As institutional investors' power has grown and corporations' impact on society has grown, corporate governance has become a topic of widespread public interest. However, opinions on how corporations should be governed differ greatly. People disagree on fundamental issues such as the purpose of the corporation, the role of corporate boards of directors, shareholder rights, and the proper way to measure corporate performance.The question of whose interests should be considered in corporate decision making is particularly contentious, with some authorities emphasising shareholders' interest in maximising their financial returns while others argue that shareholders' other interests — in corporate strategy, executive compensation, and environmental policies, for example — as well as the interests of other parties must be respected.
The debate rages on today, with a new sense of urgency. While some academics and many members of the financial community continue to believe that the corporation's purpose is to maximise the wealth of its shareholders and that it should be governed accordingly, others advocate for a more robust definition of corporate purpose. This debate may appear to be theoretical and best left to academics, but it has far-reaching practical implications. With investors, regulators, and the general public calling for greater clarity of corporate purpose, boards and executives will want to give this issue serious thought and take steps to ensure that they have a shared understanding of their purpose in governing and leading.
Let us now examine some of the most important discussions and debates that have occurred in the field of corporate governance in recent years.
1) What is the role of the shareholders?
Shareholders provide equity capital to companies and have ownership rights to the shares they hold. While shareholders are frequently referred to as company owners, this description exaggerates shareholders' rights. In most jurisdictions, shareholders have the legal right to own and sell their shares, as well as vote on certain corporate matters as defined by law and the corporate charter. The definition and exercise of ownership rights varies greatly between companies and, more importantly, between countries.
The rise of ownership concentration, increased shareholder engagement, and hedge-fund activism all point to a period of greater shareholder influence over corporations. These developments call into question the accountability of shareholders, particularly those seeking to influence corporate decisions, as well as the prevalent model of shareholder value maximisation as the goal of good corporate governance.
These developments also raise concerns about institutional investors' responsibilities to retail, or individual, investors, who are the ultimate owners or beneficiaries of the institutions' holdings. Although institutional investors describe themselves as both stewards of the corporations in which they invest and fiduciaries for their own customers and clients, some commentators question whether they can effectively play both or, indeed, either role given the inherent conflicting interests involved and the nature of the low-cost business model of passive investors.The proxy voting system and the process by which shareholders are permitted to submit proposals for shareholder vote have also become contentious issues, with some arguing that the criteria for permissible proposals should be relaxed while others argue that they should be tightened.
In this context, boards and executives would be wise to have a thorough understanding of their companies' shareholder base as well as a deliberate approach to shareholder engagement. They must be prepared to face activist investors, and their overall governance arrangements must strike an appropriate balance of power among shareholders, the board, and management.
2) What is the composition of role of the Board?
The corporation's governing body is the board of directors. The board of directors is empowered by law to manage the corporation's business and affairs, and its members have a fiduciary responsibility to act in the best interests of the corporation and its shareholders. Boards are thus collegial bodies in the traditional sense that their members share authority and responsibility and are held individually and collectively accountable.
Boards typically delegate much of their authority to an executive team that oversees the corporation's day-to-day operations. Some board duties, however, cannot be delegated, and the extent to which boards are involved in the business varies greatly. The board's core functions typically include selecting, monitoring, advising, and compensating the CEO; overseeing the company's strategy, performance, risk management, and compliance with relevant legal and ethical standards; monitoring the company's financial structure and declaring dividends; deciding on major transactions and changes in control; monitoring the company's financial reporting and internal controls; and overseeing the company's strategy, performance, risk management, and compliance with relevant legal and ethical standards.
Several trends in board composition have emerged over the last few decades, spanning jurisdictions. One example is the growing presence of female directors, who were once uncommon but are now required in some countries to make up at least 40% of the board's total. The overall percentage of female directors remains low in comparison to their workforce numbers, but the rate at which female directors are being added appears to be accelerating, and surveys indicate that adding women to boards has benefited those boards.
Another trend is an increase in the percentage of directors who are "independent," meaning they have no commercial or family ties to the company or its management and are thus assumed to have a higher or more reliable capacity for objective judgement. Boards have become more independent over the last decade, and independent directors are more likely to meet in "executive" sessions separate from the board's management members. High-performing boards around the world are looking to improve their effectiveness through more systematic self-evaluation and succession planning, as well as by adding members with a more diverse set of skills, perspectives, and backgrounds.
3) How are corporate leaders chosen and compensated?
Corporations are complex organisations that rely on leadership and day-to-day management to function. The most important job of a company's board of directors is to ensure that such leadership and management are in place. This job entails specific tasks such as appointing the company's chief executive, evaluating the executive's performance, deciding on executive pay, planning for executive succession, and, on occasion, removing an executive from office.
The board's job has become more difficult in recent years, in part because the CEO's job has become more difficult. The traditional activities of corporate leadership have become more difficult as companies have grown larger and more complex, and the pace of change has accelerated. In addition to market and competitive pressures, today's corporate leaders must contend with a slew of challenging forces ranging from increased investor activism and volatile capital markets to increased social and cultural diversity, mounting social and environmental challenges, political and regulatory uncertainty, and disruptive technologies that are transforming industries around the world. The increased demands on corporate leaders have emphasised the importance of succession planning and raised concerns about the qualities required of today's executives.
One of the most difficult tasks for the board is determining an appropriate compensation package for the CEO and top management. Typically, this task is delegated to the compensation (or remuneration) committee of the board. Over the last few decades, CEO pay has risen dramatically in relation to corporate performance and average employee pay. Some commentators argue that the increase in executive pay is justified by the increased complexity and difficulty of the CEO job or by the returns generated for shareholders, but others see it as unjustified, excessive, and unfair.
More boards are also establishing goals based on non-financial metrics such as innovation, quality, culture, or other aspects of corporate strategy, such as social and environmental performance. Critics of the current system for selecting, evaluating, and rewarding corporate leaders point to the closed nature of the selection process, the narrowness of standard performance measures, the undue influence of executives whose own forecasts are used to set targets, the excessive complexity of many plans, and the outsized and sometimes perverse rewards bestowed even on those who clearly fail at their jobs. Whether valid or not, these criticisms raise a number of issues that every board should consider in carrying out its responsibility to ensure effective leadership and management.