Governance, Risk and

Ethics
MS. RITU SINGH
 CORPORATE GOVERNANCE
• Corporate governance is the system of rules, practices, and processes by which
organizations are directed and controlled. (Cadbury report)
• Corporate governance is a set of relationships between a company's directors, its
shareholders and other stakeholders. It also provides the structure through which the
objectives of the company are set, and the means of achieving those objectives and
monitoring performance, are determined. (OECD)
• Corporate governance aims to balance the interests of a company's many
stakeholders, such as shareholders, management, customers, suppliers, financiers,
government, and the community.
 Why Corporate Governance ?

• Globalization (Parity of treatment for local and foreign investors and characteristics of
individual cultures)
• High profile corporate scandals, failures and general dissatisfaction with financial reporting
standards
• Financial Losses- financial penalties, decreased stock value, and potential bankruptcy.
• Reputational Damage-affecting customer trust and long-term profitability.
• Legal and Regulatory Penalties: Companies may face legal actions, fines, and increased
regulatory scrutiny.
• Loss of Talent: Talent may leave the company due to ethical concerns or instability, affecting
operational effectiveness.
• Impact on Stakeholders: Employees, customers, suppliers, and the broader community can be
negatively impacted by job losses, economic downturns, and environmental damage.
 Benefits of CG: (FOCUS-IS-BAGS)
F - Framework for pursuing organizational strategies
O - Operation of appropriate and adequate control system with risk management
C - Confidence and trust of shareholders
U - Underpins capital market confidence
S - Safeguards companies‟ assets and shareholders‟ interests
I - Increase in management accountability
S - Sustainable wealth creation
B - Better management leads to better financial performance
A - Attraction for institutional investors
G - Governance dividend (Benefit of increase in share price that shareholders receives from good corporate governance
S - Socially responsible dividend (Benefit of increase in revenue and share price that company receives from customers and investors)
 Key Elements of Corporate Governance
• Board of Directors: Establishing a competent board to oversee the company's direction,
strategy, and governance practices. The board is responsible for making major decisions,
selecting and overseeing executive management, and ensuring accountability.
• Management Accountability: Ensuring that the company's management acts in the best
interests of the shareholders and other stakeholders, with mechanisms in place to monitor
performance and enforce accountability.
• Shareholder Rights: Protecting shareholders' rights, including their ability to vote on key
issues, receive dividends, and access company information.
• Stakeholder Interests: Recognizing and addressing the rights and interests of all stakeholders,
not just shareholders, including employees, customers, suppliers, and the community.
• Transparency and Disclosure: Committing to transparency in financial reporting and
disclosure of material information so that stakeholders can make informed decisions.
• Ethical Standards and Integrity: Promoting ethical behavior and corporate integrity through a
clear code of conduct, ethical standards, and a commitment to legal compliance.
• Risk Management: Implementing systems to identify, assess, manage, and monitor risks
that could affect the company's business objectives, reputation, and stakeholders' interests.
AGENCY
THEORY
Applicable for larger sized
companies where the
separation of ownership
and control is the norm.
 Agency theory
• Agency theory is a fundamental concept in corporate governance that explores the relationship
between principals (shareholders) and agents (company executives and managers).
• This theory addresses the potential conflicts of interest that arise when a principal delegates
authority to an agent to perform tasks on their behalf.
• In the context of corporate governance, agency theory focuses on ensuring that company
executives and managers act in the best interests of the shareholders who own the company.
• In company law, the directors act as agents of the company. The board of directors as a whole, and
individual directors, have the authority to bind the company to contractual agreements with other
parties. Since most of the powers to act on behalf of the company are given to the board of
directors, the directors (and the management of a company) have extensive powers in
deciding what the company should do, what its objectives should be, what its business strategies
should be, how it should invest and what its targets for performance should be.
• The powerful position of the directors raises questions about the use of this power, especially
where the owners of the company (its shareholders) and the directors are different individuals: -
How can the owners of the company make sure that the directors are acting in the best interests of
the shareholders?
• If the directors act in ways that the shareholders do not agree with, what can the shareholders do
to make the directors act differently?
 Fiduciary duty of
directors
• The fiduciary duty of directors
