CORPORATE GOVERNANCE

Corporate Governance



Corporate Governance

Introduction

The role of corporate governance in creating value for shareholders has become the subject of intense interest in corporate finance research. While empirical evidence is inconclusive, the practical importance of mechanisms that aligns the interests of managers and shareholders, as well as those that curb insider expropriation, are widely acknowledged (Agrawal, 1996, 397).

Discussion

Strategic decisions concerning the use of control enhancing corporate governance provisions may be the key in understanding differences between publicly traded family and nonfamily firms since they may frame opportunistic actions of owners and/or managers as legitimate and result in idiosyncratic agency relationships and associated problems (Barth, 2005, 127). Governance is a system of control or regulation which includes the process of appointing the controllers or regulators. The central concern of corporate governance is to construct rules and incentives to effectively align the interests of managers and owners (Carney, 2005, 266). Corporate governance therefore plays a critical role in allocating residual rights of control which are rights to decide how assets should be used, given that a usage has not been specified in an initial contract (Dalton, 2003, 382). Corporate control, within the framework of corporate governance, involves the rights to determine the management of corporate resources (e.g. the rights to hire, fire, and set the compensation of top-level managers). These rights are usually determined by the ownership level and participation in management and the board.

Nevertheless, the members of the board themselves may also have interests that diverge from those of the shareholders and little incentive to monitor unless they are significant shareholders themselves (Hart, 1995, 689). In the U.S., the board of directors is often composed of managers of the firm itself, which lowers or eliminates their independence from management, and outside directors who have no ownership stake at the company, raising the issue of little incentive to monitor. In publicly traded family firms, a family member CEO is often the Chair of the board of directors as well, which can significantly lower the boards' independence and further elevate family control over the firm (Klein, 2005, 826).

The corporate governance issue has drawn increasing attention from the public and regulators in the UK. Although company law holds that the board of directors has the responsibility of financial reporting process, the boards of UK firms were generally considered passive entities which were controlled by management several decades ago.

In the late 1980s and early 1990s, different business failures occurred unexpectedly in the United Kingdom. In addition, some accounting scandals also occurred at the same time. The issues demonstrated the weakness of corporate governance systems in the United Kingdom (Beasley, 1996, pp. 433).

The weak governance of firms in the United Kingdom resulted in the development of different corporate governance codes. In 1992, the Cadbury report with the code of Best Practice was issued. The report served as the criteria of good governance and focused on the board monitoring responsibilities and highlighted the role of Non-executive directors. Following Cadbury report, Greenbury Code was issued by the ...