Governance Guide (Part 1)

Governance Guide (Part 1)

Corporate governance – how companies are run at the management level – has evolved enormously since the early days of its codification. It has developed from an ad hoc set of guidelines into a corporate discipline in its own right.

For CFOs in particular, the emphasis must be on efficient board operation, clear risk management and properly aligned executive and non-executive voices. The CFO plays a central role in ensuring good corporate governance lies at the heart of the company operations.

But what is corporate governance? How should boards approach it, and how does the regulatory framework act to enforce best practice?

Internal Governance: What is it?

"Corporate Governance": relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management (led by the chief executive officer), and (3) the board of directors," according to the definition by Monks, Robert A.G. and Nell Minow, Corporate Governance  

Put simply, internal corporate governance covers how businesses run themselves in order to comply with the regulations put in place to protect stakeholders. Staff, shareholders, investors, suppliers and financial backers (principally the banks) are entitled to expect that company boards follow well-established procedures in protecting the company’s assets and future. It also requires management to encourage participation of stakeholders in the company’s future, and to allow those stakeholders a voice in the direction the company takes.

The composition and effective functioning of management boards is one of two or three most important factors in a company’s financial success. Clear alignment of goals, effective communication and efficient reporting structures all contribute to the success of a business.

Internal governance best practice requires directors to follow a set of guidelines that in theory should ensure that standards are maintained. Corporate governance rules largely cover how the board is administered. For example, procedures cover how committees vote, how executive power is balanced and checked by non-executive voices (see part II) and how reporting structures should be designed in order to clearly communicate important information upwards and downwards throughout the organisation.

Key Principles

The most important aspects of corporate governance can be summarised as:
•    Internal controls
•    Audit
•    Reporting and transparency
•    Renumeration policy
•    Nomination of directors and their removal from the board

Of these, control and reporting tend to come to the fore in most discussions of good (and bad) governance procedures. The key element in all this is the clear accountability of the board to its stakeholders. Transparency in corporate reporting is crucial, and the Financial Reporting Council (FRC) as well as academics and professional service firms have led the way in encouraging companies to publish and explain only the most meaningful and material aspects of their corporate performance.

Endless pages of meaningless information is of less use than no information at all, so boards are now expected to highlight in a concise way the business’s strategy, the key risks it faces and how it proposes to address those challenges.

Central to best practice in this area is the issue of engagement. Allowing stakeholders a say is critical, and the Code steers companies towards using the annual general meeting, informal channels and investor roadshows as ways of engaging with stakeholders. By doing that management get a ‘sense check’ of their strategy and get the opportunity to answer any criticism that stakeholders may have. In recent years, the issue of renumeration has become perhaps the hottest topic.

The UK Corporate Governance Code (formerly the Combined Code) sets out how boards should be rewarded and goes to great pains to lay out how board performance and reward should be aligned with shareholder interests. It is not always easy to reconcile the two sides, but there do exist companies that have demonstrated a clear commitment to addressing this issue.

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