refers to the legal obligations that
members of the board of
directors owe to the company they
serve and its shareholders.
• These duties are grounded in
trust and confidence and are
designed to ensure that directors
act in the best interests of the
company and its stakeholders,
rather than in their own personal
interests.
 Cont.…
• In practice, it is very difficult for shareholders to use the law to challenge the
decisions and actions of the company’s directors. If shareholders believe that
the directors are not acting in the best interests of the company, their ability to
do something about the problem is restricted.
- The shareholders can vote to remove any director from office, but this
requires a majority vote by the shareholders, which might be difficult to
obtain.
- In a court of law, shareholders would have to demonstrate that the directors
were actually acting against the interests of the company, or against the clear
interests of particular shareholders, in order to persuade the court to take
legal measures against the directors.
In summary, although there is a legal relationship between the board of
directors and their company, the shareholders cannot easily use the law to
control the decisions or actions that the directors take on behalf of the company.
 Structure of the board of directors
• The board of directors is made up of executive directors and non-executive directors.
• Executive directors are full-time employees of the company and, therefore, have two relationships and sets of duties. They
work for the company in a senior capacity, usually concerned with policy matters or functional business areas of major
strategic importance. Large companies tend to have executive directors responsible for finance, IT/IS, marketing and so on.
• Executive directors are usually recruited by the board of directors. They are the highest earners in the company, with
remuneration packages made up partly of basic pay and fringe benefits and partly performance-related pay. Most large
companies now engage their executive directors under fixed term contracts, often rolling over every 12 months.
• Executive directors are responsible for the day-to-day management of the company working alongside the other board members.
In smaller companies, the directors and shareholders may be the same people, but the roles are very distinct. Most executive
directors are employees of the company.
• Non-executive directors are not involved in the day-to-day running of the business. They are not employees of the company.
Their role is to challenge and develop strategy, scrutinise the board’s performance, manage financial controls and risk, determine
remuneration, and appoint or remove executive directors if and when there is a need to do so.
• The chief executive officer (CEO) and the finance director (in the US, chief financial officer) are nearly always
executive directors.
• Non-executive directors (NEDs) are not employees of the company and are not involved in its day-to-day running.
They usually have full-time jobs elsewhere, or may sometimes be prominent individuals from public life. The non-
executive directors usually receive a flat fee for their services, and are engaged under a contract for service (civil contract,
similar to that used to hire a consultant).
 AGENCY COST
Agency costs are the costs of having an agent to make decisions on behalf of a principal.
Applying this to corporate governance, agency costs are the costs that the shareholders
incur by having managers to run the company instead of running the company
themselves.
- Agency costs do not exist when the owners and the managers are the same
individuals.
- Agency costs start to arise as soon as some of the shareholders are not also directors of
the company.
- Agency costs are potentially very high in large companies, where there are many
different shareholders and a large professional management.
Agency costs can therefore be defined as the ‘value loss’ to shareholders that arises from the
divergence of interests between the shareholders and the company’s management
The 4 types of agency problems
Principal-Principal
Problems

Principal-Agent
Problems

Agent-Agent
Problems and

Principal-Debt
Holders
Problems.
Reasons for Agency problem
1. Misalignment of Interests.
2. Lack of Accountability
3. Information Asymmetry:
4. inefficiency in operations
5. excessive risk taking by managers
6. overcompensation of senior executives
7. Inadequate monitoring of management actions by shareholders.
8. poor decision-making in business.
These problems have the potential to result in financial losses, damage business reputation, lower
employee morale, and possibly lead to regulatory consequences.
Overcoming Agency Problems: Solutions and Strategies

Contractual Solutions: Contracts can be set up to align the interests of the

Contracts

principal and the agent.

Monitoring: Regular audits and performance reviews can keep agent

behaviour in check.

Governance Mechanisms: Constructing a robust governance framework can

enhance accountability and discourage negative behaviours.
Agency problems have a significant impact
on corporate governance
• create conflicts of interest between shareholders and executives
• can lead to mistrust
• poor decision-making
• and risk-taking at expense of investors.