‘A company’s approach to corporate governance will be a reflection of the needs of its key stakeholders.’ Discuss how a company’s approach to corporate governance could be advantageous or disadvantageous to specific stakeholder groups. Use specific ‘real-world’ examples.
Corporate Governance & its Effects on Stakeholders
The corporate governance of any company and its approach towards it could be the deciding factor for the success or failure of the organization. The effectiveness of the approach towards corporate governance can be advantageous or disadvantageous to the stakeholder’s interests. For exploring this, first, an introduction to the corporate governance framework and its stakeholders and their interests is discussed. The conflicts that may arise in the interests of the different stakeholders are discussed. These conflicts are discussed because it shows how one approach of corporate governance may lead to serve the interest of one stakeholder only at the expense of the interests of the others (Adhariani, Sciulli and Clift, 2017).
Corporate Governance:
Corporate governance can be explained as a system control process by which an organization manages, directs and control. As strong corporate governance practices push a company towards success, weak corporate governance practices result in failures for the company and its stakeholders (Rezaee, 2009).
The corporate governance practice tends to vary beyond borders. Different countries have different practices for corporate governance. The corporate governance systems of each company either adopt shareholder theory or the stakeholder theory. Also in some cases, the convergence of these two theories is found as well. Currently, companies are inclined towards using the benefits of both theories through its convergence (Fernando, 2012).
Shareholder Theory:
The shareholder theory suggests that the most important responsibility of the management of the company is to maximize the profits and returns of shareholder (Prasnikar, 2006).
Stakeholder Theory:
The stakeholder theory suggests that the management and the corporate governance of the company should consider the interests of all the stakeholders and not solely on the shareholder’s interests. The stakeholders of the organization include the suppliers, the customers, the management, the creditors, and anyone who has an interest in the company and in its financial performance (Phillips, 2003).
The effectiveness of Corporate Governance:
A company’s approach to the corporate governance can be instructive as well as destructive for the company and its stakeholder groups. Any weakness in the practice of the corporate governance and the management of the stakeholder can result in posing several risks for the company. An effective approach can give several benefits to the stakeholders and the company (Allen, 2016).
Advantageous of Effective Corporate Governance:
The benefits of effective practices of corporate governance are long term and as well. Through a good corporate governance structure, a company can increase its improvement in operational efficiency. Because of the effective audit systems, the company control system can be improved substantially. The costs related to the weak control systems would be reduced, leading to better financial and operational performance. Moreover, the investment and business risks of the company are decreased subsequently decreasing the default risk and cost of capital of the firm (Deloitte, 2013).
Benefits to the Shareholders and Institutional Investors:
The shareholders and institutional investors can benefit from the good governance approach of the company by enjoying the transparency in the invested company. A good governance approach makes the company disclose any important information that is crucial and needed by its investors to make informed decisions. The rights of the minority shareholders are safeguarded through a good governance approach. Access to the required financial information is provided to the investors through effective governance (Chow, 2013).
Benefits to the Creditors:
The creditors provide debt financing to the company. The various bondholders, banking institutions, and financial institutions receive interest payments and also the repayment of the principal amount over a certain period. The creditors can benefit from a good governance approach through the fulfilling of their interests. A creditor needs to have full disclosure of the information regarding the financial performance of the company, and through good governance, they can have access to this information. Moreover, a good governance approach promotes regulations which prevent any conflict of interests between the managers and the directors. The rights of creditors are given to them through a good governance approach (Fernando, 2012).
Benefits to the Employees:
Employees benefit substantially from a good corporate governance approach of their company. They not only enjoy the transparency in operations, but also have the protection for whistleblowing. Good corporate governance facilitates by well-defining of roles of its employees. The ethical code of conduct for the senior management is regulated, which motivates the employees (Zemka, 2005).
