains its dominant position and sometimes acts in
isolation from stakeholders. Even worker participation in corporate governance is at times
characterized by a lack of co-ordination between trade unions and works councils.

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The Ottoman Model of Governance

The Ottoman Empire (Modern Turkish) also historically referred to as the Turkish Empire
or Turkey, was a contiguous transcontinental empire founded by Turkish tribes under Osman
Bey in north-western Anatolia in 1299. With the conquest of Constantinople by Mehmed II in
1453, the Ottoman state was transformed into an empire. The empire then grew to include
many areas in what is now present-day Europe to it eventually became one of the largest, most
powerful and longest-lasting empires in the history of the world.
During the 16th and 17th centuries, in particular at the height of its power under the reign
of Suleiman the Magnificent, the Ottoman Empire was one of the most powerful states in the
world a multinational, multilingual empire, controlling much of southeast Europe, Western Asia
and North Africa. It had a maximum area of 7.6 million square miles (19.9 million square
kilometers) in 1595 (University of Michigan). The Ottoman Empire begun to decline power in the
18th century but apportion of its land became what is turkey today.
The Ottoman Empire existed for 600 years until the early part of the twentieth century.
Although the empire itself is well known, few people know too much about it. Throughout
Europe, at least, the reality is obscured by various myths which abound - and were mostly
create during the latter part of the nineteenth century - primarily by rival states and for political
propaganda purposes. The reality was of course different from the myths and the empire had a
distinct model of governance which was sufficiently robust to survive for 600 years, although
much modern analysis suggest that the lack of flexibility and willingness to change in the model
was one of the principle causes of the failure of the empire.
According to the 15thcentury statesman, Tursun Beg, it is only statecraft which enables
the harmonious living together of people in society and in the Ottoman empire there were two

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aspects to this statecraft - the power and authority of the rule (the Sultan) and the divine reason
of Sharia (via the Caliph) (Inalcik 1968). In the Ottoman Empire these two were combined in one
person. The Ottoman Empire was of course Islamic, but notable for its tolerance of other
religions. It has been argued (Cone, 2003), that the Islamic understanding of governance and
corporate responsibility shares some fundamental similarities with the Rawlsian concept of
social justice as mutual agreement among equals (motivated by self interest). All parties must
be fully aware of the risks attendant on a particular course of action and be accepting of equal
liability for the outcomes, good or bad.
Muslims see Islam as the religion of trade and business, making no distinction between
men and women and seeing no contradiction between profit and moral acts (Rizk 2005). The
governance system was effectively a form of patronage which operated in a hierarchical manner
but with the systems procedures being delegated in return for the benefits being shared in an
equitable manner. This enabled a very devolved form of governance to operate effectively for so
long over such a large area of Asia, Europe and Africa. It is alien to the Anglo-Saxon view
because the systems involved payment for favours in a way that the Anglo-Saxon model would
interpret as corrupt but which the Ottoman model interprets simply as a way of devolving
governance. It is interesting to observe therefore that the problems with failure of governance in
the current era could not have occurred within the Ottoman model because there was no space
left for the necessary secrecy and abuse of power.

Issues Concerning Governance

These issues normally involve strategic-level decisions and actions taken by board of
directors, business owners, top executives and other managers with high levels of authority and
accountability. Although these people have often been relatively free from scrutiny, changes in

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technology, consumer activism, government attention, recent ethical scandals and other factors
have brought new attention to such issues as transparency, executive pay, risk and control,
resource accountability, strategic direction, stockholder rights and other decisions made for the
organization.

Executive Compensation
Say on pay is a term used for a rule in corporate law whereby a firm's shareholders

have the right to vote on the remuneration of executives. Directors are elected to a board that
has a fiduciary duty to protect the interests of the corporation. In large listed companies,
executive compensation will usually be determined by a compensation committee comprising
board members. Proponents argue that say on pay reforms strengthen the relationship
between the board of directors and shareholders, ensuring that board members fulfill their
fiduciary duty. Critics of the policy believe that say on pay does not effectively or
comprehensibly monitor compensation, and consider it to be reactionary policy rather than
proactive policy, because it does not immediately affect the Board of Directors. Some argue it is
counter-productive because it diminishes the authority of the Board of Directors.
Composition and structure of the board of directors
Separation of the duties of CEO and Chairman of the Board: Separating the board
chair and CEO roles remains an ongoing debate in corporate governance with compelling
arguments on both sides. The issue centers on whether a potential conflict of interest exists
when the roles are combined and whether there is an appropriate balance of power between the
CEO and the independent board members.

