The Diligent team

GRC trends and insights

Why is corporate governance so important?

Corporations in the United States have significant latitude in creating policies and governing themselves, but all public corporations must understand that corporate governance is critically important. Strong governance gets noticed by shareholders, stakeholders, employees, and customers alike and strongly affects a company’s reputation. That’s one of the many reasons corporate governance is so important; it can and does lead to a higher or a lower company valuation.

Good corporate governance is the key to transparency and accountability. It has the power to prevent corporate scandals, fraud, and corporate liability issues, including significant disasters like Enron’s fall.

So, why is corporate governance important? To answer that question, we’ll dig a little deeper into:

• The importance of corporate governance
• Who it’s vital to
• How the focus on corporate governance has evolved
• The benefits of good corporate governance
• Resources to implement a best practice approach to governance

The importance of corporate governance

Corporate governance is important because it lays a foundation for the organization’s approach to every other business activity. The governance framework directs and controls everything within the organization, from enterprise risk management (ERM) strategy and cybersecurity to environmental, social and governance (ESG) issues.

It’s not just important within the organization, either. Corporate governance is essential to investors, and shareholders have rights and expectations under sound corporate governance principles and practices. Their stake in corporate ownership makes their investments less susceptible to system risks. Following governance principles builds trust among stakeholders; with transparent reporting and disclosure and a high level of accountability, stakeholders have no reason to doubt. While effective corporate principles are a staple of the industry, they continue to evolve with the times. Modern governance accounts for using digital technology to give boards the right information at the right time. With this information at their fingertips, boards can ask the right questions and incorporate the best answers into their decision-making process.

Why is corporate governance important for private companies?

Corporate governance is equally important for private companies as it is for public ones. Private companies don’t always answer to shareholders or face regulatory scrutiny, but their performance depends on strategically sound and transparent operations.

Private companies should take governance seriously because it determines fundamental structures like ownership and succession, risk management, recruitment and retention, etc. Establishing a good governance model can also influence private companies’ access to capital; the more rigorous a private company’s governance practices are, the more confident lenders and investors will feel in infusing cash.

Why is corporate governance becoming more important?

In the United States, ownership is separate from control, so safeguards must be in place to protect the owners. The securities laws of the 1930s and 1940s were supposed to be the vehicle that required adequate controls for corporations, but they haven’t been as effective as in years past.

As a result, shareholders have sought greater accountability through corporate governance policies. That’s contributed to the rising importance of corporate governance because:

1. Governance is mutually beneficial: Good corporate governance principles provide a system of checks and balances that helps to balance the power and ensure that there are benefits for everyone involved. In essence, corporate governance is a structure whereby the shareholders own the operation, managers run the operation and board directors oversee the operation as agents of the shareholders.
2. It creates accountability: Good corporate governance ensures the company has the proper rules, policies and practices to create long-term shareholder value. When the company’s performance is down, shareholders have every right to begin asking questions. Usually, they ask questions to ensure the company practices good governance. Getting the correct answers to these questions means their investments are in good hands.
3. It affirms shareholders’ power: While shareholders have limited power to intervene, they have a lot of sway as company owners. Shareholders elect the board of directors with the expectation that the board will fulfill their fiduciary duties and keep the best interests of the shareholders at the forefront of their decision-making.
4. It boosts board efficiency: Shareholders expect boards to run as efficiently as possible. Shareholders can also reasonably expect that the board will perform strong oversight to ensure that the performance of officers and managers is ethical and robust. When the company’s performance slides negatively, shareholders can question whether board directors are independent. The original intent of corporate governance principles was to give shareholders the right to ask questions to affirm that the board and management are doing their best to increase shareholder value and to ensure that the board will be accountable to them.
5. Technology is reshaping the boardroom: Corporate governance is increasingly a product of technology. As the business landscape evolves, shareholders expect boards to be informed — but it’s challenging to manually produce cutting-edge information and insights. A centralized governance platform unites data from across the company and the industry, ensuring boards are always in the know. The more prominent technology becomes, the more shareholders expect the companies they invest in to have a seamless and effective governance structure.

