🏛️ Corporate Governance

Definition of corporate governance and how it is described in different contexts
Core principles (Cadbury Report, OECD, Sarbanes–Oxley Act)
Principal–agent and principal–principal conflicts
Models of governance: Continental Europe, US/UK, Japan, founder centrism
Regulation and country-specific legislation
Codes, guidelines and listing standards
Stakeholders, board responsibilities, and control and ownership structures
Internal and external governance mechanisms, financial reporting and auditing

📖 What Is Corporate Governance?

Corporate governance refers to the mechanisms, processes, practices, and relations by which corporations are controlled and operated by their boards of directors, managers, shareholders, and stakeholders.

It defines how power and responsibilities are distributed within a company, how decisions are made, and how performance is monitored.
Effective governance is essential for accountability, transparency and long-term sustainability, especially in publicly traded companies.

Definitions

The term can be defined in diverse ways, depending on the writer's purpose.

Writers focused on a discipline (accounting, finance, corporate law, management) often adopt narrow, purpose-specific definitions.
Writers concerned with regulatory policy often use broader structural descriptions.
A broad (meta) definition: "Corporate governance describes the processes, structures, and mechanisms that influence the control and direction of corporations."

Source	Definition
Cadbury Report (1992)	Structural: "the system by which companies are directed and controlled"
OECD (2023)	Relational-structural: a set of relationships between a company's management, board, shareholders and stakeholders; it also provides the structure and systems through which the company is directed, objectives are set, and the means of attaining them and monitoring performance are determined

Examples of narrower definitions:

"a system of law and sound approaches by which corporations are directed and controlled focusing on the internal and external corporate structures with the intention of monitoring the actions of management and directors and thereby, mitigating agency risks which may stem from the misdeeds of corporate officers."
"the set of conditions that shapes the ex post bargaining over the quasi-rents generated by a firm." Here the firm is modelled as a governance structure acting through the mechanisms of contract, and governance may include its relation to corporate finance.

🎯 Principles

Contemporary discussions refer to principles raised in three documents released since 1990:

The Cadbury Report (UK, 1992)
The Principles of Corporate Governance (OECD, 1999, 2004, 2015 and 2023)
The Sarbanes–Oxley Act of 2002 (US)

The Cadbury and OECD reports present general principles around which businesses are expected to operate. The Sarbanes–Oxley Act (informally Sarbox or SOX) is an attempt by the US federal government to legislate several of those recommended principles.

Principle	Key idea
Rights and equitable treatment of shareholders	Respect shareholder rights and help shareholders exercise them by communicating information openly and effectively and encouraging participation in general meetings
Interests of other stakeholders	Recognize legal, contractual, social, and market-driven obligations to non-shareholder stakeholders: employees, investors, creditors, suppliers, local communities, customers, and policymakers
Role and responsibilities of the board	The board needs sufficient relevant skills and understanding to review and challenge management performance, plus adequate size and appropriate levels of independence and commitment
Integrity and ethical behavior	Integrity is a fundamental requirement in choosing corporate officers and board members; develop a code of conduct for directors and executives
Disclosure and transparency	Make roles and responsibilities of board and management publicly known; independently verify and safeguard the integrity of financial reporting; disclose material matters in a timely and balanced way

Principal–Agent Conflict

Governance concerns follow from potential conflicts of interest caused by non-alignment of preferences between:

Shareholders and upper management (principal–agent problems)
Among shareholders (principal–principal problems)

In large firms with a separation of ownership and management:

Upper management is the "agent" and shareholders are the "principals".
Shareholders typically want returns through profits and dividends.
Management may be influenced by other motives: remuneration or wealth interests, working conditions and perquisites, or relationships with parties inside (e.g., management-worker relations) or outside the corporation, to the extent these are not necessary for profits.
Self-interest is usually emphasized in principal–agent problems.
From a shareholder perspective, governance effectiveness might be judged by how well practices align the interests of upper management with those of shareholders.
However, corporations sometimes undertake initiatives such as climate activism and voluntary emission reduction that seem to contradict the idea that rational self-interest drives shareholders' governance goals.

Example: stock repurchases (treasury stock)

Executives may have an incentive to divert cash surpluses to buying treasury stock to support or increase the share price.
That reduces the financial resources available to maintain or enhance profitable operations.
Executives can thus sacrifice long-term profits for short-term personal gain.
Shareholders may see it differently depending on their own time preferences, but it can also be viewed as a conflict with broader corporate interests, including other stakeholders and the long-term health of the corporation.

