Overview of Corporate Governance

Every organization works in a society/business environment and thus is comprised of many of the stakeholders that affect the organization and are influenced by the same in return. To govern the behavior of a corporation, some laws are formulated in every nation. However, apart from the rules, regulations and the laws, another concept known as corporate governance also does exist. In a general sense, corporate governance can be understood as a set of good practices, which governs the way of working of corporations for a positive change. Similar to the law of the nation, corporate governance rules are also different in every country, but the basic concept is almost the same everywhere. In an attempt to understand the need of corporate governance, it is significant to note that many of the times it has been noted that management of the corporations uses its powers in an unfair manner. Hence, in order to control such conflict of interest issues, the presence of corporate governance is essential. The necessity is significant when the entity concerned is a company, where the boards of directors manage the affairs of the entity while having a separate identity. As decided in the case of Salomon v A Salomon & Co Ltd [1896] UKHL 1, a company is a separate legal personality and directors and officers of the same cannot be held personally liable for the acts of the same. Therefore many of the times, management acts for their personal benefits and forget the fiduciary relationship with the stakeholders of the company, In addition to this, many of the times, management only works in the favour of shareholders and ignore the interest of other stakeholders. This is also a matter of concern as every stakeholder plays an important role in the success of the company and expects a good behavior in return. The objective of this essay is to evaluate the value of stakeholders while discussing various corporate governance theories. In the presented essay, the discussion will be focused on different ways and methods by the help of which interest of stakeholders can be included in the process of the corporate governance accountability process.  

There is no universal definition of corporate governance and many of the scholars and authors have defined the same differently over the years. According to Marc Goergen, corporate governance is a system that deals and manages the conflict of interest issues between the finance providers and managers, stakeholders and shareholders, the minority and majority shareholders and prevents or mitigates the said issues. Further, as per the American Management Association, corporate governance is a system by which the suppliers of the capital ensure that the management of the company are not misusing the capital by investing the same in risky projects. Thus, the corporate governance is a framework by which the creditors and shareholders monitor the managers. In an overall view, corporate governance can be understood as a system of practices, processes, and rules, which govern and control the behavior of a corporation. In the UK, the history of corporate governance is older than 30 years. In the year 1991, London Stock Exchange, the UK Government, an independent regulator supported by accountancy organization and Key members of the accountancy profession and the Financial Reporting Council constituted a committee, which was commonly known as Cadbury committee. This committee had released its report on the financial aspects of corporate governance, which has proven to be very significant. This committee also provided a definition of its own for corporate governance. According to the committee, corporate governance is a system by which companies are controlled and directed. The present model of corporate governance is the result of development of different committees, codes, and regulations on the subject of corporate governance over the years. In the country UK, Companies Act 2006 consists of the provisions of corporate governance. In the said legislation, duties of directors have been codified in a comprehensive manner. A number of the cases comprise of the pronounced judgments, in which directors have breached their duties and therefore have faced litigations and penalties. This proves the importance of corporate governance and thus it can be said that the compliance with corporate governance is no more a voluntary thing to do. However many of the scholars have argued while attempting the interpretation of section 172 of Companies Act 2006, that the focus has been made on the shareholders only. Now Companies (Miscellaneous Reporting) Regulations 2018 is regarded as a significant step in the sector of corporate governance. This code considers the interest of every stakeholder.

Corporate Governance Theories

Similar to various definitions, various approaches are also there with respect to corporate governance, which are known as corporate governance theories. Before discussing the different corporate governance theories, first, it is required to understand that what these theories are. In order to answer this question, it is significant to note that these theories make use of different approaches and concepts in respect to corporate governance, and are focused on various different groups. In the following section, some lead theories of corporate governance such as agency theory, shareholder theory, and stakeholder theory would be discussed.

Agency theory arises out of the distinction between ownership and management of the company. The theory states that shareholders are the true owners of the company but do not take part in the management process. This is the reason that being the manager of the money invested by shareholders, the board of directors acts as an agent of them. In such a situation, shareholders are regarded as the principals. As in general, the agent is responsible to work in the best interest of the principal, the same goes with the management of the company. The boards of directors are required to act in the best interest of the shareholders. Because of the separation of ownership from management and existence of agency relationship, the concept of corporate governance has been developed. It has been noted that directors and officers of the company were using their managerial position for their personal benefits and in this way, they were ignoring the interest of shareholders as well of other stakeholders. The agency theory states that managers should be accountable in their responsibilities and task.