Auditing, control and risk management

The board is charged with ensuring that the firm is financially stable and sound. This

requires strong leadership, strict regulation and supervision as well as successful market
discipline. It also mandates an effective internal control and risk-management system. This
provides valuable information to determine whether a firm meets the targets it sets and

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highlights deficits in the strategy. However, these systems are only as good as those who run
them. Firms falter when the board does a poor job communicating goals and objectives down
the chain of command. Internal controls and risk-management systems only succeed when an
organization's culture permits all employees at every level to understand their value and role in
the firm's success.

CEO selection and termination decisions

Integrity of financial reporting
Sound, Universal Accounting System
Investors must accurately assess the value of a firm. It is a key element of a firm's ability

to attract capital and remain financially viable. In recent years, regulators have called into
question the reliability of accounting practices used by some firms in the U.S. financial industry.
The need for oversight from the public sector of the private sector has raised legitimate concern
about the ability to maintain a truly free-market economy without tighter regulatory controls.
Company should develop a sound, universal accounting system--one that includes necessary
checks and balances and enables firms to operate free of overly restrictive regulatory restraint.
Lack of Disclosure
Increasing disclosure is a feature of corporate reporting as they seek to
satisfy shareholders through increased accountability and transparency.
Transparency is required in balance sheet and income statement of a
firm. Many of the firms are exercising to fake their financial statements. Proper
disclosure and reporting of revenue and operating income should be detailed.
This will help the investors a better understanding on the possible risks.
Disclosure practices must keep pace with a firm's ever-changing business
and risk-management procedures. Although firms have improved in this area,

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they generally do not update their disclosure practices to adequately reflect the
need for information by shareholders, investors and creditors. A firm must
reevaluate information it makes public and information kept proprietary on a more
regular basis to account for adjusting market conditions and regulatory changes
in order to maintain consumer confidence. Nothing weakens confidence more
than a firm believed to unnecessarily withholding important information from
consumers.
Main Issues Concerning Transparency and Disclosure
-

Accounting and auditing standards

Easy access for shareholders to Financial Statements and capital structure
Enforcement power of Securities Commissions
Information on material events
Information on conflicts of interest

Stakeholder participation and input into decisions

Main Issues Concerning Shareholders Rights

-

Access to information on shareholders structure

Information on shareholder meetings
Clear provisions concerning voting procedures during AGMs
Capacity for shareholders to vote in absentia, by proxy or mail
Rights to receive dividends

Main Issues Concerning Equitable Treatment

-

Dilution of the minority stake during capital increases

Fair treatment of minority shareholders in case of de-listing of a JSC
Related parties transactions
Insider dealing and self-trading
Possibility of legal redress

Compliance with corporate governance reform

Role of the CEO in board decisions
Organizational ethics programs

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Set Core Ethical Values

It is essential that commercial organizations set out their core ethical values as the basis
for generating and sustaining the culture of integrity in the way they conduct their business.
While most corporations are (rightly) concerned about making adequate returns for their
shareholders, they should also be concerned about making their organization good corporate
citizen and sustainable in the longer term. They way an organization does its business clearly
matters.
Restoring Public Trust
Restore public confidence in the way financial institutions are run. Primarily this is
responsibility of the Board of Directors. This can be achieved by the following:
a. Eliminating restrictive terms of service
b. Separating of the roles of Chairman and Chief Executive Officer
c. Selecting Board members by nominating committee based on their relevant expertise
and experience
d. Briefing the Board on respective revenue, net income and risk contributions
e. Creating procedures for the Board to monitor and manage risks
f. Structuring executive compensation based on performance of the company over a
three to five year horizon focusing on its financial strength and market competitiveness
Other Issues Concerning Governance

Bribery and corruption: Bribery and corruption risk continues to be a big issue for
companies, with the number of reported incidents and regulatory enforcement
increasing in 2011. To ensure respect for a program, whether it be on the part of

employees or business partners, external verification is necessary.

