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Sep 23 2012

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What is Corporate Governance and Why it is Required

corporate governance, corporate governance framework, audit committee, board of directors, financial disclosureCorporate governance is the means by which a company is operated and controlled. The aim of corporate governance initiatives is to ensure that companies are run well in the interests of their shareholders and the wider community. Corporate governance concerns such matters for example, the responsibilities of directors; the appropriate composition of the board of directors; the necessity for good internal control; the necessity for an audit committee; and relationship with the external auditors. Corporate governance consists of two elements (i) the long term relationship which has to deal with checks and balances, incentive for manager and communication between mangers and investors (ii) the transactional relationship which involves dealing with disclosures related matters.

Why Corporate Governance Required: Corporate governance is particularly important for publicly traded companies because large amounts of money are invested in them, through small shareholders, from pension schemes and other financial institutions. The wealth of these companies significantly affects the health of the economies where their shares are traded. Therefore, corporate governance ensures fair compensation to the entire stake holder of a business.

  • Ensuring the basis for an effective corporate governance framework: The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities. In other words, making sure everyone involved is aware of their individual responsibilities so no party is in doubt as to what they are accountable for.
  • The rights of shareholders and key ownership functions: The corporate governance framework should protect and facilitate the exercise of shareholders’ rights. The directors are the stewards of the company and should be acting in the best interests of the shareholders. However, the existence of the corporate collapses mentioned above proves that this isn’t always the case and shareholders need protecting from such people.
  • The equitable treatment of shareholders: The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.
  • The role of stakeholders in corporate governance: The corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprise.
  • Disclosure and transparency: The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership and governance of the company. Therefore, the annual financial statements should be produced on a timely basis and include all matters of interest to the shareholders. For any matters of significance arising during the year, these should be communicated to the shareholders as appropriate.
  • The responsibilities of the board: The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders. The introduction of audit committees and non executive directors on the board is the usual way for monitoring management. Non executive directors are not involved in the day to running of the company and are therefore more independent. They can evaluate the effectiveness of the executive board on its merits and make sure they are carrying out their duties properly.

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