What Is Corporate Governance?

Corporate governance provides the framework for how a company is led

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Corporate governance is any set of rules, corporate charter, bylaws, or formal policies by which a company and its leadership are guided in operating. Corporate governance involves balancing the interests of a company’s shareholders with those of its stakeholders, the latter of which can include a company’s employees, board members, business partners, and members of the larger community.

Because investors are increasingly interested in aligning their investments with their values, corporate governance has become a key component of companies’ overall operating structure. In fact, an investment strategy that has gained popularity is based on companies’ environmental, social, and governance (ESG) principles.

Good corporate governance allows a company to promote ethical business practices alongside its financial performance.

How Corporate Governance Works

Whether a company is publicly traded or privately held, it’s a good business practice to monitor the effectiveness of its policies as they relate to corporate responsibility, executive compensation, sustainability, human rights, diversity and inclusion, and social impact. Corporate governance is a set of rules—typically approved by a company’s board of directors—that can align corporate practices with these objectives.

Many companies strive to make their corporate governance policies as visible as possible to reinforce their commitment to the issues mentioned above.

For example, Nike, like many large corporations today, has a page on its website devoted to explaining its corporate governance policies. It lists its board members, explains how they are appointed and compensated, and provides details of Nike’s corporate governance guidelines. It also includes a letter explaining the company’s code of conduct from Nike president and chief executive officer (CEO) John Donahoe.

Like many companies, Nike also regularly reports on its corporate governance in its communication with investors. “In fiscal 2019, we also assessed and enhanced our committee charters,” Mark G. Parker, chairman of Nike’s board of directors, said in a proxy statement from that year. “Specifically, we updated our Corporate Responsibility, Sustainability & Governance Committee charter to more explicitly highlight the committee’s continuing oversight of our integrated Purpose Offense, a unified approach to our focus on and commitment to sustainability, social and community impact, and diversity and inclusion.”

Who Ensures Corporate Governance?

The overriding objective of corporate governance is to align the interests of different parties and ensure that all parties work to achieve a company’s common goals.

Corporate governance exists not only to create ethical standards, but also is aimed at holding all parties accountable for meeting those standards.

There are different corporate structures designed to enforce corporate governance guidelines. Companies, both public and private, may have any or all of these entities in place to monitor adherence to these guidelines.

Top Management Team

Typically led by a CEO, this group may also include a chief operating officer (COO), chief financial officer (CFO), chief technology officer (CTO), and a chief marketing officer (CMO).

Board of Directors

A group of elected or appointed directors whose purpose is to advise and monitor the firm’s top management team on behalf of shareholders, the board represents the interests of shareholders and stakeholders. A board often has a chairperson. Board members may be a blend of internal (company employees) and external individuals.

Shareholders

Most publicly held companies hold an annual general meeting to which shareholders are invited to attend and pose questions to the board of directors or top management team. In some cases, shareholders get to cast votes on corporate issues such as executive pay. Shareholders expressing dissatisfaction with some aspect of the company’s corporate governance—a practice known as shareholder activism—may also be effective in forcing change.

What It Means for Individual Investors

Investors want to be assured that the companies they own shares in have strong corporate governance guidelines in place.

Surprises in terms of ethical failures by publicly traded companies can drastically impact shareholder value.

In addition to carefully reviewing financials in a company’s 10-K or 10-Q reports or other disclosed documents, smart investors will complete a thorough review of a company’s corporate governance policies. Careful consideration should be given to how a company has handled past conflicts between corporate actions and its operating guidelines, or how it responded to shareholder complaints. Investors should aim to determine whether a board of directors has the necessary power to hold top management teams accountable.

More than ever, the majority of investors want to own shares of companies that will do well as an investment while also adhering to policies that make them good corporate citizens. Carefully reviewing a company’s corporate governance policies can help assure a prospective investor that this is the case.

Key Takeaways

  • Corporate governance is any set of rules, corporate charter, bylaws, or formal policies by which a company and its leadership are guided in operating.
  • A company’s leadership team is expected to adhere to the corporate governance in place. A board of directors is primarily responsible for enforcing corporate governance guidelines.
  • Investors are increasingly diligent about ensuring that companies they invest in have strong corporate governance guidelines in place that lead to ethical and sustainable business practices.
  • Corporate governance principles typically relate to company practices toward responsibility, executive compensation, sustainability, human rights, diversity and inclusion, and social impact.