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Subject 2. What is Corporate Governance?

Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders, and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which company objectives are set and the means of attaining those objectives and monitoring performance.

Corporate governance is about promoting corporate fairness, transparency, and accountability. Its purpose is to prevent one group from expropriating the cash flows and assets of one or more other groups.

Good corporate governance practices:

  • Board Members act in the best interests of Shareowners.
  • The Company deals with all stakeholders in a lawful and ethical manner.
  • All Shareowners have the same right to participate in the governance of the Company and receive fair treatment from the Board and management. All rights of Shareowners and other stakeholders are clearly delineated and communicated.
  • The Board and its committees can act independently from other stakeholders such as management.
  • Appropriate controls and procedures are in place covering management's activities in running the day-to-day operations of the Company.
  • The Company's operating and financial activities, and its governance activities, are consistently reported to Shareowners in a fair, accurate, timely, reliable, relevant, complete, and verifiable manner.

Practice Question 1

Which of the following best defines the concept of corporate governance?

A. A system for monitoring managers' activities, rewarding performance, and disciplining misbehavior
B. Identifiable and measurable accountabilities for all stakeholders
C. Corporate values and governance structures that ensure the business is conducted in an ethical, competent, fair, and professional manner
D. A system of principles, policies, and procedures used to manage and control the activities of a corporation so as to overcome conflicts of interest inherent in the corporate form

Correct Answer: D

Practice Question 2

Which of the following best describes the corporate governance responsibilities of board members?

A. Establish long-term strategic objectives for the company.
B. Establish global best practice standards for proxy voting.
C. Ensure that at board meetings no subject is off the table for discussion and dissent is regarded as an obligation.
D. Ensure that the board negotiates with the company over all matters such as compensation.

Correct Answer: A

Practice Question 3

A corporate board of directors has a fiduciary duty to act in the interest of ______.

A. shareholders
B. pension fund beneficiaries
C. officers of the corporation

Correct Answer: A

Practice Question 4

The objectives of an effective system of corporate governance include all of the following except ______

I. ensuring that the assets of the company are used in the best interest of investors and other stakeholders.
II. ensuring that the assets of the company are used efficiently and productively.
III. ensuring complete transparency in disclosures regarding operations, performance, risk, and financial position.
IV. eliminating or mitigating conflicts of interest among stakeholders.

A. II and IV
B. III only
C. I and III

Correct Answer: B


Study notes from a previous year's CFA exam:

a. define corporate governance;

b. describe practices related to board and committee independence, experience, compensation, external consultants, and frequency of elections, and determine whether they are supportive of shareowner protection;