When corporate giants fall, we often associate it with poor governance or the lack of it. Just ask WorldCom or Enron, which were brought almost to their knees by high-profile fraudulent allegations, mainly relating to corporate governance lapses.
In contrast, companies like PepsiCo, Unilever, and Coca-Cola have always rode on the wave of success due to a solid corporate governance culture. So, there’s undeniably a correlation between corporate governance and business performance.
Good governance forms the basis of good corporate practices like transparency, accountability, compliance, ethics, and integrity. On the other hand, poor governance opens a window for corporate malfeasances like fraud, insider trading, bribery, and money laundering.
With corporate governance’s topography changing daily, the only way to keep up is to stay abreast of everything happening in and around the boardroom, and that’s where this guide comes in.
You’ll learn the meaning of corporate governance, its principles, and key stakeholders’ role in promoting good governance and business performance. Moreover, you’ll discover the general impact of corporate governance on business operations and the best governance practices for improving business performance.
Let’s dive in!
Key Takeaway:
- Corporate governance depicts the framework that runs a company and encompasses rules, regulations, and principles.
- Good corporate governance is founded on transparency, independence, accountability, responsibility, fairness, integrity, and risk awareness.
- The board of directors, audit committee, and shareholders are key governance stakeholders whose actions directly impact business performance.
- Corporate governance impacts business performance through incentive alignment, corporate strategy, value creation, value retention, risk management, corporate hygiene, and brand image.
- Good corporate governance practices, which include effective recruitment, board independence, strategy alignment, board accountability, ethics and integrity, board clarity, accurate reporting, effective communication, technology leveraging, sustainability practices, proactive risk management, and policy documentation, can improve business performance.
What’s Corporate Governance?
Corporate governance refers to the process by which a company is run and the rules and practices employed in its management. In order to establish and implement these rules and practices, it’s necessary to balance the interests of various stakeholders, which include shareholders, company employees, senior management, suppliers, lenders, customers, regulators, and the community.
However, the board of directors is the primary force driving corporate governance.
Corporate Governance Principles for Improved Business Performance
Solid corporate governance is founded on several pillars instrumental to improving business performance. These pillars/principles include the following:
a) Transparency
The board of directors, which relishes the mandate of spearheading the business’s corporate governance drive, should ensure the clarity, accuracy, and reliability of the information it provides. This is particularly important when sharing information about the business’s financial performance, potential risks, compliance, and conflicts of interest.
b) Independence
All boards of directors need some level of independence, and that’s where external or outside directors come in. They are independent—unaffiliated with company leadership—and thus can offer unbiased oversight. This can help identify areas where the business is lagging in performance and fix them.
c) Accountability
The board, in particular, should account for the decisions it makes on behalf of the company. It should communicate and provide convincing proof of asset allocation, budgeting, executive compensation, and risk management efforts.
Doing so keeps the business on course. Ideally, when board members are accountable for their actions, they are usually self-driven to achieve desired results, which significantly helps boost the business’s performance.
d) Responsibility
The board of directors has an oversight role on corporate matters. It must ensure everyone understands their roles, especially the leadership, and takes responsibility for their actions. With defined responsibilities, everyone can do their job.
More importantly, there’s time productivity, where directors set priorities and can manage their time wisely in attending to their corporate mandate. In the long run, their output improves, and so does the performance of the business.
e) Fairness
All board members must feel respected, appreciated, and needed in the company. The same goes for shareholders, employees, and other stakeholders. The board should treat all stakeholders fairly, and that will prompt them to play their part diligently.
f) Integrity
A solid governance foundation is built on strong moral principles—the ability to distinguish good from wrong. Integrity encompasses principles such as honesty, decency, and respect. The board sets the tone, which the management must reflect and the rest of the workforce must follow.
g) Risk Awareness
As long as you run a business, risks will always exist. They are just inevitable. However, the company must identify potential hazards, assess their severity, and develop the best mitigation efforts. Good corporate governance demands effective risk management, leading to improved business performance.
Key Governance Stakeholders and Their Impact on Business Performance
Several company stakeholders are pivotal to promoting good governance, and their contribution directly affects the business’s performance. Let’s explore them below.
Board of Directors
As the primary driving force behind corporate governance, the board’s contribution to enforcing the right corporate governance culture is invaluable. They do that by making critical decisions on executive appointments and compensations, dividend policies, budgeting, and risk management. The board acts in the best interest of shareholders and other stakeholders, which means doing what it takes to keep the business competitive.
