Corporate Governance

Corporate governance tackles the detachment between ownership and domination and has been a topic of special interest in academic research for a long time. Corporate governance has moved to the forefront in all sectors of the public domain due to its apparent importance in the economic health of corporations in particular and the broader society in general.

Becht et al. (2002) claim that it is due to the following reasons that corporate governance has become such a prominent topic in the past two decades: firstly, a series of recent U.S. scandals and corporate failures that built up but did not surface during the bull market of the late 1990s; secondly, the 1998 East Asia crisis, which has put the spotlight on corporate governance in emerging markets; thirdly, the worldwide wave of privatization of the past two decades; fourthly, deregulation and the integration of capital markets; fifthly, pension fund reform and the growth of private savings; and finally, the takeover wave of the 1980s.

The severity of the current financial crisis is seen as one of the most serious financial impasse since the Great Depression. A 2009 OECD Report concludes that this financial crisis can be, to an important extent, attributed to failures and weaknesses in corporate governance arrangements (OECD, 2009b). For example, when put to the test, corporate governance routines did not serve their purpose to safeguard against excessive risk experienced by a number of financial services companies.

Many scholars suggest that other factors unrelated to corporate governance – such as macroeconomic policy and weakness in the global financial infrastructure –  have played a significant role in causing the financial crisis.

Many scholars admit that, in many cases, national corporate governance systems did little to stem the crisis; particularly with respect to financial institutions (Manen, 2008; Barker, 2009). Furthermore, failures of corporate governance which, to a large extent, led to the current crisis could be a reflection of corporate law more generally, in the sense that it did not prevent management to extract large short-term benefits at the expense of shareholders (Ostrup et al., 2009, p. 22).

Corporate governance in the academic literature is defined by Eells (1960, p. 108) to denote “the structure and functioning of the corporate policy”. In its simplest and literal form, corporate governance is the manner in which firms established in the legal form of a corporation are governed (Becht, et al., 2002).  However, the varied interests given by several different groups and fields have made definitions of corporate governance much more dynamic. The most prominent of these definitions was originated by the Cadbury Committee, which was set up in the UK in 1991 to raise standards in corporate governance. In accordance to their vision, ‘Corporate governance is the system by which companies are directed and controlled’ (Cadbury Committee, 1992, p. 15).  Lord Cadbury, the Head of Cadbury Code of Conduct of Corporate Governance, which was adopted by the London stock exchange, pointed out in 1994:

The purpose of corporate governance of a corporation is to align as nearly as possible the interest of individuals, corporations and society.

This is similar to the definition given by the Organisation for Economic Co-operation and Development (OECD), which asserts:

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 the company objectives are set, and the means of attaining those objectives and monitoring performance (OECD, 2004).

These varied definitions reflect diversification in the nature and aims of different participants in the corporation, along with the interaction and relationship involving the organisations and individuals implicated or concerned with decision-making (Charkham, 1995). Therefore, there is a need for a system or structure to govern the corporations in which the interests of shareholders and corporate managers or controllers (Hellwig, 2000).

This research adopts a limited definition of corporate governance than might be found elsewhere.  As highlighted earlier, over the past decade a developing body of literature pioneered and developed by LLSV demonstrates that an essential feature of good corporate governance is strong investor protection that in turn instills investor confidence, defined as the extent of the laws protecting investors’ rights and the strength of the legal institutions that facilitate law enforcement.

This was clearly highlighted in LLSV (2000), where they defined corporate governance as “a set of mechanisms through which outside investors protect themselves against expropriation by the insiders, i.e. the managers and controlling shareholders” (LLSV, 2000, p. 3). This role played by legal system in corporate governance and in protecting the minority shareholders will be the crux of the discussion of the next chapter (Sections 3.2 and 3.3).