If a spotlight wasn’t shone on corporate governance after the Enron and WorldCom debacles, then it most certainly was with the federal government’s recent $700 million bailout plan.
The bottom line is corporate governance is necessary to ensure corporations can attract capital, perform efficiently, generate profit and meet both legal obligations as well as the expectations of society, says Edwin J. Broecker, a partner in the Business and Finance Department and Real Estate Practice Group of Taft Stettinius & Hollister LLP in Indianapolis.
Smart Business spoke with Broecker about what exactly comprises corporate governance and why it’s so important to a business’s health.
What is corporate governance?
Corporate governance is the relationship between shareholders, directors and managers that encompasses a combination of laws and regulations that enable a corporation to attract capital, perform efficiently, generate profit and meet both legal obligations as well as the expectations of society. Put another way, it is the means by which a corporation assures its investors that corporate assets provided by them are being put to appropriate, legal and profitable use.
How is corporate governance structured?
In the United States, the corporate structure is characterized by share ownership of individual, and increasingly institutional, investors not always affiliated with the corporation. Generally, shareholders bear the entire economic risk of the enterprise, are the residual claimants of income and elect a board of directors to manage the day-today affairs of the corporation. The board of directors then chooses management to make the decisions to maximize the value of the shares owned by the shareholders while considering the best interests of the corporation’s other constituents, including laborers, management and suppliers of debt capital. The objective of management decision-making may be to enhance the wealth and power of the corporation as an entity in itself.
The corporate structure assumes the separation of ownership and control. This is an important legal distinction that serves a valuable business and social purpose: Investors contribute capital and maintain ownership in the enterprise while generally avoiding legal liability for the acts of the corporation. Investors avoid legal liability by ceding control of the corporation to management and paying management to act as their agent by undertaking the corporation’s affairs. Effective corporate governance makes it more likely that the interests of the shareholders, directors and managers are aligned.
Why is it important to have regular and effective meetings?
Past market studies suggest that corporations that have active and independent boards responsible for constantly monitoring corporate governance issues tend to have a higher economic profit over time. When corporate governance is effective, it provides managers with oversight and holds boards and managers accountable for the effective and efficient use of corporate assets.
Regular board meetings make management focus on the importance of the process. Such meetings create a formal structure that helps management focus and realize the importance of the information being provided and the process of decision-making. It also helps directors establish a formal environment to focus on the fact that they are fiduciaries responsible for looking out for the shareholders’ best interest.
Who should attend these meetings, and what information should be disclosed/exchanged?
In the public company context, boards are required to have a certain percentage of independent directors. In addition, certain committees of the directors (e.g., the compensation and audit committees) must be composed of only outside directors. Often these directors will engage separate counsel or advisers to assist them in discharging their duties.
In the privately held company, there is no requirement to have independent directors. Nevertheless, having outside directors can benefit internal deliberations by providing a different and unbiased perspective on the issues at hand.
For both the public and private companies, the company’s counsel should regularly attend meetings of the board of directors and shareholders. In a closely held company that may not have dedicated personnel, other key advisers such as the company’s accountant and insurance agent should attend the meetings so that they can make the appropriate recommendations about risk management and strategic financial decisions.
In general, the meetings should cover a review of the past year, the company’s financial situation and a discussion of current issues and significant expenditures or initiatives for the upcoming year. In addition, on an annual basis the directors should appoint officers and should review and affirm their compliance program and corporate code of conduct.
EDWIN J. BROECKER is a partner in the Business and Finance Department and Real Estate Practice Group of Taft Stettinius & Hollister LLP in Indianapolis. Reach him at (317) 713-3500 or email@example.com.