Example-Whole Foods Market-Stakeholder Synergy:
A sound culture not only embodies openness, but can also hold collaboration among employees, inclusiveness, employee job satisfaction, and health. Moreover, a sound organizational culture may consider employees as the stakeholder of the company. It shows that the resulting effect of considering the interests of each stakeholder results in an open and sound culture (Raviv and Harris, 2017).
As per the author, the most common type of cancer for the corporate governance is the idea of maximizing shareholder profits and value. While taking this as the focal of a business the interests and intrinsic value of the other stakeholders are ignored. It is the reason that has led to the financial crisis. The financial institutions were concerned with the short-term benefits and did not consider the harm that it may cause to the other stakeholders and to the society at large (Mackey and Sisodia, 2014).
The solution in his point of view is the enlightened management through which positive social impact can be made. It can be done through stakeholder collaboration and harmonization. The example of this collaboration is that of Whole Planet Foundation, which is funded and set up by the Whole Food Market. This foundation provides microcredit in more than 50 countries. As per the author, this synergy has advantages in improving the living standard of more than 1.2 million people. It has also raised the morale of the employees of WFM. They are proud of their organization and its work. The brand value and goodwill of whole food market have increased substantially. Moreover, the suppliers of the company are better involved with the business. Most importantly, it has resulted in 1000% return for the shareholders of Whole Food Market factoring all the benefits mentioned (Chow, 2013).
Example-Xerox:
The benefit of the good governance approach to the companies is evident from the CR List assembled by CR Magazine. This list ranks the best corporate citizens on an annual basis. The performance in terms of their contribution to the society, their employee relations, corporate governance, philanthropy, and promoting of human rights is measured. Hasbro, a popular toy making company was ranked first on the 2017 list. The activities like employee volunteer programs, social work contributions, environment preservation, human rights promotion, and corporate governance are considered. Microsoft was ranked third on the list. Xerox who was ranked first in the 2013 list also made it to the list this year (Strauss, 2017). The company’s green world alliance program, electronic industry citizenship coalition, and other philanthropic activities are phenomenal. However, these were attained with a balanced corporate governance approach. The company has 90% independent board of directors. These directors are expected to be directors on not more than four other boards and are needed to have a meaningful hold on equity ownership. The standing committees of Xerox are all composed of independent directors. This shows that a good governance approach has paid off for Xerox and Habros in the form of true value to its stakeholders (Xerox, 2017).
Disadvantageous from Poor Corporate Governance:
There is a potential risk of an ineffective corporate governance approach that one stakeholder group may gain more at the expense of any other stakeholder group. Moreover, the managers can tend to make poor and inefficient investment decisions, which are for their own benefit and are hurting the company and its shareholders. With ineffective corporate governance, a company’ exposure to reputational, regulatory and legal risk can become more apparent. An example of this can be of that when a company is under investigation by a regulatory authority because of some violation of law or because of the lawsuits from its stakeholders. It can not only cost legal costs but also hurt the reputation of the company. Furthermore, the company can lack its ability to pay its debts and can get into bankruptcy risks given that it debtors want to take any legal action (Finch, 2012).
Lack of Balanced Approach-Major Cause of Poor Governance:
We have defined the various stakeholders that any given corporation may have. Each has their own interest associated with the company. Corporate Governance provides the direction for the company to keep guard the interests of these stakeholders with a balanced approach. Still, many conflicts may arise. The reason can be the nature of the relationship. The principal-agent relationship often leads to a conflict of interest. This relationship is used when an arrangement is made whereby one entity legally makes another entity responsible for acting on their behalf for the providing of a specific service. The agent, which is appointed by the entity, has to take action in the best interests of the principal. However, as mentioned, this relationship often results in conflicts due to various reasons (Reichwald and Wigand, 2008). The reason is that the management is linked to the company operations and tends to have more knowledge in terms of the company, as compared to the nonexecutive board members. It turns out difficult for the board members as they are not similar to the day to day operations of the company (Coyle, 2004). Furthermore, the divergence in the risk tolerance among creditors and shareholders is different as per their nature of interests in the company. The creditors tend to be more risk aversive and try to invest in a company which has a stable stream of cash flows. The shareholders are interested in the rising equity value of their firm. It can become a conflicting point among these stakeholders (Adhariani, Sciulli and Clift, 2017).