Whistleblower bounty program (Informers reward): to encourage the public to
extend full cooperation in eradicating smuggling, a cash reward equivalent to ten
percent (10 percent) of the fair market value of the smuggled and confiscated goods

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or One Million Pesos (P1, 000,000) per case, whichever is lower, shall be given to
persons instrumental in the discovery and seizure of such smuggled goods. The
cash rewards of informers shall be subject to income tax, collected as a final
withholding tax, at a rate of ten percent (10 percent). Furthermore, all public officials,
whether incumbent or retired, who acquired the information in the course of the
performance of their duties during their incumbency, are prohibited from claiming

informer's reward.
Demand for information: In order to influence the directors, the shareholders must
combine with others to form a voting group which can pose a real threat of carrying

resolutions or appointing directors at a general meeting.

Monitoring costs: A barrier to shareholders using good information is the cost of
processing it, especially to a small shareholder. The traditional answer to this
problem is the efficient hypothesis market (in finance, the efficient market hypothesis
(EMH) asserts that financial markets are efficient), which suggests that the small

shareholder will free ride on the judgments of larger professional investors.

Supply of accounting information: Financial accounts form a crucial link in
enabling providers of finance to monitor directors. Imperfections in the financial
reporting process will cause imperfections in the effectiveness of corporate
governance. This should, ideally, be corrected by the working of the external auditing

process.
Financial Stability - can be achieved only by the interaction of three basic
necessities: sound leadership at the firm level, strong prudential regulation and
supervision, and effective market discipline.

The Internal and External Institution of Corporate Governance

Institutions of corporate governance are institutions that determine the playing field of
internal and external stakeholders in the firm. These are repeated mechanisms that allocate

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authority of the top management and that affect, modulate, and control the decisions made at
the top of the firm.
Corporate governance contains both internal and external control relationships. Internal
control refers to the interplay between management, shareholders, and other stakeholders,
such as debt holders and employees. External control refers to regulating agencies, reputational
agents and markets that function as a disciplining device for top management.
Institutions can also be formal and informal. The institutions mentioned above are
considered as the formal internal and external institutions. Informal institutions, on the other
hand, may be the firm specific norms and values, management codes of conduct in business,
as well as more general norms and values existing in society at large, self-regulation within a
certain industry, and the reputation of a firm in its relations with its competitors, suppliers and
customers

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Internal Institutions of Corporate Governance

Internal corporate governance monitors activities and then takes corrective action to
accomplish organizational goals.

Board of Directors
The board of directors, with its legal authority to hire, to fire and to compensate top
management, safeguards invested capital. Regular board meetings allow potential problems to
be identified, discussed and avoided.

Roles:
Directors serve as a source of advice and counsel, serve as some sort of discipline, and
act in crisis situations.
Control of the process by which top executives are hired, promoted, assessed, and, if
necessary, dismissed.
Involved in the setting of strategy or, somewhat equivalently, the selection of projects.
Board of directors in a company has the overall responsibility for management and
direction of its affairs. In this regard, the directors should exercise strategic oversight of

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business operations while directly monitoring, measuring and rewarding managements

performance.
The board should also ensure the integrity of accounting and financial reporting systems
and oversee the process of disclosure and communications.
Types of Directors and Their Roles in Corporate Governance
1. Bankers - monitor the firm for the lender for whom they work and provide nancial
expertise
2. Venture Capitalists
As a condition of receiving funding, new enterprises must yield some degree of
control to the venture capitalists. Venture capitalists have a duciary
responsibility to their own investors to exit these enterprises relatively quickly,
and generally leave these enterprises boards when they sell their ownership
stake in them.
3. CEOs as Directors
One of the most common occupations of outside directors is CEO of another
rm. CEOs of other rms clearly have management skills and an understanding
of the issues facing top management.
4. Stakeholder Representatives on Boards
A variety of stakeholders with an interest in a rm are represented on the rms
board. A particularly important set of such stakeholders is labor. Presumably the
reason why labor is eager to gain such representation is to inuence
management to take actions favorable to workers.

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Shareholders
Roles:
The minority shareholders have much greater role in the decision making process of
large corporations.
They have an overriding responsibility to their clients, but they have different investment
objectives.
They are responsible for the nomination of new directors that will manage the company

Internal Auditors
Internal audit is required to meet the expectations of audit committees and to proactively
help CEOs and CFOs to improve business processes, and to tackle emerging risks.
Roles:
Discharge its governance responsibilities by delivering a review of the organizations
culture and adherence to its code of ethics;
Evaluate the existing risk assessment and management processes;
Evaluate of business processes, associated controls, and their linkages to risk areas;
Review the existence and valuation of assets, source of information on major frauds
and irregularities, including periodic assessment of fraud risks; and
Review regulatory compliance and specific concerns flagged by the board and senior
management.
External Institutions of Corporate Governance
The Laws of the country
Corporations are created as legal persons by the laws and regulations of a particular
jurisdiction. These may vary in many respects between countries, but a corporation's legal
person status is fundamental to all jurisdictions and is conferred by statute.
A corporation cannot create its own rules and regulations which are in contrary with the
existing laws governing the country of its operation.

