Corporate Finance

What are the Factors Affecting Corporate Governance ?

Corporate Governance states the set of principles, processes, and systems that regulate the Company. On the basis, these principles, processes, and guidelines Company directs and controls the decisions to fulfil its goals and objectives. It helps to add value to the Company, and proves beneficial for all the stakeholders in the long term. In this blog, we will learn about the objectives of Corporate Governance, factors affecting corporate governance.

Readers will also get knowledge about the essentials of corporate Governance, Who are the stakeholders? How corporate Governance affects these stakeholders?, etc.

What are the Elementary Principles of Corporate Governance?

The elementary principles of corporate governance are as follows;

• Good corporate Governance focuses on conducting the business with all integrity, fairness, and being as transparent as possible regarding all the transactions.
• The Company makes all the necessary disclosures and decisions by complying with all the laws of the land.
• It takes accountability and responsibility towards the stakeholders. Commit to conducting business in an ethical manner.
• As per the SEBI reports on the essentials of corporate Governance, the controller of the companies must be able to distinguish between personal and corporate funds.

Read our article:Mandatory Website Disclosures- A Requirement under Companies Act 2013 and SEBI

Corporate Governance -Scope and Application

The scope of corporate Governance includes but limited to the collection of procedures, processes, and provisions through which the Company controls and operates. It refers to the mechanism by which the Company directs and manages its affairs. Business ethics play a substantial part in corporate governance and it is among the key factors influencing corporate governance.

The ideal model of corporate Governance follows the universally accepted principles of corporate Governance. As per the good Corporate Governance model, the Company carries out the business according to the stakeholders’ desire to earn profits. Board of directors and other related committees are responsible for running the organization conduct these business decisions to maintain a balance between individual & societal goals, and economic & social goals.

It is essential to refer to the  Shareholder vs. stakeholder theories of Corporate Governance to understand the aim and beneficiaries of the corporate governance process

Shareholder vs. Stakeholder Theory

As per the Agency Theory of Corporate Governance, the management and the shareholder hold a principal-agent relationship. This means that the management is bound to serve the interests of shareholders as an agent. However, shareholders are not the only group that is having interests in the company. Proper implication of these theories are important factors affecting corporate governance.

Let us read more about Shareholder vs. Stakeholder Theory of Corporate Governance.

Shareholder theory of Corporate Governance

The shareholder theory of corporate Governance states that the primary focus of any organization is the protection and value maximization of shareholders interests. The aim is defined to increase the market value of equity held by shareholders. As per this theory, the principles of corporate Governance aims to resolve the conflicts between shareholders and management.

Stakeholder theory of Corporate Governance

The scope of stakeholder theory is broader in comparison to shareholders theory. As per the stakeholder^[1] theory, the function of corporate governance is to protect the interests of various stakeholders that have interests in the Company. This list of beneficiaries is not limited to shareholders but also includes managers, employees, creditors, suppliers, etc.

Factors Affecting Corporate Governance

Corporate Governance is a dynamic practice consisting of internal control provisions and procedures to manage a company. It affects and gets affected by a number of factors. These factors can range from internal to external factors. Let us read more about the factors affecting corporate governance.

Market factors can be cited as an example of external factors, whereas the practice of effective communication can be an example of internal factors. 

There are different models of corporate Governance in practice as per the local laws and affiliated economic ecosystem. These have different issues in the corporate governance process as per the affairs of the organization and the influence of external factors

The prominent factors that affect corporate Governance are as follows. 

1. Shareholders Activism

Activist shareholders pressure companies to pass their proposals of change. This class of people acts in the belief that the proposal will increase the market values of their equity.

They may use various tactics for creating pressure on the board, such as filing of lawsuits and seeking representation on the board. Raising their issues during shareholders meetings or even among the public is another tactic practised by activist shareholders to influence the decision making and ultimately the corporate governance processes.

2. Threat of Hostile Takeover

The management acts as an agent of the shareholders. The principle job of the board is to serve the interests of the shareholders. If the management fails to do so, the shareholders may replace the board. Shareholders do so in a belief that by doing so, the performance will improve, and results will change.

This threat of hostile takeover for management keeps them in pressure to act in the best interest of the shareholders. Policies, procedures, and practices adopted by the board are influenced by their expected alignment with the shareholder’s interest. This may act as a factor to keep other stakeholders at a disadvantaged position. Principles of good corporate Governance expect that board to work in an impartial manner.

3. Legal Environment

Another factor that influences the relationship between the Company and its stakeholders is the prevailing legal environment. The legal system of the state influences the affairs of corporate Governance. 

Shareholders and creditors tend to have more protection in countries where common law is in practice. Under this system, previously held rulings can act as the rule of law. This is unlike the civil law system, where the rule of law books has the highest authority. The punishment, compensation, and procedures are defined in the book of the law, and rulings are based on these enacted laws.

What do Shareholders Expect from Corporate Governance?

There is a social responsibility of business to make profits along with social welfare. To increase the share value of the investors in the short-term, companies may take some irrational steps such as putting off the safety corners, or reducing expenditure on research and development, or compromising with the workplace safety, or stopping the customer support expenses, etc. These steps will increase in the share value and satisfy the investors but for the short term.

However, this is not what shareholders want. Any shareholder invests his or her money, once they have trust in a company as a whole. These shareholders want better returns, but not only in the short run. They are looking for steady and increasing dividends out of their investments.