Another major theory is shareholder theory, which is based on the principles of agency theory in a manner, as it believes that directors and officers owe their duty towards the real owner of the company. Milton Friedman developed this theory. The theory prevents the willful behavior of directors and controls the issue of unethical decision-making. Thus, it would not be wrongful to state that agency theory provided the basis of the shareholder theory. However, the shareholder theory was also not perfect in itself. There were some issues with this theory as the same only made it is focus on the shareholders and did not recognize the interest of other stakeholders. According to the developer of this theory, a company has no social responsibility about anyone else apart from the shareholder as they invest their capital to a company. In the year 1984, R. Edward Freeman firstly described the stakeholder theory in his book titled as “Strategic Management: A Stakeholder Approach.” As the name implies, this theory develops it focus on all the stakeholders and do not consider the interests of shareholders only. This theory identifies the accountability of the management of the companies towards a vast range of stakeholders, such as the consumers, employees, investors and others. The reason behind the development of this theory is that shareholder theory had some deficiencies. Although directors acts as the agents of the shareholder, yet they own responsibility towards each of the stakeholder. If directors would act considering the interest of shareholders only, then there will be an unfair situation for the rest of the stakeholders. To conclude the different approaches of corporate governance it can be stated that, the current business scenario demands that the stakeholder theory must be considered. This is because; stakeholders have their different and unique role and importance in an organization.

Agency Theory

To elaborate the stakeholder theory a bit more, it is significant to state that the theory believes every person who has a direct or indirect interest in the affairs of the company creates a liability for directors to work for their favour. Many of the supporting points of this theory are there. This theory is the reason because of which the organization uses various methods and techniques of stakeholder engagement. Before moving ahead to discuss the importance of stakeholder engagement, first it is necessary to know the people that come in the category of stakeholder. Although every organization has a different set of stakeholders according to the nature and working of the company, yet some common groups of people are there which exist in almost every organization. Stakeholders of an organization can be divided into two categories i.e. the internal and the external stakeholders. However, for the consideration of stakeholder theory, this bifurcation is not the matter of significance. The reason for the same is that both the kinds of stakeholders are important from the perspective of stakeholder theory.

Firstly, the employees of the organization are one of the key stakeholders of the company. These people are responsible to provide goods/services to the customers/clients. An organization is very much dependent on its employees as without them there would be no production and a company cannot think to carry their business. Another important stakeholder is the government. Every organization works in a regulated environment and therefore various industrial and government authorities regulate the behavior of the organizations. The government has a great interest in the affairs of an organization as the same affects society as a whole. Investors on the different side cannot be considered as less important. These people invest their money in a business and expect some earning in the form of interest or dividend. These investors also include shareholders. In addition to all these people, the environment is a factor, which is very important to consider, as it is get affected by the workings of an organization. Therefore, businesses are required to take care of the environment while doing their business activities. Consumer and suppliers are the people, an organization depends on for the selling and purchasing of goods. Without consumer and suppliers, a business cannot run, especially when the same deals in goods. Every organization runs its business in a society that consists of other people. Being a part of society, it becomes the responsibility of a business to consider the interest of other people and various factors and the issues of the society. Apart from the mentioned stakeholder too, some others can be there depending on the business activities of an organization.

Shareholder Theory

After identifying the various stakeholders, the next step is to know the benefits that a corporation can reap by involving their interest in the process of corporate governance. The first and most significant benefit that a firm gets out of the stakeholder engagement process is the effective decision making. When a firm includes the stakeholders in the corporate governance process, the same makes a decision after having a discussion with those stakeholders or considering their interest. This step makes the decision process more efficient as all the stakeholders agree and co-operate with the decisions. Another benefit of considering the interests of stakeholder in corporate governance is the development of trust and goodwill. An organization, which considers the interest of stakeholder in their activity, gains more faith and trust; and held as a socially responsible organization. Some economic benefits are also there which a firm gets by considering the interest of stakeholders. This can be understood by an example. For instance, when a firm understands the concern of employees and involves their interest in the working of the same, employees act more efficiently. This prevents the issues such as lockout and strike of employees. The firm gets economic benefits out of the same. Involvement of stakeholder in the business process also increases the transparency. Stakeholders get to know that what the management of the company is doing and therefore they do not hamper their working, as they know the reasoning of the same. Because of this, the working of the directors does not get interrupted and the same becomes more focused. In order to conclude the benefits of stakeholder engagement, it is significant to state that a firm can get achieve a significant number of benefits from the same. Further to note, the engagement is required to include the stakeholders in the corporate governance rather than shareholders only. Companies that only focus on the shareholders and profit maximization cannot continue its business in the long run.

This is now clear that stakeholders are important for an organization for various reasons and therefore it is important to involve their interest. Further, it is necessary to understand what the stakeholder engagement is. This is to mention that stakeholder engagement is a process by which the management of the company involves people who are expected to be affected by their decisions or can influence the same in any manner. Stakeholder engagement is one of the important parts of the corporate governance process. However, the question is that how the management of a corporation can include the interest of stakeholders in the corporate governance accountability process. What are the steps that directors of the company need to take about this? To address all these queries, it must be noted that some methods and techniques have been formulated by which the directors can ensure the involvement of stakeholders and good governance.