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Reputational agents
Reputational agents are private sector agents that remove information asymmetry,
improve the monitoring of firm, and shed light to an opportunistic behavior.

a. Independent auditors
Independent auditors, with their certifications, help achieve a more informed and
objective appreciation of the governance risks that investors and other stakeholders face with
regard to specific corporate units.
They are responsible in providing assurance to shareholders and stakeholders regarding
the true and fair nature of the information presented in their audit clients financial and other
related statements.
b. Regulators
They are responsible for the protection of investors in general, as well as absentee
shareholders and shareholders who are not in operational control in particular.
c. Rating agencies
Many investors base their decisions on the rating agencies certifications and
assurances with regard to rated securities, and also the way they rate other corporate practices
d. The media
To comprise corporate entities, publishers, journalists, and reporters who constitute the
communications industry. The media is a powerful agent in disseminating public opinion and
inducing a change in the mindsets of the public by altering their perceptions through
representational communication modes.

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Markets
Stock exchange market serves the dual purpose of, first, providing an initial stocktaking
of some of the commonly agreed main aspects of stock exchanges influence on corporate
governance; and, secondly, suggesting a number of issues arising from recent changes in the
role of the exchanges.

Choices within Legal Constraints

1. Anti-takeover
Takeover refers to transfer of control of a firm from one group of shareholders to another
group of shareholders. It is a change in the controlling interest of a corporation, either through a
friendly or an unfriendly acquisition.
Friendly takeover is a situation in which a target company's management and board of
directors agree to a merger or acquisition by another company.
Hostile Takeover is the acquisition of one company by another that is accomplished not
by coming to an agreement with the target company's management, but by going directly to the
companys shareholders or fighting to replace management in order to get the acquisition
approved. A hostile takeover can be accomplished through either a tender offer or a proxy fight.

Pre-offer Anti-takeover Defenses

Staggered Board Board of directors are grouped into classes. During each election
term only one class is open to elections, thereby staggering the board directorship.
White Knight Another company makes a friendly takeover to a target company that is
being faced with a hostile takeover from a separate party.

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Lobster Trap The company passes a provision preventing anyone with more than 10%
ownership from converting convertible securities into voting stock.
Poison Pills With a poison pill, the target company attempts to make its stock less
attractive to the acquirer.

Post-offer Anti-takeover Defenses

Pac-Man Defense In a Pac-Man defense, the target firm turns around and tries to
acquire the other company that has made the hostile takeover attempt.
Scorched Earth Defense An anti-takeover strategy that a firm undertakes by liquidating
its valuable and desired assets and assuming liabilities in an effort to make the proposed
takeover unattractive to the acquiring firm.
Greenmail The target company repurchases the stock held by an unfriendly company
at a substantial premium to prevent a takeover.
Macaroni Defense The company issues a large number of bonds with the condition
they must be redeemed at a high price if the company is taken over.

2. Mitigation and indemnification of director and officer liability

Mitigation in law is the principle that a party who has suffered loss has to take
reasonable action to minimize the amount of the loss suffered.
Indemnification is a legal term meaning to pay the costs of another, or to reimburse
another person for costs incurred.

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Mitigation and indemnification of director and officer liability protects against legal claims
for wrongful acts performed by corporate directors or officers in performing their corporate
duties.

3. Shareholder Limitations, through classes of stock, supermajorities

Two Kinds of Stock
1. Common Stock
2. Preferred Stock
Features of Equity:
Maturity
Right to income
Claim on asset
Right to control
Pre-emptive rights
Limited Liability

Common and Preferred Stocks: Similarities

Payments - Both are equity instruments that pay dividends from the company's after-tax
profits.