Audit Committee
The audit committee is another fundamental player in promoting good corporate governance and improving business performance. This board-level committee ensures that the company’s financial reporting is correct and reliable and that the interests of the business are well protected.
The audit committee oversees financial reporting, internal controls, risk management protocols, and external auditor performance. It also holds the board and everyone responsible accountable for audit missteps.
Shareholders
The shareholders, who may form part of the executive board, have a paramount role in corporate governance. They wouldn’t want it to fail because they have a financial interest in the business. They are thus concerned with its operations.
For example, shareholders exercise their voting rights to have a say in the business’s strategic decisions. Overall, their support is critical to driving the company’s corporate objectives.
Discussing the Impact of Corporate Governance on Business Performance
There’s a momentous relationship between corporate governance and business performance. Here are the general impacts that the former have on the latter:
1. Incentive Alignment
Corporate governance offers the proper mechanisms for aligning incentives between stakeholders (mainly shareholders) and managers. Performance-based pay and other compensation frameworks make such alignment attainable.
Moreover, corporate governance promotes incentive alignment by providing transparent and accurate financial reporting, which minimizes information asymmetries between investors and company managers.
2. Corporate Strategy
Good governance sets the tone for the company’s long-term plan. With good governance, a company can define its goal, vision, mission, and strategic direction. Good governance enables a company to establish a variety of strategies, especially growth strategy, competitive strategy, risk management strategy, turnaround strategy, retrenchment strategy, divestiture strategy, and stability strategy, among others.
3. Value Creation
Corporate governance enables businesses to create more value using different mainstreams. A robust corporate governance structure is critical to promoting these value-creation advantages:
- Better return: Companies with good governance generate twice as much return as those without a solid governance structure. In terms of profit, companies with strong governance are up to 29% more efficient in generating profits from allocated resources, according to a study by Grant Thornton UK.
- Improved cash flow: The study by Grant Thornton UK also shows that solid corporate governance can help a business generate 3-4 times the cash flow from its operations. Even more, companies that continuously enhance their corporate governance are more likely to improve their subsequent operating cash flow by up to 44%, which is impressive.
- Investor attraction: Good governance attracts investors who become more confident in the board and senior management and can trust them with their money. The more investors support the leadership, the harder they work and influence employees to work and the better their output.
4. Value Retention
Corporate governance not only enables a business to create value but also to retain it. Over time, a business that adapts a solid governance structure becomes more valuable by the day. Here’s how that is possible:
- Staff retention: Good governance motivates employees and improves trust in leadership. As a result, more staff members will likely stay with the company and give their all, leading to improved business performance.
- More liquidity: According to the Grant Thornton UK study, companies with effective governance enjoy up to 25% more liquidity. Governance improves liquidity by improving financial and business operation efficiency and board decision-making.
- Operation resilience: Most companies fail because of poor governance—it’s no longer a secret. However, those with a solid governance structure are more resilient to operations-related failures and thus able to retain their value longer.
- Debt management: Businesses with a solid governance structure are 15% less financially leveraged, which means they can pay off their long-term debt. Also, having at least 25% more liquidity means they have more success with debt management.
5. Risk Management
Risk awareness and mitigation are critical pillars of good governance. Good governance means a business can identify potential risks and proactively mitigate the likely impacts. The risk management protocols are clear, and emphasis is placed on actions that are in the best interest of stakeholders.
6. Corporate Hygiene
Generally, it goes against a company’s policies to put personal interest above stakeholders’ interest. Bad practices like fraud and corruption are avoidable, as there’s improved accountability and transparency. The business can stay compliant and avoid anything that could ruin its image or result in costly financial implications.
7. Brand Image
Good governance improves your business’s image. It gives the company a reputational boost in the eyes of stakeholders, especially the community, staff, and regulatory authorities. Corporate governance calls for compliance with all business regulations and laws. Once a business does that, its public image improves, enhancing its performance.
Best Corporate Governance Practices for Improved Business Performance
For corporate governance to work and boost public performance, these practices are worth adopting:
a) Effective Recruitment
Board composition is a crucial consideration for effective corporate governance and business performance. Ideally, a nominating and recruiting committee should handle recruiting effective board members and nominating top executives.