Stakeholder Theory

The first method is “briefing and meetings.” To achieve the effective and two way communication, meetings are a significant tool. Here meeting refers to an open house discussion session where stakeholders can come, meet, and let the directors of the corporation know about their expectations. Meetings include workshops also where stakeholders can discuss their issues. In the meetings and briefings, management of the company can invite some representatives from each stakeholder group to have an open question-answer session. By doing the same they can get to know the expectations of stakeholders and will also be able to inform them of the expectations of companies. Further, directors can inform the reasoning for that they are not able to entertain the demands or expectations of those stakeholders groups.

Another method by which directors can include the stakeholder in the corporate governance process is the establishment of the advisory committees. These committees include a representative of stakeholders. They meet on a regular basis, consider the needs and expectations of stakeholders, and then let the directors know about the same. Advisory committees are different from briefings and meetings, as no two way communication is involved there. Only the representatives of stakeholders meet and decide that what actions director should take for them. The advisory committee method is important for another reason too. This method decreases the requirement of trade union and other representative groups. Thus, the method provides a peaceful approach by which the interest of stakeholder can be present before the board of directors. As stated earlier, there are many methods of stakeholder engagement but not all of them can apply to each group of the stakeholders.

Transparency is another thing, which needs to be there between corporates and stakeholders. Management of a company can develop transparency with different stakeholders in a different method. Directors of a company can choose various methods to increase the transparency in their affairs. Corporate governance and suitability report are one of the best methods to promote transparency. In this report, the company can state how many compliances the same has done and what were the reasons for non-compliance. In the stated report, the company can report the compliance in respect of all the stakeholders such as shareholders, government, society, customers, and suppliers. The main benefit of this report is to inform the stakeholders about the working of the company. When stakeholders of a company are aware of the decisions and performance of directors, they feel involved in the corporation. Another benefit of corporate governance report is that the same works as a standard and performance of the board of directors can be checked by the same.

Importance of Stakeholder Engagement

If not to state in general and provide the specific methods of involvement according to the specific category of stakeholder, this is to mention that a company can involve the employee in the corporate governance process by including one of their representatives in the board of directors. Although other ways such as meetings and advisory committees are there but this option can prove better than earlier stated ones. When there is a person on the board of directors who represent the interest of the employee, there are high chances of good governance practices.  Further, by using the environmental friendly materials in the production process, the company can recognize the interest of the environment and society. Further, a company can appoint a person and make the same responsible to look after the interest of the environment in its dealings. When it comes to the customers, directors should develop such policies, which are in the best interest of them. Customer grievance redress is another effective method to consider their interest in the corporate social responsibility process. By appointing some people to address the queries and complaints of consumers, directors can introduce the same to the corporate governance mechanism. Moving towards another and one of the important stakeholders of a company, which is shareholders, this is to mention that directors should use the provided capital in best projects. Before investing money to a project, views of some of the major shareholders should be invited. The reason behind doing the same is to promote the involvement of shareholders in corporate governance mechanism. Further, a continuous reporting should be there in respect of investments of the firm. By providing continuous disclosure about the investment of funds, directors can ensure the shareholders as a part of corporate governance mechanism. Every company provides an annual report to its shareholders and members, which consists a brief of the annual working of a company. This is also a good method of corporate governance which makes the stakeholders enable to know and understand that what and how a company is doing.

Moving the discussion towards the best methods of stakeholder engagement, this is to be stated that regardless of the kind of stakeholder, the best suitable method of stakeholder engagement is the one, which ensures the transparency and accountability in the dealing. The reason behind the same is that transparency is the core of a good governance practice. Until the stakeholder will not be aware of the working and decisions of the company, they would not be able to feel themselves important for management. Providing working reports and let the stakeholders know about the decisions of directors seems to be the best methods where it shows that corporate actually cares about them. Other methods such as briefings and meetings and advisory committees are also good but they have certain limitations and can make the working of directors delayed sometimes Further, it also ensures that directors are taking responsibilities of their decisions and in future will be there to provide an explanation about the same if needed.

Categories of Stakeholders

To conclude this essay, it is stated that corporate governance is one of the important aspects of business in a current business scenario. In the presented essay, the discussion has been made about meaning or corporate governance. Further, some lead theories of corporate governance have also been discussed. In conjunction with this, some other questions such as who the stakeholders are. What is the importance of the same? How their interest can be introduced to corporate governance mechanism have also been answered. This is to conclude that in UK Companies Act 2006 prescribes the duty of directors and ensure the good corporate governance practices, yet improvement is needed in this sector. Often the directors breach their duties and ignore the interest of stakeholders. Further, some companies only consider the interest of shareholder, which is also not correct again. Every stakeholder is important and directors should take care of all of them. Profit should not be the only focus of directors as the same can provide as a short-term success to the company. In the above discussion, reasoning has been mentioned that why every stakeholder is important. The government, customer, suppliers, society, and environment, all play an important role and affect the organization. If the company will avoid their interest, the same can face issues in future for sure. Being a part of the business environment, companies should involve all the stakeholders in the governance process in order to ensure success in the long run.

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