These goals will only be possible with the perfect essentials corporate Governance of a company involved. Dissatisfied shareholders is one of the factors affecting corporate governance negatively which leads to organisational downfall.

What are the Rights of Shareholders under Corporate Governance?

The Company must look to protect and ease the way to exercise the rights of shareholders. Below are the rights of shareholders-

• The Company should grant rights to the shareholders to participate and get information regarding the decisions related to fundamental corporate changes.
• Shareholders have a right to participate actively and vote in shareholders meetings.
• The organization must inform the shareholders about the rules, voting procedures that regulate the shareholder meetings.
• Shareholders can ask questions to the board of directors, featuring new items on the list of agenda, recommend resolutions, subject to the limitations.
• Participation in the nomination and selection of board members.
• Shareholders have the power to exercise their right of ownership.

What is Stakeholder Management

Stakeholder management refers to the practice of safeguarding the interest of various stakeholders by means of polices, procedures, and incentives. Effective communication with stakeholders plays an important role in the stakeholder management process. Stakeholders management is one of the leading factors affecting corporate governance process.

There are four infrastructure of shareholder relationship management.

1. Legal Infrastructure

The legal infrastructure talks about the governing laws and legal remedies available to the stakeholders in case of violation of their rights.

2. Contractual Infrastructure

The contractual infrastructure defines the contract between the Company and the stakeholders. This contractual relationship defines the rights and responsibilities of both parties.

3. Organizational Infrastructure

Organizational infrastructure refers to processes, policies, and routine practice of the organization mentioned in the corporate governance doctrine for managing the relationship with stakeholders.

4. Government Infrastructure

The government infrastructure refers to laws and regulations which a company is obliged to follow. These include regulatory regulations and laws of the state.

Measures for Effective Stakeholder Management in Corporate Governance?

In every Company, there is a time to time communication with the stakeholders through transparent and effective communication by demonstration of general and annual reports and holding meetings.

The Company must have the most effective Governance to retain these stakeholders and have their confidence. Your Company must be able to understand the requirements of various stakeholders so that you can address them in the best way possible.

You must know when an employee wants a bonus, a shareholder looking for controlling rights, or a government wants you to fulfil the new compliance, etc. The need for corporate governance is essential for the satisfaction of various stakeholders.

Companies who are having effective communication with the stakeholders other than statutory meetings tend to have better relations with stakeholders.

Importance of Corporate Governance

Corporate Governance plays an important role in every Company. Let’s see how it is important for an organization-

• Good Corporate Governance leads to optimum level of confidence between the Company and its stakeholders,
• For better corporate Governance, your Company must have an active group of independent directors on the board. It ensures confidence in the market.
• Foreign institutional investors consider corporate Governance before investing in any of the companies. It is one of the most important criteria in the foreign investors list.
• Good corporate Governance puts a positive influence on the share price of the Company
• If the Company is maintaining a clean record and has a positive image on the corporate governance front, then it is much easier for the companies to source capital at a more reasonable cost.
• Companies having good corporate Governance are far away from scams and other bad exposures.

Benefits of Corporate Governance

If the Company is practising good corporate governance , it ensures lots of benefits to the Company-

• If the Company has good corporate Governance, it leads to corporate progress and economic growth
• In the case of strong corporate governance, the Company has the investor’s confidence. Also helps in raising the capital efficiency and be effective in its corporate matters
• It ensures a lot of saving by lowering the capital cost
• It leads to a positive impact on the prices of a share
• Corporate Governance stimulates the owners and managers of the Company to fulfil the objectives that are in the interest of the shareholders and the organization.
• Governance mitigates the risk, reduces corruption, minimizes wastage etc. and ensures better management
• It helps in the formation of the brand and development of an organization
• Corporate Governance makes the management of the company work in a way that fits the best interest of all.

Corporate Governance Forums

There is an institutional framework for corporate Governance in India that layout the constitution of Corporate Governance. Below is the list of noticeable forums and institutions of corporate Governance-

• Conference Board
• Institute of Directors
• The Institute of Company Secretaries of India
• The Asian Corporate Governance Association
• International Corporate Governance Network
• National Foundation for Corporate Governance
• Corporate Secretaries International Association
• Organization for Economic Co-operation and development
• The European Corporate Governance Institute
• The Institute of Company Secretaries of India
• Global Corporate Governance Forum

Consequences of Corporate Governance focusing on Short-term Maximization of Wealth

• The Short-term goal towards the stakeholders (such as employees, customers, suppliers, creditors, etc.) of the Company affects the long-term growth of the Company.
• Annoyed employees, dissatisfied customers, outstanding creditors, or supplies do not stay with the Company in the long run
• This affects the business and fluctuates the profits of the Company
• If the Company tends to cut back on the critical aspects of the Company, investors lose their faith in the Company. It ultimately damages the relationship with the already existing customers.
• Every shareholder looks for a stable and continuous return in the next five or ten years, rather than short-term goals and growth.

Conclusion

For the smooth and better operation of the Company, the Ministry of Corporate Affairs has mandated good corporate Governance . It keeps the stakeholders intact with the Company. The Company could focus on long-term growth and huge profits.

The Company needs to follow the fundamental principle of the essentials of corporate Governance for better profits and keep the shareholders happy. Taking diligent care of factors affecting corporate governance is the roadmap to stakeholders satisfaction.

In case of not practicing the good corporate Governance, companies face brutal consequences, losing their shareholders, drop in share prices, etc. Please mention your questions, suggestion and doubts regarding working of corporate governance in the comment section.