Principal–Principal Conflict (the Multiple Principal Problem)

The principal–agent problem can be intensified when management acts on behalf of multiple shareholders, which is often the case in large firms.

Multiple shareholders face a collective action problem: individuals may lobby management or otherwise act in their individual interests rather than the collective interest.
Result: free-riding in steering and monitoring of management, or conversely high costs from duplicate steering and monitoring.
Conflict may break out between principals, leading to increased autonomy for upper management.

Mitigation:

Ways of mitigating conflicts include the processes, customs, policies, laws, and institutions that affect how a company is controlled. This is the challenge of corporate governance.
Appointing one or more shareholders to govern is likely to cause problems because of the information asymmetry it creates.
Shareholders' meetings are necessary. Because of the median voter theorem, they lead power to be devolved to an actor that approximately holds the median interest of all shareholders, so governance best represents the aggregated interest of all shareholders.

Other Themes

The nature and extent of corporate accountability.
At the macro level, the effect of a governance system on economic efficiency, with strong emphasis on shareholders' welfare, producing a literature focused on economic analysis.
A comparative assessment of governance principles and practices across countries was published by Aguilera and Jackson in 2011.

🌍 Models of Corporate Governance

Models differ according to the variety of capitalism in which they are embedded.

Model	Emphasis
Anglo-American	Interests of shareholders
Coordinated / multistakeholder (Continental Europe and Japan)	Also recognizes workers, managers, suppliers, customers, and the community

A related distinction is between market-oriented and network-oriented models.

Continental Europe: Two-Tier Board System

Some countries, including Germany, Austria, and the Netherlands, require a two-tiered board.

Executive board: made up of company executives; generally runs day-to-day operations.
Supervisory board: made up entirely of non-executive directors who represent shareholders and employees; hires and fires members of the executive board, determines their compensation, and reviews major business decisions.
Germany is known for co-determination, established under the German Codetermination Act of 1976, which grants workers seats on corporate boards as stakeholders, separate from those allocated to shareholder equity.

United States and United Kingdom

The Anglo-American model emphasizes shareholders.

Relies on a single-tiered board normally dominated by non-executive directors elected by shareholders, hence also called "the unitary system".
Many boards include some executives (ex officio members).
Non-executive directors are expected to outnumber executive directors and hold key posts, including audit and compensation committees.
UK: the CEO generally does not also serve as chairman. US: having the dual role has been the norm despite major misgivings, though the number of firms combining both roles is declining.

US legal structure:

Corporations are directly governed by state laws; the exchange of securities is governed by federal legislation.
Many states have adopted the Model Business Corporation Act, but the dominant law for publicly traded corporations is the Delaware General Corporation Law, the place of incorporation for the majority of publicly traded corporations.
Individual rules are based on the corporate charter and, less authoritatively, the corporate bylaws.
Shareholders cannot initiate changes to the corporate charter, although they can initiate changes to the bylaws.
The claim that "the shareholders own the company" is a misconception, as argued by Eccles and Youmans (2015) and Kay (2015). The American system has long been based on a belief in the potential of shareholder democracy to efficiently allocate capital.

Japan

The Japanese model has traditionally held a broad view that firms should account for the interests of a range of stakeholders.

Managers do not have a fiduciary responsibility to shareholders.
Rooted in the belief that a balance among stakeholder interests can lead to a superior allocation of resources for society.

Key principles:

Securing the rights and equal treatment of shareholders
Appropriate cooperation with stakeholders other than shareholders
Ensuring appropriate information disclosure and transparency
Responsibility of the board
Dialogue with shareholders

Founder Centrism

An article published by the Australian Institute of Company Directors, "Do Boards Need to become more Entrepreneurial?", considered the need for founder centrism behaviour at board level to appropriately manage disruption.

⚖️ Regulation

Corporations are created as legal persons by the laws of a jurisdiction. Legal person status is fundamental to all jurisdictions and is conferred by statute.
This allows the entity to hold property in its own right and gives the modern corporation perpetual existence.
Incorporation arises from general purpose legislation (the general case) or from a statute creating a specific corporation, often in the form of a Companies Act or Corporations Act.

Scandals and regulatory response

Regulatory attention to governance of listed corporations (especially transparency and accountability) increased after the high-profile scandals of 2001–2002, many involving accounting fraud, and again after the 2008 financial crisis.
US: Enron and MCI Inc. (formerly WorldCom) led to the Sarbanes–Oxley Act of 2002.
Australia: HIH and One.Tel are linked to the CLERP 9 reforms (2004).
Italy: Parmalat is another example of a failure that stimulated regulatory interest.

