Corporate Governance, I believe goes beyond the written word and is much more than just following the book. In fact, many-a-times its principles are unwritten. Simply put, corporate governance is a set of rules and procedures for steering corporate behaviour. It is less about policing and more about inculcating transparency and accountability, as an intrinsic part of corporate culture.
Embedding an efficacious corporate governance framework is really a function of how well its need is understood by the three key stakeholders - Management, the Board and the Shareholders. Needless to say, tone-at-the-top is the most important ingredient.
The importance of good corporate governance is that bit more, also because of the fiduciary duty towards customers and other stakeholders, including investors, and for the trust they repose in a company. Because in addition to asking ‘what a company does’, people today are also asking and are more interested in ‘how it does it’.
One important skill set that every governance manager must possess, is the ability to understand the business, because there is no one-size-fits-all solution for governance. While the basic key tenets remain the same and constant, the framework needs to be tailor-made for a best fit.
Let’s talk about some key cornerstones of effective corporate governance:
- Transparency – Transparency is a critical pillar of corporate governance which ensures that the processes and transactions of a company are open to scrutiny and verification and that the Company has nothing to hide; it means the Company has made meaningful disclosures, keeps all stakeholders updated and complies with applicable legal requirements.
- Accountability – Accountability is a trait that helps take all actions reach the planned goals and objectives. It makes management responsible for its actions – not only for the failings, but also for all accomplishments. Positively taken, accountability brings in motivation and drives employees across the pyramid.
- Diversity at the board level - A diverse Board is a strong Board. While many countries, including India have mandated participation of women on Boards, the gender diversity continues to be in favour of men. Studies have shown that companies with women on Boards, perform better, and not just in terms of profitability. Not only gender diversity, but a diverse skill set of directors also brings in better ideas and judgement to the Board table. A healthy mix of independent and executive directors is also essential, so that management and the Board work at their respective levels and there is no overlap of authority.
- Flow of information – It’s a known fact that more information makes better decisions. It is the responsibility of the management to ensure sufficient and relevant flow of information to the Board, which helps in effective decision making. Regular disclosures to Customers, Regulators, Shareholders etc also increases confidence and says much about the fairness and transparency levels of the company.
- Control functions - It is important to have a clear demarcation between the three lines of defence within an organisation - business, risk & compliance and internal audit, which will ensure that conflict of interest situations are handled effectively and there is a proper mitigation of risks. All well governed companies also require to have in place a mechanism for employees and others to raise concerns, around irregularities that they notice and a defined framework to handle these concerns.
- Board evaluation – Stakeholders are increasingly interested in Board evaluation results, which is a direct indicator of effectiveness of a Board and its accountability. An effective evaluation process, helps the Board, its committees and individual directors perform to their optimum capabilities.
- Effective delegation - The Board needs to have a well-defined charter/ terms of reference, which would enlist its roles and responsibilities and the Board room processes. The Board must also effectively delegate responsibilities to its committees, so as to allow adequate time to discharge its strategic responsibilities and provide the directional advice.
Why do we need corporate governance?
It is a very well known fact that good governance leads to higher returns and profitability. Good governed companies are rewarded with governance premium and deficit leads to serious eroding of profits in the long term. Strong culture of corporate integrity is a direct contributor to sustainable growth.
Many corporate failures have revealed chips in the corporate governance framework, be it non-disclosures, lack of control mechanism etc. Investor attention to corporate governance of an investee company is increasing and a large number of empirical evidence indicates that well-governed companies not just attract higher market valuations, but are also able to increase capital flow, because of the trust factor.
Good governance delivers good businesses and good businesses lead to good reputation. Good corporate reputation converts good companies into great companies.
Governance and ethics are actually two sides of the same coin and go hand-in-hand. In true sense, Ethics is really what our primary teachers taught us during moral science classes - speak the truth, be good to others, don’t hurt the environment and do your work diligently.
As Thomas Friedman (Author – The World is Flat) once said – "We don’t need a financial bailout; we need an ethical bailout. We need to re-establish the core balance between our markets, ethics and regulations."