Why You Should Care About Corporate Governance

For economic, environmental, and ethical reasons, how corporations are run should matter to all of us.

Nov. 22 saw the publication of Board Games, the Globe and Mail’s 9th annual report on corporate governance. Bay Street has been reading it carefully, no doubt, along with the lawyers and consultants whose job it is to worry about how Canada’s biggest companies are governed. But, for several reasons, the issue of corporate governance should be of much broader interest than that.

“Corporate governance” is the term used to refer to the policies and processes by which a corporation (or really any large, complex institution) is controlled and directed. It refers especially to the way power and accountability flow between corporate shareholders, boards of directors, CEOs, and senior managers. Many regard governance as largely a legal or regulatory matter, and indeed many matters of governance are regulated by various bits of legislation, such as the Sarbanes-Oxley Act in the U.S. and Ontario’s Securities Act.

But corporate governance isn’t just about laws and regulations, and it’s not a concern just for folks on Bay Street. It is also a matter of ethics, and it should be a matter of concern to the public generally.

Governance is fundamentally about who is responsible to whom, and for what, and under what conditions. At a well-governed company, the actions of employees, and especially those of senior executives, are driven by the values that ought to drive their actions. They are not driven by personal greed, or nepotism, or cronyism. Good governance practices are intended to make it more likely that those who carry out the company’s work will act upon their ethical obligations.

As an example, consider one of the most basic rules of corporate governance, namely the requirement that publicly traded companies make detailed disclosure of their financial performance, and that such statements be audited and given a stamp of approval by an independent auditing firm. That requirement is basically a way of keeping management honest. Current and potential investors in a firm are owed an honest accounting of the firm’s financial status, and it is generally understood that the best way to get that is to have the books checked out by someone with relevant expertise but without an insider’s interest in presenting the numbers in the best possible light. So the obligation to have the numbers checked by independent external auditors is a regulatory requirement with an ethical underpinning.

Another example: one key governance principle concerns the “compensation committee” of a company’s Board of Directors – the committee responsible for determining salaries, incentives, and bonuses for senior executives, including especially the CEO. Governance experts recommend that this committee be composed entirely of “independent” directors, i.e., directors who are not either current or recent employees of the firm, or relatives of such employees, or people who do business with the company (lawyers, consultants, suppliers, etc.). The goal here is to make sure that the people setting the CEO’s salary are as likely as possible to do so based on getting the most value for the shareholders’ money, rather than, say, giving unjustifiably fat paycheques to their pals. Again, the goal is to make ethical behaviour more likely. It is no accident that the research institute at which I am located – the Clarkson Centre for Business Ethics and Board Effectiveness – has both the terms “business ethics” and “board effectiveness” in its title. The two are inextricably linked.

It’s true that governance at publicly traded companies is largely about making sure that directors and officers of the corporation carry out their ethical duties to people who have invested in the company by buying shares; however, the issue goes beyond this consideration.

For one thing, shareholders are very far from being the only people affected by the governance of major corporations. When executives are paid more than they are worth, that leaves less money for raises for front-line employees, or for measures that will improve working conditions. When corporate boards are rife with unchecked conflicts of interest, contracts are liable to be handed out to suppliers with the right connections rather than those who are innovative and efficient. And in extreme cases, poor governance practices can wreck a company, putting employees out of work and jeopardizing local or even national economies. Ultimately, the public interest is at stake when companies – particularly large companies – are mis-governed. The collapse of Enron, for example, is fundamentally a story of poor governance.

But even thinking beyond purely economic terms, corporate governance should matter to all of us. Corporations are under increasing pressure to integrate social and environmental values into their practices. Ideally, that should mean integrating those values into high-level strategic decisions, precisely the sort of thing that corporate governance is concerned with. Accordingly, some corporate boards now feature special committees to oversee issues related to particular ethical and social values. Some, for example, have committees responsible for environmental issues, or occupational health and safety issues, or even for corporate social responsibility. These are properly board-level issues precisely because the board is responsible for making sure that the corporation as a whole is governed appropriately and driven by the right set of values. And regardless of your perspective on corporate governance, it is impossible to deny that the way decisions get made, and the interests that corporate policies encourage decision-makers to serve, are ethically important matters.