Other regulatory devices

Statutory laws on the functioning of stock or securities markets
Consumer and competition (antitrust) laws
Labour or employment laws
Environmental protection laws (which may entail disclosure requirements)
Common law in some countries

Corporate constitution: most jurisdictions give corporations rules that authorize or constrain decision-makers. In English-speaking jurisdictions it is sometimes called the corporate charter or articles of association (which may be accompanied by a memorandum of association).

Country-Specific Regulation

Country	Key points
Australia	Incorporation originated under state legislation but has been under federal legislation since 2001
Canada	Incorporation can be done under either federal or provincial legislation
The Netherlands	Corporate law is embedded in the ondernemingsrecht and, for limited liability companies, the vennootschapsrecht
Poland	Regulated in the Code of Commercial Companies, covering incorporation and liquidation, and the rights, obligations and operating rules of corporate bodies (Management Board, Supervisory Board, Shareholders Meeting)
UK	A single jurisdiction for incorporation
US	Incorporation is under state-level legislation, with important federal acts: Securities Act of 1933, Securities Exchange Act of 1934, Uniform Securities Act

Netherlands: Corporate Governance Code

Adopted in 2016 and updated twice since.
In the 2022 version, the Executive Board is responsible for the continuity of the company and its sustainable long-term value creation.
The executive board considers the impact of corporate actions on People and Planet and takes effects on stakeholders into account.
In the Dutch two-tier system, the Supervisory Board monitors and supervises the executive board.

UK: Bribery Act 2010

Made it illegal to bribe government or private citizens, or to make facilitating payments (payments to a government official to perform routine duties more quickly).
Required corporations to establish controls to prevent bribery.

US: Sarbanes–Oxley Act of 2002 (SOX)

Enacted after a series of high-profile scandals that cost investors billions of dollars. It influenced similar laws in many other countries. Key governance changes:

The Public Company Accounting Oversight Board (PCAOB) was established to regulate the auditing profession, which had been self-regulated. Auditors review financial statements and issue an opinion on their reliability.
The CEO and CFO attest to the financial statements. Before the law, CEOs had claimed in court they hadn't reviewed the information.
Board audit committees have independent members and disclose whether at least one is a financial expert, or why none is.
External audit firms cannot provide certain consulting services and must rotate their lead partner every 5 years. An audit firm cannot audit a company if those in specified senior management roles worked for the auditor in the past year. This addresses the conflict of interest between giving an independent opinion and also providing lucrative consulting services.

US: Foreign Corrupt Practices Act (FCPA)

Passed in 1977, with later modifications.
Made it illegal to bribe government officials and required corporations to maintain adequate accounting controls.
Enforced by the Department of Justice and the Securities and Exchange Commission (SEC).
Substantial civil and criminal penalties have been levied on corporations and executives convicted of bribery.

📜 Codes and Guidelines

Codes have been developed in different countries and issued by stock exchanges, corporations, institutional investors, or associations of directors and managers, with support from governments and international organizations.
As a rule, compliance is not mandated by law, although codes linked to stock exchange listing requirements may have a coercive effect.

G20/OECD Principles of Corporate Governance

First published as the OECD Principles in 1999, revised in 2004, in 2015 (when endorsed by the G20), and in 2023.
Often referenced by countries developing local codes.
The UN ISAR working group produced Guidance on Good Practices in Corporate Governance Disclosure: more than fifty disclosure items across five categories:
- Auditing
- Board and management structure and process
- Corporate responsibility and compliance in organization
- Financial transparency and information disclosure
- Ownership structure and exercise of control rights
The OECD Guidelines on Corporate Governance of State-Owned Enterprises complement the Principles for state-owned enterprises.

Stock Exchange Listing Standards

The NYSE Listed Company Manual requires, among other things:

Requirement	Detail
Independent directors (Section 303A.01)	A majority of independent directors. An independent director is not part of management and has no "material financial relationship" with the company
Executive sessions (Section 303A.03)	Non-management directors must meet at regularly scheduled sessions without management
Committees	A nominating/corporate governance committee composed entirely of independent directors, responsible for nominating new board members; Compensation and Audit Committees are also specified

Other Guidelines

ICGN (International Corporate Governance Network): investor-led, set up in 1995 by individuals centred around the ten largest pension funds in the world. Aims to promote global governance standards; led by investors managing US$77 trillion, with members in fifty countries; guidelines range from shareholder rights to business ethics.
WBCSD (World Business Council for Sustainable Development): work on governance, particularly accounting and reporting.
2009 report by the International Finance Corporation and the UN Global Compact, "Corporate Governance: the Foundation for Corporate Citizenship and Sustainable Business", linking environmental, social and governance responsibilities to financial performance and long-term sustainability.
Most codes are largely voluntary. Since the 2005 Disney decision in the US, an issue is whether companies merely try to exceed the legal threshold or create guidelines that rise to best practice. Voluntary documents may still prompt other companies to adopt similar practices.
ISO 37000 (2021): the first international standard for good governance, emphasizing purpose (a meaningful reason to exist); values inform both the purpose and how it is achieved.

