List of Key Corporate Governance Terms
Companies feature a variety of approaches to their boards of directors. Many closely held companies see management effectively functioning at the board level and some boards are formulated solely to meet legal requirements and play no serious role in the life of the company.
In contrast, other boards strive to fulfill the strategic and oversight roles dictated by good corporate governance practices.
Board committees allow a subset of directors with appropriate skills to spend additional time focusing attention on their assigned subject matter. These committees, however, do not relieve the full board of its responsibility for these matters, they merely allow for specialization and help streamline the operations (and the meetings) of the full board. The committee chairs typically present a report to the full board with the committees’ recommendations on how the board can best fulfill its responsibilities.
Good practice dictates a majority of independent directors on the most important committees to ensure that executive management does not have undue influence over their handling of matters which require decision making at the board level. Also, best practice requires that the board’s chairperson does not chair any of the committees.
The most common committees are as follows:
Control refers to the ability of an individual, a group or a legal entity, acting alone or in concert, to predetermine a company’s decisions, its oversight and its management bodies.
The term “controlling shareholder” refers to a shareholder or a group of shareholders acting in concert who have the ability to control the company. The size of the ownership stake that will confer such controlling ability will vary depending on the ownership structure of a company (dispersed vs.concentrated) and the voting rights attached to each class of shares.
A code of ethics (also called a code of conduct) is a guide of behavior and values that imposes duties and responsibilities on a firm’s directors, managers and employees towards its stakeholders, including colleagues, customers, business partners, government and society.
This code usually serves to: (i) emphasize the firms’ commitment to ethics and compliance with the law; (ii) set forth basic standards or principles of ethical and legal behavior; (iii) provide reporting mechanisms for known or suspected ethical or legal violations; (v) indicate penalties for code violations (in spirit or in letter) and (iv) help prevent and detect wrongdoing.
In addition to a code of conduct, many firms signal their commitment to the highest ethical and legal standards by becoming signatories to national and international initiatives to combat corruption, environmental degradation, and child labour and support other protocols of good corporate citizenship. Examples of such initiatives include the Principles for Countering Bribery and the Equator Principles.
A firm adopts ethics and/or anti-corruption codes because they: (i) enhance a company’s reputation/image; (ii) form a part of its risk and crisis management; (iii) help build a corporate culture around enunciated values; and (iv) communicate its commitment to ethical behavior to its stakeholders.
The term “conflict of interest” refers to any situation in which an individual or corporation (either private or government) is in a position to exploit a professional or official capacity in some way for their (or that of a related party) personal or corporate benefit.
In short, it is a conflict between a person’s private interests and public or professional obligations.
Depending upon the law or rules related to a particular organization, the existence of a conflict of interest may not, in and of itself, be evidence of wrongdoing. In fact, for many professionals, it is virtually impossible to avoid having conflicts of interest from time to time. A conflict of interest can, however, become a legal and ethical problem if an individual tries (and/or succeeds in) to influence the outcome of a corporate decision for personal benefit. A director or executive of a corporation can be subject to legal liability if a conflict of interest results in a breach their fiduciary duty of loyalty.
Corporate codes of ethics often provide procedures for managing conflicts of interest. Commonly, the individual is required, in good faith, to disclose any material transaction or relationship that can reasonably be expected to give rise to such a conflict to the board (or to the board’s ethics, governance or audit committee). Directors are expected to recuse board in which they have a conflict of interest.
The term “conflict of interest” is often confused with conflicting interests. Conflict of interest is not the appropriate term to use if two or more persons have differing opinions or conflicting interests. A conflict of interest arises when one person has a “conflict of roles’ and is serving two or more competing interests.
An appearance of or a perceived conflict of interest can cause a loss of public confidence and directors and managers should avoid such situations.
There several definitions of corporate governance, including the following:
Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.
OECD Corporate Governance Principles, 2004
Corporate governance relates to the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment.
Shleifer & Vishny (1997) The Journal of Finance, Vol. 52, No.2, 737-783. June 1997
Corporate governance is the system by which companies are directed and controled.
Cadberry Report, 1992
The corporate governance code of a company is a document developed and approved by the board of directors which stipulates the company’s governance policies as regards the shareholders rights, functioning of the board of directors and management, control environment, information disclosure and transparency.
Many nations have a corporate governance country code¹, developed and approved by national regulators or civil society, giving non-binding guidance to all companies on similar topics as a typical company code as well as in other areas such as anti-takeover defenses and executive compensation.
Cumulative voting is a system for electing members of the board of directors that allows each shareholder to cast all his votes to a single nominee director and where the total number of votes he has is equal to the number of his voting shares multiplied by the number of directors put up for election.
For example, if the election is for 5 directors and your equity stake is 1000 shares (each with a vote per share) under the regular voting system you could vote a maximum of 1000 shares for any single candidate. This would give you 5000 votes in total – 1000 for each of five potential directors. With cumulative voting, you could decide to vote all 5000 votes for a single candidate, 2500 each to of two candidates or allocate your total 5000 votes in anyway as you wish.
Cumulative voting makes electing a director to the board much easier for holders (i.e., voters) of small equity stakes. Under the regular or statutory voting system the impact of their votes is less than under the cumulative system.
¹A Collection of corporate governance country codes can be found at:
https://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/ifc+cg/topics/codes+and+scorecards
https://ecgi.global/content/codes
Persons serving as members of the company’s board are directors. They are usually elected by voting the company’s shares under rules established in the firm’s organic documents. Directors have formal fiduciary duties established under relevant company and other law. If the firm is publicly listed, directors may also have additional accountability under applicable securities legislation.
