If a spotlight wasn’t shone on corporate
governance after the Enron and
WorldCom debacles, then it most certainly was with the federal government’s
recent $700 million bailout plan.
The bottom line is corporate governance
is necessary to ensure corporations can
attract capital, perform efficiently, generate profit and meet both legal obligations
as well as the expectations of society, says
Edwin J. Broecker, a partner in the
Business and Finance Department and
Real Estate Practice Group of Taft
Stettinius & Hollister LLP in Indianapolis.
Smart Business spoke with Broecker
about what exactly comprises corporate
governance and why it’s so important to a
business’s health.
What is corporate governance?
Corporate governance is the relationship
between shareholders, directors and managers that encompasses a combination of
laws and regulations that enable a corporation to attract capital, perform efficiently,
generate profit and meet both legal obligations as well as the expectations of society.
Put another way, it is the means by which a
corporation assures its investors that corporate assets provided by them are being
put to appropriate, legal and profitable use.
How is corporate governance structured?
In the United States, the corporate structure is characterized by share ownership of
individual, and increasingly institutional,
investors not always affiliated with the corporation. Generally, shareholders bear the
entire economic risk of the enterprise, are
the residual claimants of income and elect
a board of directors to manage the day-today affairs of the corporation. The board of
directors then chooses management to
make the decisions to maximize the value
of the shares owned by the shareholders
while considering the best interests of the
corporation’s other constituents, including
laborers, management and suppliers of
debt capital. The objective of management
decision-making may be to enhance the
wealth and power of the corporation as an
entity in itself.
The corporate structure assumes the separation of ownership and control. This is
an important legal distinction that serves a
valuable business and social purpose:
Investors contribute capital and maintain
ownership in the enterprise while generally avoiding legal liability for the acts of the
corporation. Investors avoid legal liability
by ceding control of the corporation to
management and paying management to
act as their agent by undertaking the corporation’s affairs. Effective corporate governance makes it more likely that the interests of the shareholders, directors and
managers are aligned.
Why is it important to have regular and effective meetings?
Past market studies suggest that corporations that have active and independent
boards responsible for constantly monitoring corporate governance issues tend to
have a higher economic profit over time.
When corporate governance is effective, it
provides managers with oversight and
holds boards and managers accountable for the effective and efficient use of corporate assets.
Regular board meetings make management focus on the importance of the
process. Such meetings create a formal
structure that helps management focus and
realize the importance of the information
being provided and the process of decision-making. It also helps directors establish a
formal environment to focus on the fact that
they are fiduciaries responsible for looking
out for the shareholders’ best interest.
Who should attend these meetings, and what
information should be disclosed/exchanged?
In the public company context, boards
are required to have a certain percentage
of independent directors. In addition, certain committees of the directors (e.g., the
compensation and audit committees) must
be composed of only outside directors.
Often these directors will engage separate
counsel or advisers to assist them in discharging their duties.
In the privately held company, there is no
requirement to have independent directors. Nevertheless, having outside directors can benefit internal deliberations by
providing a different and unbiased perspective on the issues at hand.
For both the public and private companies, the company’s counsel should regularly attend meetings of the board of directors and shareholders. In a closely held
company that may not have dedicated personnel, other key advisers such as the company’s accountant and insurance agent
should attend the meetings so that they can
make the appropriate recommendations
about risk management and strategic
financial decisions.
In general, the meetings should cover a
review of the past year, the company’s
financial situation and a discussion of current issues and significant expenditures or
initiatives for the upcoming year. In addition, on an annual basis the directors
should appoint officers and should review
and affirm their compliance program and
corporate code of conduct.
EDWIN J. BROECKER is a partner in the Business and Finance Department and Real Estate Practice Group of Taft Stettinius & Hollister
LLP in Indianapolis. Reach him at (317) 713-3500 or [email protected].