The recruitment should be merit-based, whereby the candidates meet all the minimum qualification requirements, and one isn’t there just because of affiliation with shareholders. More importantly, diversity and inclusion must be considered when constituting the board or replacing members.
b) Board Independence
As much as inside directors do most of the heavy lifting and most are shareholders, there’s the need for outside directors. They offer non-partisan and objective-driven oversight and contribute to accountability and regulatory compliance by the executive board.
Moreover, independent directors facilitate effective succession planning, board dynamics, and stakeholder engagement and, in the long run, lead to better corporate governance.
c) Strategy Alignment
Everyone should work towards the company’s strategic goals for good governance to reign. The board, in particular, should align its risk mitigation efforts with the company’s objectives. Proper frameworks should be in place to monitor and address emerging risks and drive the company to its strategic plans and long-term goals.
d) Board Accountability
The board of directors needs to be held accountable for the decisions it makes on behalf of shareholders and other stakeholders. It should be measured against key performance indicators (KPIs) and other metrics to ensure it delivers on its mandate. Accountability applies to resource allocation, board member compensation, and general performance.
e) Ethics and Integrity
Ethics and integrity are the moral scopes that drive a company and enable it to be held to high standards by everyone. With good ethics and integrity, board members can avoid corporate misconduct like bribery, corruption, fraud, and money laundering.
Instead of acting in self-interest, they act in the interest of the company and stakeholders. Whistleblower policies, honest rewards for ethical conduct, and accountability are some of the best practices that can build a culture of good moral conduct and integrity.
f) Board Clarity
Everyone looks at the board of directors for clarity regarding governance. The board members should all have defined roles and understand their rights and boundaries. The management should also have the same clarity. They shouldn’t overstep any boundaries.
Moreover, the board should clearly define the company’s corporate strategy, and everyone should work toward the strategic direction that the leadership takes.
g) Accurate Reporting
Good governance cannot exist without accurate reporting, especially on financial performance and risk management. Financial reporting, in particular, should be reliable, timely, and transparent.
Doing so safeguards the integrity of the business and the interests of stakeholders, improving their confidence in the business and ultimately leading to better performance.
h) Effective Communication
Good communication is critical to solid corporate governance. Everyone on the board should have the freedom and opportunity to speak up, and their perspectives must be considered.
Effective communication is generally possible with a clear, long-term communication strategy. That will encourage collaboration between ownership and leadership.
Companies should also employ the right communication technology, emphasize transparency, and encourage constructive dialogue. Effective communication enhances collaboration and respect for the chain of command.
i) Technology Leveraging
Technology has power in the boardroom, but sadly, few use it to gain an edge. AI governance is taking over the boardroom as robo-directors are replacing human directors to offer unbiased oversight and help the board make shrewd decisions.
The contribution of machines in boardroom discussions is becoming increasingly invaluable, increasing their overreliance. So, it’s about time we leverage their influence in the boardroom. They now have voting, data collection, information processing, and analytical ability, which are indispensable in the boardroom.
j) Sustainability Practices
It’s hard to talk about corporate governance without mentioning sustainability. The best-performing companies prioritize ESG (ethical, social, and governance) reporting and sustainability initiatives like waste reduction and energy efficiency. Corporate sustainability is now built on reporting transparency, regulatory compliance, and social responsibility.
k) Proactive Risk Management
It takes proactive approaches to effectively manage corporate risks and ensure they don’t negatively affect the business’s performance. It all starts with the assessment phase, where you identify potential hazards and determine the probability of their negative impact.
Then, there are the management planning, mitigation, and control phases, and lastly, the response planning and action plan phases. All these phases are essential for taking proactive steps to manage risks in a corporate setting.
l) Policy Documentation
While developing governance policies and protocols is imperative, it’s equally important to document everything. Documentation makes it easy for everyone to appreciate the magnitude of their importance, and it serves as a reference point for newcomers who learn about what the company stands for and what goes against its beliefs and corporate drive.
Improve Business Performance with Corporate Governance Training!
We at the Center for Corporate Governance understand why corporate governance and business performance are inseparable. We also understand that the corporate governance landscape is fast changing and directly affecting the business terrain.
Our mission is to help promote the correct corporate governance culture, champion its best practices, and equip our client companies with the paraphernalia they need to leverage the potential of corporate governance.
We run a monthly corporate governance program, which we invite you to check out and sign up for. Thousands of corporate leaders have benefited from this groundbreaking program, which is tailor-made to address specific corporate governance issues your company is dealing with.
