Introduction
Corporate governance is the system by which companies are directed and controlled. The term ‘corporate governance’ means the governance of companies (corporate bodies). Similar issues arise for the governance of other entities, such as government bodies, state-owned entities and non-government organisations such as charities. Cadbury Report (1992).
Corporate governance is one key element in improving economic efficiency and growth as well as enhancing investor confidence. The presence of an effective corporate governance system, within an individual company and across an economy as a whole, helps to provide a degree of confidence that is necessary for the proper functioning of a market economy. As a result the cost of capital is lower and firms are encouraged to use resources efficiently, thereby underpinning growth.
The separation of ownership from control
The owners of a company are its equity shareholders. The control over a company’s strategies and activities is in the hands of its directors and senior management. In small companies, the owners of a company (its shareholders) are also the managers: this means that the same individuals have both ownership and control.
In larger companies, however, the shareholders are not involved in control over the business. Control is in the hands of professional managers and directors, who are expected to provide leadership for the company in the interests of its shareholders. In these companies, ownership is separated from control.
Objectives of the OECD Principles
The OECD Principles are published by the Organisation for Economic Co- operation and Development, and they are intended to:
- assist governments of countries to improve the legal, regulatory and institutional frameworks for corporate governance in their countries, and
- provide guidance to stock exchanges, investors and companies on how to implement best practice in corporate governance.
The members of the OECD are governments of about 30 economically- developed countries, and its objective is to encourage the development of the world economy. The OECD has recognised that a key to economic development in any country is an efficient market economy in which investors have confidence to invest their money. The Introduction to the OECD Principles makes a link between corporate governance and economic growth
Content of the OECD Principles
The OECD Principles (2015) provide guidance through recommendations and annotations across six chapters (OECD Principles of Corporate Governance – 2015 Edition, © OECD 2015)
Principle I: Ensuring the basis for an effective corporate governance framework
“Effective corporate governance requires a sound legal, regulatory and institutional framework that market participants can rely on when they establish their private contractual relations. This corporate governance framework typically comprises elements of legislation, regulation, self-regulatory arrangements, voluntary commitments and business practices that are the result of a country’s specific circumstances, history and tradition. The desirable mix between legislation, regulation, self-regulation, voluntary standards, etc., will therefore vary from country to country. The legislative and regulatory elements of the corporate governance framework can usefully be complemented by soft law elements based on the “comply or explain” principle such as corporate governance codes in order to allow for flexibility and address specificities of individual companies.”
This principle is concerned with the framework for good corporate governance that is provided by the stock market and financial intermediaries, the regulation of the markets and the information that is available to investors about companies (‘transparency’ in the markets). It is useful to think about this principle in terms of countries that fail to provide transparency in markets, or stock markets that function efficiently, or markets in which the rule of law is fair and properly applied.
Principle II: The rights and equitable treatment of shareholders and key ownership functions
“The corporate governance framework should protect and facilitate the exercise of shareholders’ rights and 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.” Shareholders have “basic shareholder rights, including the right to information and participation through the shareholder meeting in key company decisions.” There should also be disclosure of control structures, such as different voting rights. Issues relating to the rights and equitable treatment of shareholders include the use of information technology at shareholder meetings, and shareholder participation in decisions on executive remuneration.
This Principle is concerned with the basic rights of shareholders, which should include the right to transfer the ownership of their shares, the right to receive regular and relevant information about the company, the right to vote at general meetings of company shareholders, the right to share in the company’s profits , the right to remove directors from the board and the right to participate in decisions about executives’ remuneration.
These basic shareholder rights might seem ‘obvious’. However, there are countries in which these rights do not properly exist, especially for foreign shareholders. For example the laws of a country may permit a company to insist that shareholders wishing to vote at a general meeting of the company must attend the meeting and cannot be represented by a proxy. This requirement in effect would remove the right to vote of most foreign investors, who do not have the time to attend general meetings in person in countries around the world.
Principle III: Institutional investors, stock markets, and other intermediaries
“The corporate governance framework should provide sound incentives throughout the investment chain and provide for stock markets to function in a way that contributes to good corporate governance.” This Principle is concerned particularly with the responsibilities of institutional investors, such as pension funds and insurance company funds, to ensure that good corporate governance practice is applied by themselves and by the companies they invest in.
Principle IV: The role of stakeholders in corporate governance
The corporate governance framework should recognise the rights of stakeholders that are 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. This will include, for example, employment rights and agreements negotiated for employees with trade union representatives.
“The competitiveness and ultimate success of a corporation is the result of teamwork that embodies contributions from a range of different resource providers including investors, employees, creditors, customers and suppliers, and other stakeholders. Corporations should recognise that the contributions of stakeholders constitute a valuable resource for building competitive and profitable companies. It is, therefore, in the long-term interest of corporations to foster wealth-creating co-operation among stakeholders.”
Principle V: Disclosure and transparency
“The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation (company), including the financial situation, performance, ownership and governance of the company.”
The disclosure of information to shareholders and investors is a critically important aspect of corporate governance.
The Principles support timely disclosure of all material developments that arise between regular reports. They also support simultaneous reporting of material or required information to all shareholders in order to ensure their equitable treatment. In maintaining close relations with investors and market participants, companies must be careful not to violate this fundamental principle of equitable treatment.
Principle VI: 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 board’s accountability to the company and the shareholders.”
This Principle relates to many of the functions of the board. It includes the requirement that “board members should act on a fully informed basis, in good faith with due diligence and care, and in the best interests of the company and the shareholders.” The board should also apply high ethical standards and take into account the interests of the company’s stakeholders.
The Impact
- Building Trust and Confidence: Implementing OECD principles cultivates trust among stakeholders. Transparent and accountable practices enhance investor confidence, attracting investments and fortifying the company’s reputation.
- Risk Mitigation and Resilience: Strong governance practices mitigate risks. They provide a safeguard against financial downturns, ethical breaches, or corporate scandals, ensuring the organization’s resilience.
- Long-Term Value Creation: By aligning corporate strategies with sustainable goals, adherence to the principles fosters long-term value creation, benefitting both shareholders and society.