Corporate Governance and Ethics
“Corporate governance” is the term used to refer to the policies and processes by which a corporation (or other large, complex institution) is controlled and directed. It refers especially to the way power and accountability flow between shareholders, boards of directors, CEOs, and senior managers.
For most corporations, the basic governance structure is this: shareholders vote for, and hence empower, a board of directors, who then have a fiduciary responsibility to look out for shareholders’ interests. The board hires a CEO, who is accountable to the board. The CEO (sometimes with input from the board) hires a management team, and so on. At each step, there is a flow of power down the chain (from shareholders through to front-line employees), and a flow of accountability back up that chain. And there are all sorts of rules — including various policies and principles of good governance — that establish how that power and accountability is to be implemented. There will be internal rules, for example (partly determined by relevant corporate law), about how board elections are to be carried out. There are also governance principles that apply to things like the inclusion of external, “independent” directors on the board.
In case it’s not obvious, I’ll say it explicitly: corporate governance is out-and-out a matter of ethics. It is about who is responsible to whom, and for what, and under what conditions.
Now, to an investor, governance might look first and foremost like a matter of economics: no one particularly wants to invest in a poorly-governed company. And governance is also legal matter (for example, the Sarbanes-Oxley Act of 2002 includes a number of requirements about corporate governance). Governance is properly a legal matter because (at least arguably) shareholders need protection from unscrupulous or merely lazy boards of directors and executives, and because the public interest is at stake when large companies are mis-governed. Enron used to be the prime example of poor governance practices having a devastating effect on shareholders and the broader public. These days we could probably look to a few major financial institutions for object lessons in the ill effects of bad governance.
But even where the law is silent, governance remains important: regardless of whether you think in terms of a narrow, shareholder-driven, profits-first perspective, or instead in terms of a broader ‘stakeholder’ approach, you simply have to agree that the way decisions get made, and the interests that corporate policies tell decision-makers to serve, are ethically important matters.
My mind is on governance a lot lately, not least because I’m currently a Visiting Scholar at the Clarkson Centre for Business Ethics and Board Effectiveness (at the University of Toronto’s Rotman School of Management).
While I’m at Clarkson, I’m helping out with the CCBE blog. The blog is focused primarily on governance and board effectiveness, but in most cases the ethical implications of those issues are pretty clear. Today, for instance, the blog features a posting about changes in the way boards of directors are elected — and how at last some companies (including one Canadian company, Linamar Corp.) have been slow to catch on. Here’s the blog entry: Trend Watch: How are Directors Elected?
See also: the entry on Corporate Governance in the Concise Encyclopedia of Business Ethics.
- What Directors Need to Know: Corporate Governance, by Carol Hansell (the focus of this book is on Canada, but much of it is generally applicable)
- Harvard Business Review on Corporate Governance
The Business Ethics Blog 
Chris,
No doubt this is all familiar territory to you, but how about the nominating process?
If I am a shareholder, I can vote up or down on a candidate, but these candidates are always chosen by the board. (Or, in a proxy battle, an alternative slate may be offered by an outside group.) So we might wonder how “accountable” the directors are to shareholders in fact. Isn’t their key constituency the board itself? (Has Clarkson looked any trends relating to shareholders’ power in this domain, i.e., over the nominating process?)
Thanks,
Jeff
Jeff:
Good question. And there has been some movement on that issue lately, in the U.S.
See this:
SEC Adopts New Measures to Facilitate Director Nominations by Shareholders
I’ll ask around the Centre and get back to you about trends. My (non-expert) understanding is that here in Canada we have greater proxy access, but it’s seldom used.
Chris
Thanks! It has been interesting to see the strong — strident! — opposition in the U.S. to proposals like Lucian Bebchuk’s for great “shareholder democracy.”
Jeff:
Indeed. One factor fueling that opposition is what I take to be a lack of clear empirical evidence that shareholder democracy leads to better outcomes. I’ll likely be blogging about that soon-ish.
Chris.
I totally agree with your comment “corporate governance is out-and-out a matter of ethics” and the depiction of the flow of power from shareholders down to workers. The recent bizzare corporate frauds has indeed generated huge trust deficit amongst the investors regarding the efficacy of laws to control the moral decadency that has captured the mindset of the Board of Directors. The case of Madoff with his Ponzi scheme defrauding innocent investors speaks eloquent of this slippery slope.
Maybe the investors themselves can effect corrective actions by choosing ethical investment and by doing so, can perceptibly tilt their power over unethical corporations by reducing their cash flow. Awareness should be created amongst the investors about the decisive role that they can play in making ethical behavior as the main criterion for influencing investment choices. In fact, why can’t the investors be squarely blamed for perpetrating the unethical practices when they choose blindly to invest in companies like Enron, Worldcom etc. driven solely by the primitive instinct of greed rather than by caution and due diligence?
I also guess, in MHO, that alternative business models like the co-operative businesses may be encouraged to well nigh make it impossible for the moral compass of the business to go awry.
You mention Enron as an example of a company struggling with ethical issues, but how much were the share holders truly aware of? For sure, pressure was being applied for growth (as in every board room) but are you suggesting the major Enron share holders had insider information on what was happening with the accounting irregularities?
Ben:
No, I said nothing about shareholders. Shareholders aren’t usually the root of governance problems. In Enron’s case, it was things like having the Board allow exceptions to Enron’s conflict of interest policy.
Chris
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Thank you Chris