Subject 2. Corporate governance: objectives and guiding principles

There are two objectives of corporate governance:

  • To eliminate or mitigate conflicts of interest particularly those between managers and shareholders; and
  • To ensure that the assets of the company are used efficiently and productively and in the best interests of its investors and other stakeholders.

There are certain characteristics that are common to all sound corporate governance structures:

  • Delineation of the rights of shareholders and other core stakeholders.
  • Clearly defined manager and director governance responsibilities to stakeholders.
  • Identifiable and measurable accountabilities for the performance of the responsibilities.
  • Fairness and equitable treatment in all dealings between managers, directors, and shareholders; and
  • Complete transparency and accuracy in disclosures regarding operations, performance, risk and financial position.

Practice Question 1

Which of the following statements are true with respect to the core attributes of an effective corporate governance system?

I. The spelling out of the rights of all stakeholders of the firm, particularly shareholders.
II. The duty of management to pay out dividends to shareholders.
III. Transparency in disclosing operating results.
IV. The spelling out of the responsibilities of directors and managers.
Correct Answer: I, III and IV

The duty to pay dividends is not a core attribute of corporate governance. For instance, shareholders rights could be served just as well if the firm repurchases its share instead of paying dividends.

Practice Question 2

Which of the following statements are true with respect to the objectives of an effective corporate governance system?

I. An effective corporate governance system should minimize the likelihood that a firm will go bankrupt.
II. An effective corporate governance system should ensure the assets of the firm are used efficiently.
III. An effective corporate governance system should ensure that the firm is in compliance with not just laws and regulations, but also high ethical codes of conduct.
IV. Corporate governance is a system of procedures and accountabilities used by stakeholders to overcome conflicts of interest that may exist between management's self interest and the interest of stakeholders.
Correct Answer: II and IV

The likelihood of bankruptcy is determined by the operational and financial risk of the company. While an effective corporate governance system will reduce the likelihood of fraud committed on the part of management, it does not necessarily mean that it will save a firm from going bankrupt.