What are the benefits of good corporate governance?

The benefits of corporate governance reach beyond the boardroom. Though board efficiency is critical, the actual value of good governance is its trickle-down effect across day-to-day operations and shareholder relations. That includes:

1. Aligning board and shareholder points of view: One of the main principles of corporate governance is to equally recognize all shareholders regardless of how big or small their ownership is. All shareholders should have a voice at the annual general meeting. Board directors should be on the same page as shareholders concerning the company’s mission, vision, values and culture.
2. Upholding board integrity: All boards are required to have a code of conduct and to ensure that there are no conflicts of interest. Boards should regularly practice good ethical behavior and always display a high level of integrity. Board directors should be responsible for modeling the company’s values as part of the corporate culture. Practicing good governance keeps companies honest, compliant and out of trouble.
3. Fostering positive shareholder relations: Good governance requires boards to consider all stakeholders’ input, concerns and interests. A good and honest relationship with stakeholders will improve the company’s reputation, strengthen its ties with the community, and enable it to be accurate and responsible in handling requests by the media.
4. Promoting financial transparency: You can’t overstate the need for transparency of financial records and earnings reports. All financial documents should be clearly and accurately stated and should be accessible and available for review.

Why is corporate governance important to investors?

Corporate governance is like the table of contents for board decision-making; it charts a path shareholders can follow to either build trust with the organization or lose faith in the board of directors. How a company approaches corporate governance directly influences performance, transparency, and risk management, all factors shareholders care about.

Investors rely on good governance to:

1. Understand board decision-making: Boards should prepare to answer the many questions that shareholders might present. Shareholders expect the board’s chairperson to be different from the CEO. Shareholders may also inquire how many other boards their board directors are serving on so they know that each board director has adequate time to devote to their duties. At this time, shareholders can reasonably expect that most, if not all, board directors will be independent.
2. Unpack conflicts of interest: Shareholders may ask questions about how much ownership each board director has in the company and whether there are any conflicts of interest or interpersonal relationships between the board and management.
3. Examine board and executive compensation: It’s common for shareholders to want information about how boards structure management’s pay, how they disclose it, and how much the board pays itself. Shareholders will also want assurance that the board didn’t approve overly generous stock options that could dilute their investment later.
4. Verify audit independence: Shareholders may also ask questions about the independence of the audit committee and whether regulators have challenged any audits. They want to know financial statements are accurate and free of misstatements and are a reliable point of reference for future investment decisions.

Strengthen your governance with best practices

Today’s leaders need the ability to engage in the industry at the company level and across the industry and gain insight into whatever the future brings. That’s the value of corporate governance, but only if you have best practices in place. Companies large and small, public and private, can benefit from a system of best practices. These practices underpin your governance framework, ensuring its effectiveness and reassuring stakeholders that corporate governance is important to how you do business. Learn more about the elevent corporate governance best practices you should implement today.

FAQ

Why is accountability important in corporate governance?

Accountability is important in corporate governance because it establishes a framework of responsibility and transparency, ensuring that decision-makers within a company answer for their actions and choices. This accountability fosters trust among stakeholders, including investors, employees, and the public, as it demonstrates a commitment to ethical conduct and sound management practices.

Why is risk management important in corporate governance?

Risk management is important in corporate governance because it enables companies to identify, assess, and mitigate potential challenges and uncertainties that could impact their operations and financial stability. By incorporating robust risk management practices, corporate governance helps safeguard stakeholders’ interests, including investors, employees, and customers, minimizing the likelihood of adverse events.

Why is board composition important in corporate governance?

Board composition is important in corporate governance because it directly influences a company’s decision-making process and strategic direction. A well-balanced and diverse board brings a variety of perspectives, skills, and expertise, ensuring a more comprehensive assessment of opportunities and risks. This diversity fosters effective governance, helps prevent groupthink, and enhances the board’s ability to make informed decisions that align with the company’s and its stakeholders’ long-term interests.

Take charge of your company's success with these eleven essential corporate governance practices.