View Point
September 28, 2007

Governance issues

Issues related to governance are more prominent today than they have been at any time in the past, but it is often difficult to define exactly what the term stands for and what are its objectives. Governance refers to the way in which some organization or entity is governed, as well as to the function of actually governing.{{more}} The governance of a country, for example, refers to the powers and actions of the legislative assembly, the executive arm of government and the judiciary. Corporate governance, on the other hand, is concerned with the way in which companies are governed and to what purpose. Its objectives could be to maximize the wealth of its owners- shareholders, but there are other groups which would have an interest in how the corporation acts, and they would include employees, customers and the general public.

As a field of economics, therefore, corporate governance investigates how to secure efficient management of corporations by the use of incentive mechanisms such as contracts, organizational structures and legislation. In essence, it is a system by which business corporations are directed and controlled. It can be defined narrowly as the relationship of a company to its shareholders, or more broadly as its relationship to society, and is about promoting corporate fairness, transparency and accountability.

In the case of governing a country, the process would be concerned with who has the power to rule and what the government of the country should be trying to achieve. The government of a democratic country would set its self the objective of protecting its people and acting in their best interests, whatever these might be. Powers are shared between the Legislative, the Executive and the Judiciary, but it is a matter of debate how these powers should be shared and exercised. In a large corporation, similar issues of governance arise. In this instance, corporate governance is concerned with how powers are shared and exercised by different groups to ensure that the objectives of the corporation are achieved. At the heart of the corporate governance debate is the potential conflict of interest between shareholders and either the board of directors as a whole or individual board members. The directors might be tempted to take risks and take decisions aimed at boosting short term performance. Many shareholders are more concerned with the longer term, the continuing survival of their corporation and the value of their investment. If a corporation gets into financial difficulties, professional managers can move to another corporation to start all over again, whereas shareholders suffer a financial loss.

Occasionally, the collapse of a company may be caused by an error of judgment on the part of the board of directors in its choice of strategy for the company. However, this is not always the case. It was reported in 2001, prior to the collapse of Enron, that some of its directors and senior managers had sold shares in the company, giving rise to the suspicion that they might have used insider information to protect their interests.

Where a country does not have a reputation for strong corporate governance practices, it will find that investment capital flows elsewhere. If investors are not confident with the level of disclosure in a country or if the country opts for lax accounting and reporting standards, capital will also flow elsewhere. Markets today exist by the courtesy of investors. And it is today’s more empowered investors who will determine which companies and which markets will attract their funds. Any developing country which pays scant respect to sound corporate governance practices will do so at its own peril. But those which develop ‘Codes of Best Practice’ and ensure that they are complied with will have taken a significant step towards making their environment more conductive to inflows of foreign investment.