👥 Stakeholders

Key parties: the board of directors, management and shareholders.
External stakeholders also exert influence: creditors, auditors, customers, suppliers, government agencies, and the community.
Agency view: the shareholder forgoes decision rights (control) and entrusts the manager to act in the shareholders' best (joint) interests. Because of this separation, governance mechanisms include controls intended to align managers' incentives with shareholders'. Agency concerns are necessarily lower for a controlling shareholder.
In private for-profit corporations, shareholders elect the board. In nonprofits, stakeholders may help recommend or select members, but the board typically decides who serves, making it a "self-perpetuating" board.
In practice at large organizations, executive management (principally the CEO) drives major initiatives with board oversight and approval.

Responsibilities of the Board of Directors

"The board is responsible for the successful perpetuation of the corporation. That responsibility cannot be relegated to management." (John G. Smale, former Chairman of General Motors, 1995)

The board is responsible for:

CEO selection and succession
Providing feedback on strategy
Compensating senior executives
Monitoring financial health, performance and risk
Ensuring accountability to investors and authorities

Boards typically have committees (e.g., Compensation, Nominating and Audit).

OECD Principles (2025) on board responsibilities:

Act on a fully informed basis, in good faith, with due diligence and care, in the best interest of the company and shareholders, taking stakeholders into account.
Treat all shareholders fairly where decisions affect groups differently.
Apply high ethical standards.
Key functions:
- Reviewing and guiding strategy, major plans, budgets and business plans; setting performance objectives; monitoring implementation; overseeing major capital expenditures, acquisitions and divestitures
- Reviewing and assessing risk management
- Monitoring the effectiveness of governance practices
- Selecting, overseeing and, when necessary, replacing key executives, and overseeing succession planning
- Aligning executive and board remuneration with longer term interests
- Ensuring a formal and transparent nomination and election process
- Managing conflicts of interest, including misuse of corporate assets and abuse in related party transactions
- Ensuring the integrity of accounting and reporting systems, including the independent external audit
- Overseeing disclosure and communications
Exercise objective independent judgement.
Have access to accurate, relevant and timely information.
Where employee representation is mandated, provide information and training so it is exercised effectively.

Stakeholder Interests

Stakeholder	Interest
Directors, workers, management	Salaries, benefits, reputation
Lenders	Specified interest payments
Equity investors	Dividends or capital gains
Customers	Certainty of provision of goods and services of appropriate quality
Suppliers	Compensation and possible continued trading relationships

A key factor in participation is confidence that the corporation will deliver expected outcomes.
If stakeholder categories lack confidence, they engage less. When this becomes endemic, loss of confidence and participation in markets may affect many other stakeholders and increases the likelihood of political action.

"Absentee Landlords" vs. Capital Stewards

In 2016 the director of the World Pensions Council (WPC) said institutional asset owners seem more eager to take negligent CEOs to task.
Part of a broader trend toward more fully exercised asset ownership, notably by boards of trustees of large UK, Dutch, Scandinavian and Canadian pension investors.
No longer "absentee landlords", trustees exercise governance prerogatives more forcefully, forming engaged pressure groups to shift the system toward sustainable investment, with enthusiasm for the UN's Sustainable Development Goals and other ESG-centric practices.
UK: following the 2008–2012 great recession, many of the largest pension funds are active stewards, engaging with corporate boards.

Control and Ownership Structures

In many countries, notably most of Continental Europe, ownership is not necessarily equivalent to control, due to dual-class shares, ownership pyramids, voting coalitions, proxy votes, and clauses giving additional voting rights to long-term shareholders.
Ownership is typically defined as ownership of cash flow rights; control refers to ownership of control or voting rights.
Group structures include pyramids, cross-shareholdings, rings, and webs.
- German Konzern: legally recognized corporate groups with complex structures.
- Japanese keiretsu and South Korean chaebol (tend to be family-controlled): complex interlocking business relationships and shareholdings. Cross-shareholding is an essential feature.
SMEs: governance operates differently than in large companies. The presence of controlling shareholders has a significant positive impact on firm value, reinforcing the importance of ownership concentration in reducing agency conflicts and enhancing oversight (Spanish SME evidence, 2023).

