Corporate governance is about what the board of a company does and how it sets the values of the company. It is to be distinguished from the day to day operational management of the company by full-time executives.
Good governance is not just about compliance with formal rules and regulations. It is about establishing internal processes and attitudes that add values, enhance the reputation of a business, make it more attractive to external investors and lenders and ensure its long term success.
Corporate governance and compliance practices have undergone enormous change in a relatively short time and best practices are continually developing. The level of scrutiny of a board’s monitoring – or failure to monitor – a corporation’s ethics and compliance activities has increased dramatically. The challenge for boards, executive officers, and ethics and compliance officers is to view the increased scrutiny and enhanced standards not merely as a host of new legal requirements but as an opportunity to review and enhance their corporate governance and ethics and compliance practices and set a true tone from the top.
According to the UK Financial Reporting Council, one of the key roles for the board is to establish the culture, values and ethics of the company. It is important that the board sets the correct tone form the top; the directors should lead by example and ensure that good standards of behaviour permeate throughout all levels of the organisation.
According to the OECD, a corporate governance framework should consist of three main elements:
The 'comply or explain' approach has been in operation since the Cadbury Report in 1992. Some national codes also use 'comply and explain', or "apply and explain".
The purpose is to let the market decide whether a set of standards is applicable for individual companies. It rejects the view that one size fits all but requires disclosure of explanations to market investors so that they can decide whether to accept the explanations, hence creating a market sanction rather than a legal one.
Good governance can be seen in the quality of decisions; effective decision making is based on hard information from robust systems and processes that are used effectively by leaders in a culture that supports challenge and scrutiny. Good governance helps mitigate or reduce risk and avoid scandals, fraud, and criminal liability of the company.
If companies are well governed, they will usually outperform other companies and will be able to attract investors whose support can help to finance further growth. Effective corporate governance attracts higher levels of investment. A survey by the International Finance Corporation, part of the World Bank, found that governance is an important factor in making investment decisions in emerging markets. In fact, investors will pay a premium for firms in emerging markets that can demonstrate better governance.
It is now accepted that sound governance results in better performing companies that deliver total economic value within its broader meaning and corporate governance is now established in many countries across the world.