The board of directors should periodically assess its performance as a collegial body as well as the performance of its individual directors. Many boards undertake this evaluation exercise annually. If done well, appraisals help boards: (i) become more effective by clarifying the individual and collective responsibilities; (ii) improve the working relationship with managers; (iii) keep an appropriate balance of power between the board and the CEO; and (iv) take a developmental perspective.
The purpose of identifying and appointing independent directors is to ensure that the board includes directors who can effectively exercise their best judgment for the exclusive benefit of the Company, judgment that is not clouded by real or perceived conflicts of interest. It is expected that in each case where a director is identified as “independent”, the board of directors will affirmatively determine that such director meets the requirements established by the board and is otherwise free of material relations with the Company’s management, controllers, or others that might reasonably be expected to interfere with the independent exercise of his/her best judgment for the exclusive interest of the Company. An indicative definition from IFC follows². In each case, the Company and the investing DFI should consider changes tailored to those sorts of relationships that would impair a director’s independence, taking into account the circumstances of the particular Company.
Internal auditing can be seen as an organizational control that functions by measuring the effectiveness of other controls.
Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.
The Institute of Internal Auditors
Internal control is a process, affected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:
Committee of Sponsoring Organizations of the Treadway Commission (COSO I)
The Basle Committee on Banking Supervision has issued special guidelines for internal controls in financial institutions. For details on internal controls system in listed financial institutions, see Framework for Internal Control Systems in Banking Organisations, Basle, September 1998.
²Please also see the EC Commission Recommendation dated 15 February 2005 on the role of non-executive or supervisory directors of listed companies and on the committees of the supervisory board – http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2005:052:0051:0063:EN:PDF
The purpose of the disclosing non-financial in addition to financial information is to provide context necessary to the understanding of the firm’s financial condition, changes in financial condition, and results of operations.
The appropriate content of the non-financial disclosure will vary with the particular firm and from year to year. However, the information should be salient, concise and clear. Generally, non-financial disclosure covers discussions of critical accounting estimates, material changes in revenue, discontinued operations, extraordinary items, liquidity and capital resources.
Other companies include more diverse issues including management of intellectual capital, executive remuneration, occupational health and safety practices, research and development, corporate governance, compliance with anti-corruption protocols, the firm’s code of conduct, reputation risk and the environmental and social impact of corporate activity.
The regulations for Management Discussion and Analysis (MD&A) established by the US Securities and Exchange Commission provide extensive guidance on the appropriate content of non-financial disclosure. Comparable guidance can be obtained from the U.K.’s practices for the Operational and Financial Review (OFR).
As a part of their investor communications programs, many firms combine the publication of their audited, statutory financial statements with their non-financial disclosures (both mandatory and voluntary) to produce an annual report.
Generally, a recognized auditing firm should have the following characteristics: (i) be legally registered and authorized under applicable company law, tax law, securities regulations, banking laws and other legal frameworks to audit and attest financial statements; (ii) work is conducted under the supervision of persons licensed by internationally recognized professional accounting and auditing bodies; (iii) the work is conducted consistent with international accounting and auditing standards such as the IFRS and ISA; and (iv) the firm’s work is subject to peer review or regulatory inspection.
Independence refers to a mental attitude which ensures freedom from control by or influence of others. Auditors should be independent in fact and in appearance. In assessing auditor independence reliance is usually placed on indicators or existence of actual or perceived factors that could impair independence rather than guessing mental states.
In many countries, the financial statements of state-owned enterprises are audited by state auditors that report to the parliamentary bodies or congress. These are not considered external and these firms must use professional firms (i.e., chartered accountants, certified public accountants) instead of or in addition to these internal examinations.
Parties are considered to be related if one party has the ability to control the other party or to exercise significant influence or joint control over the other party in making financial and operating decisions.
(a) Directly, or indirectly through one or more intermediaries, the party:
(b) The party is an associated entity ( See relevant accounting standards on associated companies);
(c) The party is a joint venture in which the entity is the venturer;
(d) The part is a member of the key management personnel of the entity or its parent;
(e) The party is a close member of the family of any individual referred to in (a) or (d);
(f) The party is an entity that is controlled, jointly or significantly influenced by, or for which significant voting power in such entity resides with, directly or indirectly, any individual referred to in (d) or (e); or
(g) The party is a post-employment benefit plan for the benefit ofany entity that is a related party of the entity
Close members of the family of an individual are those family members who may be expected to
influence, or be influenced by, that individual in their dealing with the entity. They may include: (i) the individual’s domestic partner and children; (ii) children of the individual’s domestic partner; and (iii) dependants of the individual or the individual’s domestic partner.
The following are deemed not to be related: (i) two enterprises simply because they have a director or key manager in common; (ii) two venturers who share joint control over a joint venture; (iii) providers of finance, trade unions, public utilities, government departments in the course of their normal dealings with an enterprise; (iv) a single customer, supplier, franchiser, distributor, or general agent with whom an enterprise transacts a significant volume of business merely by virtue of the resulting economic dependence.
A related party transaction is a transfer of resources, services or obligation between related parties, regardless of whether a price is charged.
Please see IFRS 24 and International Public Sector Accounting Standard 20 and both titled “Related Party Disclosures” for technical guidance on related party transactions and their disclosure. For listed financial institutions, see also Guidelines on Disclosure of Related Party Transactions (with Focus on Financial Institutions) – Suggested Outline for RPT Disclosure on the CCGCP’s website.
Regulatory compliance refers to systems or departments at corporations and public agencies to ensure that personnel are aware of and take steps to comply with relevant laws and regulations.