Difference in Firm Size

In smaller companies, founder-owners play a pivotal role in shaping corporate value systems.
In larger companies that separate ownership and control, managers and boards play an influential role. Labour forms part of the corporate organization, whereas shareholders, creditors and investors act outside it.

Family Control

Family interests dominate some corporations, and it has been suggested that family-controlled corporations are overseen better than those controlled by institutional investors or management.
A 2003 Business Week study: "One of the biggest strategic advantages a company can have, it turns out, is blood lines."
A 2007 Credit Suisse study found that European companies in which the founding family or manager retains a stake of more than 10 per cent of capital enjoyed superior performance over sector peers: about 8% per year since 1996.

Diffuse Shareholders

In developed Anglo-American countries (Australia, Canada, New Zealand, UK, US), institutional investors dominate the market for stocks in larger corporations.
In Japan, most shares are held by financial companies and industrial corporations, which are not institutional investors if holdings are largely within-group.
The largest funds diversify across a very large number of corporations, which largely eliminates individual firm risk. A consequence is relatively little interest in the governance of a particular corporation; if pressing for change would be costly, they will likely simply sell out.

Proxy Access

Particularly in the US, proxy access lets shareholders nominate candidates who appear on the proxy statement, instead of restricting that power to the nominating committee.
The SEC tried a proxy access rule for decades; the Dodd–Frank Act specifically allowed the SEC to rule on it, but the rule was struck down in court.
Beginning in 2015, proxy access rules spread, driven by major institutional investors. By 2018, 71% of S&P 500 companies had one.

🔧 Mechanisms and Controls

Mechanisms are designed to reduce inefficiencies arising from moral hazard and adverse selection.

Internal monitoring: e.g., by large shareholders in privately held companies or business-group firms, and by board mechanisms.
External monitoring: e.g., an independent third party such as the external auditor attests the accuracy of information from management. Stock analysts and debt holders may also monitor.
An ideal system regulates both motivation and ability, and provides incentive alignment. Incentives should not be so strong that individuals are tempted to cross ethical lines, for example by manipulating revenue and profit figures to raise the share price.

Internal Corporate Governance Controls

Internal controls monitor activities and take corrective actions to accomplish organisational goals.

Monitoring by the board of directors: the board has legal authority to hire, fire and compensate top management, safeguarding invested capital. Non-executive directors are thought more independent but do not always produce more effective governance or higher performance; different structures are optimal for different firms. The board's ability to monitor depends on access to information. Executive directors have superior knowledge of decision-making and evaluate management on the quality of decisions (ex ante), so they may look beyond financial criteria.
Internal control procedures and internal auditors: policies implemented by the board, audit committee, management and others to provide reasonable assurance of reliable financial reporting, operating efficiency, and compliance with laws and regulations. Internal auditors test the design and implementation of these procedures and the reliability of financial reporting.
Balance of power: simplest form is requiring that the president be a different person from the treasurer. Further developed where divisions check each other: one group proposes changes, another reviews and can veto, a third checks that outside interests (customers, shareholders, employees) are met.
Remuneration: performance-based pay relates some proportion of salary to individual performance (cash, shares, share options, superannuation or other benefits). Such schemes are reactive: they provide no mechanism for preventing mistakes or opportunistic behavior, and can elicit myopic behavior.
Monitoring by large shareholders, banks and other large creditors: their large investment gives them the incentive, and the control and power, to monitor management.

CEO duality

In publicly traded US corporations, boards are largely chosen by the president/CEO, who often also takes the chair, making it harder for institutional owners to "fire" him or her.
Common in large American corporations, but relatively rare elsewhere. In the UK, successive codes of best practice have recommended against duality.

External Corporate Governance Controls

Controls exercised by external stakeholders over the organization:

Competition
Debt covenants
Demand for and assessment of performance information (especially financial statements)
Government regulations
Managerial labour market
Media pressure
Takeovers
Proxy firms
Mergers and acquisitions

Financial Reporting and the Independent Auditor

The board has primary responsibility for internal and external financial reporting. The CEO and CFO are crucial participants, and boards rely on them for the integrity and supply of accounting information. They oversee internal accounting systems and depend on accountants and internal auditors.
Under International Accounting Standards and U.S. GAAP, managers have some choice in measurement methods and recognition criteria. Using that choice to improve apparent performance increases information risk for users, as does financial reporting fraud (non-disclosure and deliberate falsification).
To reduce this risk and enhance perceived integrity, financial reports must be audited by an independent external auditor who issues a report accompanying the financial statements.

Corporate Governance: Business Study Notes