The disadvantage of Pro-Shareholder Approach:
Managers are liable to work as an agent for the principal. It can be done by maximizing the value of the equity of the shareholders invested by them. However, these two stakeholders usually tend to have a different point of view on the level of risk a company should take in order to maximize their returns. Managers are more risk aversive. They tend to act in a manner which makes the company does not take any high risks. However, the shareholders of the company usually are risk takers and want their management to take more risk in order to increase their value (Raviv and Harris, 2017).
Moreover, the management is also much more aware of the strategic and financial position of the company as compared to the shareholders. Therefore, it can tend to work negatively as the managers would know which strategic decisions would be best and which would not be beneficial for owners (Peters and Handschin, 2012).
Example:
The example of conflict between the management and the shareholders leading to a poor corporate governance approach has recently been witnessed in the UK, when the Prime Minister had to get involved after continuous scandals in FTSE 100 of BP, GlaxoSmithKline, Rolls-Royce, Toshiba, Wells Fargo, and Volkswagen due to their poor corporate governance (Mathews and Heimer, 2016). The problem is that boards have been failing in identifying dubious practices of neglecting of the environment, money laundering, false accounting, corruption, or sanctions busting. The comfort from the familiar faces has led the boards to pay less attention. The Prime Minister has confirmed that not only consumers, but workers will also be represented on the board.
The companies are very reluctant to this new development and are seeking any excuse to avoid the challenge in the boardroom arising from a different perspective. The workers are also showing distrust of the business causing stress in the workplace. The workers are angry at the falling of real wages as compared to the executives pays (Augar, 2017).
Example-British Petroleum Oil Leakage:
For looking deeply into the disadvantage of ineffective corporate governance approach, the example of the incident of crude oil leakage in the Deepwater Horizon in the Gulf of Mexico from BP’s oil drilling installation is discussed. The story has also been shown as a movie and depicted as a tragedy on an epic scale. The company was later found to have been extremely negligent in the handling of the oil well and consequently faced billions of penalties.
The analysts have criticized the company of BP. According to them its profit-driven decisions has led it to the disaster. According to Stout, the story of the BP oil spilling incident would be remembered as one of the horrific realities of cost-cutting and ignore of safety procedures for the benefit of short-term gains for the shareholders. It shows how the approach of short-term gains ended up in long-term losses for BP.
The problem in this example is highlighted as the assumption of the belonging to the company solely to the shareholders of the company. It consequently makes the interests of the shareholders also the interests of the organization, which is to maximize the wealth of shareholders. There are many other examples of companies who have led to cost-cutting and pro shareholder strategies compromising on the benefits to the long-term financial performance and stability of the company (Allen, 2016).
Example-Sports Direct Employee Misconduct:
Another Example is that of Sports Direct. It faced anger from its shareholders after it accepted that it has been ignored in trying it, employees. The news agency reported the fear in employees at the warehouse of the company of Derbyshire. The led to minds pressure on the founder Mike Ashley leading to the admission of the fact. The revelations of the company affected its reputation and consequently, its share price fell, and the shareholders then came to give voice to their anger.
The examples show that ineffective corporate governance for the sake of guarding one stakeholder’s interests makes everyone lose. The workers, the business, the shareholders, and the management, everyone gets affected by the reputation of the company.
It is evident that the legal system for our business strangles them to put shareholders’ interests at first. It is their prime duty to safeguard their interests. It leads the management to look for the ways in which it can increase the share price of the company, as it has become the key indicator of the success of the company.
As in the example of the Deep Water Horizon of BP, when the chief executive officer and all the management behind him manage the share price rather than the company, short-termism quickly hijacks all other goals. The strategies for investment suffer at the expense of paying out to the dividend demands of the shareholders. It can lead to dangerous results. When the shareholder is the king; all the other interest of the stakeholders comes second (Allen, 2016).