Common and Preferred Stocks: Differences

Payments - Preferred stocks have fixed dividends and, although they are never
guaranteed, the issuer has a greater obligation to pay them. Common stock dividends, if they

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exist at all, are paid after the company's obligations to all preferred stockholders have been
satisfied.
Appreciation - Preferred stocks have lower volatility than common stocks. This is where
preferred lose their luster for many investors. Lower volatility of preferred stocks may look
attractive, but preferred will not share in a company's success to the same degree as common
stock.
Voting - Whereas common stock is often called voting equity, preferred stocks usually
have no voting rights.

What is a Supermajority?
A corporate amendment in a company's charter requiring a large majority (anywhere
from 67-90%) of shareholders to approve important changes, such as a merger. This is
sometimes called a "supermajority amendment". Often a company's charter will simply call for a
majority (more than 50%) to make these types of decisions.

4. Contractual matters such as management agreement

What is a management contract?
Agreement between investors or owners of a project, and a management company hired
for coordinating and overseeing a contract. It spells out the conditions and duration of the
agreement, and the method of computing management fees.

Contractual Matters

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The scope and enforceability of the contracts underlying a business are key to its
continued profitability and inherent value. The prime focus of any legal diligence process on an
acquisition is evaluating the enforceability of material contracts, particularly post-transfer. Any
defect in material contracts could well result in a diminution in the value of the business as a
whole.

5. Venture Capital and other investment agreement

Venture Capital
Money provided by investors to start-up firms and small businesses with perceived longterm growth potential. This is a very important source of funding for start-ups that do not have
access to capital markets. It typically entails high risk for the investor, but it has the potential for
above-average returns.

Investment Agreement
A contract establishing the terms of an investment. The contract typically specifies such
things as the amount of the investment and the rights of the investors.

6. Voting Agreements
A Shareholder Voting Agreement is a legal contract among shareholders of a corporation
relating to the voting of shares. The shareholder voting agreement often covers how members
of the Board of Directors are to be elected and sometimes covers major corporate events such
as mergers and acquisitions.

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Agency Problem in Corporate Governance: Accountability of Managers and Stakeholders

The owner of a business, when contemplating any change, is led by his own interest to
weigh the whole gain .. against the whole lost. But the private interest of the salaried manager,
or official, often draws him in another direction: the path of least resistance, of greater comfort
and least risk to himself, is generally that of not striving very energetically for improvement; and
of finding plausible excuses for not trying an improvement suggested by others, until its success
is established beyond question (Alfred Marshall, 1920)

Another Glance for Corporate Governance:

Corporate governance includes the structures, process, cultures and systems that
engender the successful operation of organizations (Keasey and Wright 1993).
Corporate governance represents the relationship among stakeholders that is used to
determine and control the strategic direction and performance of organizations.

What is Agency?
Agency relationships occur when one partner in a transaction (the principal) delegates
authority to another (the agent) and the welfare of the principal is affected by the choices of the
agent.
The agency view of the corporation suggests that the decision rights of the corporation
should be entrusted to a manager to act in shareholders interests. Agency costs mainly occur
when ownership is separated, or when managers have objectives other than shareholder value
maximization.

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Agency relationships occur when one partner in a transaction (the principal) delegates
authority to another (the agent) and the welfare of the principal is affected by the choices of the
agent.
The separation of ownership and control leads to this principal-agent relationship.
Principal- one who directs the activities of the agent.
Agent- one who acts on behalf of the principal, based on the principals direction. The
agent owes a duty of loyalty to the principal.

The following are the reasons why principal do delegate authority to agents:
1. Size
2. Simplicity of business operations (conceiving opportunity, funding, making and implementing
decisions)
3. Decision making situation can overwhelm the cognitive capacity of a single individual,
decision quality can be improved by assigning different parts of the decision to different
individuals

For public corporations, shareholders are principals and managers are agents. For this,
an agency problem may exist. Agency problem is the possibility of opportunistic behavior on the
part of the agent that works against the welfare of the principal. It occurs since agents have
incentives to act in ways that are contrary to the interests of their principals. Managers try to
benefit themselves at the expense of shareholders and other stakeholders through self-serving
behaviors (too high compensation, over-diversification, mergers, etc.).

What is Agency Problem?

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The possibility of opportunistic behavior on the part of the agent that works against the
welfare of the principal.
(e.g. Conflict of Interest Between Shareholders and Managers)

What is Agency Cost?

It refers to instances when an agent's behavior has deviated from a principal's interest.
In this case, the principal would be the shareholder. These types of costs mainly arise because
of contracting costs, or because individual managers might only possess partial control of
corporation behavior. They also arise when managers have personal objectives that are
different from the goal of maximizing shareholder profit.

