Loading the player...

What is 'Corporate Governance'

Corporate governance is the system of rules, practices and processes by which a firm is directed and controlled. Corporate governance essentially involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Since corporate governance also provides the framework for attaining a company's objectives, it encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure.

BREAKING DOWN 'Corporate Governance'

Governance refers specifically to the set of rules, controls, policies and resolutions put in place to dictate corporate behavior. Proxy advisors and shareholders are important stakeholders who indirectly affect governance, but these are not examples of governance itself. The board of directors is pivotal in governance, and it can have major ramifications for equity valuation.

Communicating a firm's corporate governance is a key component of community and investor relations. On Apple's investor relations site, for example, the firm outlines its leadership and governance, including its executive team, its board of directors and also the firm's committee charters and governance documents, such as bylaws, stock ownership guidelines and Apple's articles of incorporation.

Corporate Governance and the Board of Directors

The board of directors is the primary direct stakeholder influencing corporate governance. Directors are elected by shareholders or appointed by other board members, and they represent shareholders of the company. The board is tasked with making important decisions, such as corporate officer appointments, executive compensation and dividend policy. In some instances, board obligations stretch beyond financial optimization, when shareholder resolutions call for certain social or environmental concerns to be prioritized.

Boards are often made up of of inside and independent members. Insiders are major shareholders, founders and executives. Independent directors do not share the ties of the insiders, but they are chosen because of their experience managing or directing other large companies. Independents are considered helpful for governance because they dilute the concentration of power and help align shareholder interest with those of the insiders.

Good and Bad Governance

Bad corporate governance can cast doubt on a company's reliability, integrity or obligation to shareholders — which can have implications on the firm's financial health. Tolerance or support of illegal activities can create scandals like the one that rocked Volkswagen AG in 2015, when it was revealed that the firm had rigged engine emissions tests in America and Europe. Volkswagen saw its stock shed nearly half its value in the days following the start of the scandal, and its global sales in the first full month following the news fell 4.5%.

Companies that do not cooperate sufficiently with auditors or do not select auditors with the appropriate scale can publish spurious or noncompliant financial results. Bad executive compensation packages fail to create optimal incentive for corporate officers. Poorly structured boards make it too difficult for shareholders to oust ineffective incumbents. Corporate governance became a pressing issue following the 2002 introduction of the Sarbanes-Oxley Act in the United States, which was ushered in to restore public confidence in companies and markets after accounting fraud bankrupted high-profile companies such as Enron and WorldCom.

Good corporate governance creates a transparent set of rules and controls in which shareholders, directors and officers have aligned incentives. Most companies strive to have a high level of corporate governance. For many shareholders, it is not enough for a company to merely be profitable; it also needs to demonstrate good corporate citizenship through environmental awareness, ethical behavior and sound corporate governance practices.

RELATED TERMS
  1. Inside Director

    An inside director is a board member who is an employee, officer ...
  2. Market-Based Corporate Governance ...

    A system relying on the investors of a firm to exert control ...
  3. Directorate

    An organization headed by a director. In finance, directorate ...
  4. Nomination Committee

    A nomination committee is a committee that acts as part of an ...
  5. Corporate Resolution

    A corporate resolution is a written statement created by the ...
  6. Classified Board

    A classified board is a structure for a board of directors where ...
Related Articles
  1. Investing

    Evaluating The Board Of Directors

    Corporate structure can tell you a lot about a company's potential. Learn more here.
  2. Managing Wealth

    How To Become A Corporate Board Member

    We look at how corporate boards are constructed, and how investors can get involved.
  3. Managing Wealth

    Retired execs: How much do corporate boards pay?

    If you have the right skill set, getting a seat on a company board can be a lucrative and stimulating way to spend some of your new free time.
  4. Managing Wealth

    Know Your Shareholder Rights

    Common-stock owners have numerous privileges and should be vigilant in monitoring a company.
  5. Investing

    How Your Vote Can Change Corporate Policy

    Shareholders are getting a bigger say in how companies are run. Find out how you can be heard.
  6. Investing

    Proxy Season 2016: Most Wonderful Time of the Year

    Each year, public companies hold shareholder meetings where individual and institutional investors vote on the future. Here is what to watch in 2016.
  7. Small Business

    Risks Associated With Government Contracts

    Government contracts can be rewarding, but they also come with a variety of risks.
  8. Insights

    Government Regulations: Do They Help Businesses?

    These rules are in place to protect consumers and help businesses thrive at the same time.
  9. Investing

    A Peek Into Shareholder Meetings

    Shareholder meetings can be glamorous, exciting or controversial, but not particularly revelatory.
RELATED FAQS
  1. What are the different groups involved in corporate governance?

    Learn about the challenges inherent to defining and executing corporate governance, and understand why different groups work ... Read Answer >>
  2. How do a corporation's shareholders influence its Board of Directors?

    Find out how shareholders can influence the activity of the members of the board of directors and even change official corporate ... Read Answer >>
  3. What is the difference between a president and a CEO?

    In corporate governance and structure, the roles of both CEO and president often vary across firms. Read Answer >>
  4. What rights do all common shareholders have?

    Learn what rights all common shareholders have, and understand the remedies that can be taken if those rights are violated ... Read Answer >>
  5. What are some examples of different corporate governance systems across the world?

    Read about the three major types of corporate governance systems: the Japanese model, the Anglo-Saxon model and the continental ... Read Answer >>
  6. What is a staggered board?

    A staggered board of directors (also known as a classified board) is a board that is made up of different classes of directors. ... Read Answer >>
Hot Definitions
  1. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  2. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  3. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  4. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  5. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  6. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
Trading Center