Conclusion:
After a deep discussion, it is concluded that the corporate governance gives the direction to the company. If this direction is set to serve the interests of a stakeholder at the expense of another stakeholder then it will not benefit the company and subsequently, all the stakeholders will lose in the long run. Similarly, a balanced approach, keeping in consideration the interests of all the stakeholders tends to move the company and the stakeholders towards benefits in the long run.
References:
Adhariani, D., Sciulli, N. and Clift, R. (2017) Financial Management and Corporate Governance from the Feminist Ethics of Care Perspective, Springer.
Allen, K. (2016) Everyone loses out when corporate governance falls by the wayside, 11 Sept, [Online], Available: https://www.theguardian.com/business/2016/sep/11/corporate-governance-deepwater-horizon-shareholders [30 Dec 2017].
Augar, P. (2017) Corporate scandals demand boardroom shake-up, 14 April, [Online], Available: https://www.ft.com/content/570b60b2-1ece-11e7-b7d3-163f5a7f229c [30 Dec 2017].
Chow, W. (2013) For better governance, think stakeholders, 18 Dec, [Online], Available: http://www.ethicalcorp.com/stakeholder-engagement/better-governance-think-stakeholders [30 Dec 2017].
Coyle, B. (2004) Risk Awareness and Corporate Governance, Global Professional Publishi.
Deloitte (2013) The Role and Benefits of a Corporate Governance Framework, 24 May, [Online], Available: http://deloitte.wsj.com/riskandcompliance/2013/05/24/the-role-and-benefits-of-a-corporate-governance-framework/ [30 Dec 2017].
Fernando, A.C. (2012) Corporate Governance: Principles, Polices and Practices, Pearson Education India.
Finch, B. (2012) Financial Times Briefing on Corporate Governance: Financial Times Briefing, Pearson UK.
Mackey, J. and Sisodia, R. (2014) Conscious Capitalism, With a New Preface by the Authors: Liberating the Heroic Spirit of Business, Harvard Business Review Press.
Mathews, C. and Heimer, M. (2016) The 5 Biggest Corporate Scandals of 2016, 28 Dec, [Online], Available: http://fortune.com/2016/12/28/biggest-corporate-scandals-2016/ [30 Dec 2017].
Peters, A. and Handschin, L. (2012) Conflict of Interest in Global, Public and Corporate Governance, Cambridge University Press.
Phillips, R. (2003) Stakeholder Theory and Organizational Ethics, Berrett-Koehler Publishers.
Prasnikar, J. (2006) Competitiveness, Social Responsibility and Economic Growth, Nova Publishers.
Raviv, A. and Harris, M. (2017) Shareholders vs. Management: Split Decision, June, [Online], Available: https://insight.kellogg.northwestern.edu/article/shareholders_vs_management_split_decision [30 Dec 2017].
Reichwald, R. and Wigand, R.T. (2008) Information, Organization and Management, Springer Science & Business Media.
Rezaee, Z. (2009) Corporate Governance and Ethics, John Wiley & Sons.
Strauss, K. (2017) America’s 100 Best Corporate Citizens In 2017, 11 May, [Online], Available: https://www.forbes.com/sites/karstenstrauss/2017/05/11/americas-100-best-corporate-citizens-in-2017/#14d268fc2b68 [31 Dec 2017].
Xerox (2017) Xerox Makes “100 Best Corporate Citizens List” In Corporate Responsibility Magazine, 6 June, [Online], Available: https://www.news.xerox.com/news/Xerox-Among-Top-100-Companies-by-CR-Magazine [31 Dec 2017].
Zemka, J.A. (2005) Role for Stakeolder in Corporate Governance, [Online], Available: http://www.ecseonline.com/PDF/Role_of_Stakeholders_in_CorpGov.pdf [31 Dec 2017].
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