Essential Sources of Agency Problems:

Moral hazard; more of the agents actions are hidden from the principal or are costly to
observe
Adverse selection; the agent possesses information that is, for the principal
unobservable or costly to obtain
Risk aversion; as organizations grow managers become risk averse (they would like to
protect their position, managers would like to max. chance of success by projects that have
already brought success, managers build structures to increase their chances of control)

Duties of the managers for an ethical corporate agency include:

1. To provide accurate and timely information about the corporations performance and
business prospects
-so shareholders can make informed decisions about their investments

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2. Best efforts to enhance shareholder wealth

3. To avoid self-serving behaviors

Duties of the stakeholders for an ethical corporate agency include:

1. To monitor performance of the top management team
2. To provide the proper level and function of executive compensation, profit related
bonuses, and executive share option
-so managers will loyally and accordingly perform their duties. However,
executive compensation shall take into account a variety of strategic and financial
indicators and then give the reward for superior performance.
3. To provide promotions or other forms of recognition which may enhance reputations
and probability of increased future income of the managers

To protect principals interests and to reduce the possibility that agents will misbehave, agency
costs are incurred:
1. Monitoring expenditures by principals
-observing the behavior and performance of agents
2. Bonding expenditures by agents
-arrangements that penalize agents for acting in ways that violate the interests of
principals or reward them for achieving principals goals
3. Residual loss of the principal
We have emphasized the separation of ownership and control in public corporations.
The owners (shareholders) cannot control what the managers do, except indirectly

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through the board of directors. This separation is necessary but also dangerous. You
can see the dangers. Managers may be tempted to buy sumptuous corporate jets or
to schedule business meetings at tony resorts. They may shy away from attractive
but risky projects because they are worried more about the safety of their jobs than
about maximizing shareholder value. They may work just to maximize their own
bonuses, and therefore redouble their efforts to make and resell flawed subprime
mortgages.

Agency Problems Are Mitigated by Good Systems of Corporate Governance

Legal and Regulatory Requirements. Managers have a legal duty to act responsibly and
in the interests of investors. For example, the U.S. Securities and Exchange Commission (SEC)
set accounting and reporting standards for public companies to ensure consistency and
transparency. The SEC also prohibits insider trading, that is, the purchase or sale of shares
based on information that is not available to public investors.
Compensation Plans. Managers are spurred on by incentive schemes that produce big
returns if shareholders gain but are valueless if they do not.
Board of Directors. A company's board of directors is elected by the shareholders and
has a duty to represent them. Boards of directors are sometimes portrayed as passive stooges
who always champion the incumbent management. But response to past corporate scandals
has tipped the balance toward greater independence. The Sarbanes-Oxley Act (commonly
known as SOX) requires that corporations place more independent directors on the board, that
is, more directors who are not managers or are not affiliated with management. More than half
of all directors are now independent. Boards also now meet in sessions without the CEO
present. In addition, institutional shareholders, particularly pension funds and hedge funds, have

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become more active in monitoring firm performance and proposing changes to corporate
governance.
Monitoring. The company's directors are not the only ones to be scrutinizing
management's actions. Managers are also monitored by security analysts, who advise investors
to buy, hold, or sell the company's shares, and by banks, which keep an eagle eye on the safety
of their loans.
Takeovers. Companies that consistently fail to maximize value are natural targets for
takeovers by another company or by corporate raiders. Raiders are private investment funds
that specialize in buying out and reforming poorly performing companies. Takeovers are
common in industries with slow growth and excess capacity.
Shareholder Pressure. If shareholders believe that the corporation is underperforming
and that the board of directors is not holding managers to task, they can attempt to elect
representatives to the board to make their voices heard.

We do not want to leave the impression that corporate life is a series of squabbles and
endless micromanagement. It isn't, because practical corporate finance has evolved to reconcile
personal and corporate intereststo keep everyone working together to increase the value of
the whole pie, not merely the size of each person's slice. Few managers at the top are lazy or
inattentive to stockholders' interests. On the contrary, the pressure to perform can be intense.

Corporate Governance in Non-Commercial Organizations

It is important to consider the nature of the sector. The not for profit (NFP) sector is one
which is growing in importance all over the world. Moreover it is much bigger than people
generally realize.

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There is a growing movement within the non profit and non-government sector to
define itself in a more constructive, accurate way. Instead of being defined by non words,
organizations are suggesting new terminology to describe the sector. The term civil society
organization (CSO) has been used by a growing number of organizations.

Definition
A not for profit organization is one whose objective is to support or engage in activities of
public or private without any commercial or monetary profit.
A non-governmental organization is a legally constituted organization which operates
without any participation or representation of any government. In the cases in which NGOs are
funded totally or partially by governments, the NGO maintains its non-governmental status
insofar as it excludes government representatives from membership in the organization.

Available Resources
For many NFPs the main source of funding comes from the government. Other sources
of funding include borrowing but this is only really an option for capital projects when some
security can be provided. So for many NFPs the other main source of funding is from fund
raising.

Accounting Issues
We have dealt with a number of accounting issues already in our consideration of
planning and budgeting; of the measurement and reporting of performance: and of the

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evaluation of results. Another important point to make though is concerning the time horizon
adopted by these organizations. Many projects are long term in nature but sources of funds are
often short term in nature. So there is a long term horizon for expenditure but a short term
horizon for income, this is problematic and a source of difficult in planning for many of these
organizations.

Governance Issues in NFPs

It is often thought that if an organization exists for a public or charitable purpose then it
must be socially responsible organization demonstrating good governance. Governance is
about how an organization conducts its operations and deals with its stakeholders. For NFPs we
can see that there is a different focus and we need to consider this in terms of governance
implications. We can consider this according to these criteria:
1. Stakeholders
There are different stakeholders for a not for profit organization and the different
stakeholder groups have different amounts of power to a profit seeking organization. It is
inevitable therefore that dealing with these stakeholders will be a much more important function
for a NFP. Moreover the sources of conflict might be different and the actions taken in resolution
of this might also be different. Inevitable also the decision making process is likely to be
different.

2. Sustainability

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In terms of doing more with fewer resources then this is always an objective for this kind
of organization. In terms of affecting the choices available to future generations then an NFP
actually seeks to do this and to redistribute resources more equitably. In terms of seeking a
continual existence then really an NFP should strive to make its purpose of existence no longer
relevant and should not seek sustainability.
Thus, sustainability is an equally important issue for these organizations but its
implications are very different in terms of both motivation and decision making.

3. Accountability
Accountability is an even more important issue for this kind of organization and who it is
accountable to can be very different. Without either shareholders or customers then
accountability is to donors, beneficiaries and a wide range of other stakeholders. Moreover, it
needs to address this accountabilitywhich can be different for different stakeholders in order
to be able to continue with its operations.

4. Transparency
With this diverse set of stakeholders groupings who all have considerable interest in the
organization and it activity then there is obviously a great need for transparency and all such
organizations will strive for this. This is particularly exacerbated by the need to keep fund for
specified restricted purposes. On the other hand, it is the interest of the NFP to seek to use its
accounting system and procedures to classify indirect costs as direct and thereby to minimize

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the apparent administrative costs incurred. This is contrary to the principle of disclosure but
completely understandable.

5. Disclosure
Increasing disclosure is a feature of corporate reporting as they seek to satisfy
stakeholders through increased accountability and transparency. Disclosure has of course
always been a feature of NFP activity as such disclosure is necessary to seek additional funds
as well as to satisfy the diverse but powerful and vociferous stakeholder groupings. In this
respect therefore it might be considered that profit seeking organization are becoming more like
not for profit organizations.

The environment in which not for profit organizations operate is somewhat different but
there are still governance implications which are mostly concerned with sustainability and with
accountability. Particular features of this environment are:
1. uncertain resource availability and its effect on long term planning
2. stakeholder power involvement
3. conflicting priorities
4. legal environment
5. managing ambiguity

References:
De George, R. (1999). Business Ethics. Prentice-Hall International, Inc. A Simon & Schuster
Company, Englewood Cliffs, New Jersey 07632

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Fraedrich, J., Ferrell, O., Ferrell, L., (2012). Ethical Decision Making for Business. 8 th Edition,
Cengage Learning Asia Pte. Ltd (Philippine Branch), Raffles Corporate Center, Emerald
Avenue, Ortigas Avenue, Pasig City, 1605 Philippines
Friedman, M. (1970). The Social Responsibility of Business is to Increase Its Profits. The New
York Times Magazine.
Maximiano, J. (2007). Business Ethics and Social Responsibility. Rex Bookstore.