corporate governance

(noun)

involves the roles and relationships between a company's management, its board, its shareholders and other stakeholders, and the goals for which the corporation is governed. Much of the contemporary interest in corporate governance is concerned with mitigation of the conflicts of interests and the nature and extent of accountability of people in the business.

Related Terms

Examples of corporate governance in the following topics:

  • Defining Corporate Governance

    • Corporate governance is the system by which companies are directed and controlled.
    • Corporate governance is the system by which companies are directed and controlled.
    • An important theme of corporate governance is the nature and extent of accountability of people in the business.
    • Contemporary discussions of corporate governance tend to refer to principles raised in three documents released since 1990: The Cadbury Report (UK, 1992), the Principles of Corporate Governance (OECD, 1998 and 2004), the Sarbanes-Oxley Act of 2002 (US, 2002).
    • Corporate governance deals with the conflicts of interests in a company.

  • Conflicts Between Managers and Shareholders

    • Partly as a result of this, mechanisms of corporate governance include a system of controls that are intended to align the incentives of managers with those of shareholders.
    • The chief goal of current corporate governance is to eliminate instances when shareholders have conflicts of interest with one another.
    • Another important goal is to evaluate whether a corporate governance system hampers or improves the efficiency of an organization.
    • Research of this type is particularly focused on how corporate governance impacts the welfare of shareholders.
    • Advocates of governance typically encourage corporations to respect shareholder rights, and to help shareholders learn how and where to exercise those rights.

  • Default Risk and Bond Price

    • We draw the supply and demand for two markets: government bond market and corporate bond market.
    • Some investors demand fewer corporate bonds and invest more in government bonds.
    • Thus, the demand for corporate bonds falls while the demand for government bonds rise because the investors consider the government bonds default-free.
    • Did you notice the government bonds have a higher bond price while corporate bonds have a lower bond price?
    • Hence, the difference between government and corporate interest rates would widen.

  • Liquidity and Bond Prices

    • For instance, U.S. government securities are widely traded and are the most liquid.
    • We start the analysis with the same liquidity in both the government bond and corporate bond markets in Figure 2.
    • Demand function increases and shifts rightward for government bonds.
    • Thus, the government bond prices rise, which reduces the interest rate for government bonds.
    • On the other hand, the corporate bond prices decrease, raising the market interest rate for corporate bond.

  • The Valuation of Bonds

    • A coupon bond differs from a discount bond because its interest rate is stated on the certificate.During the old days, an investor would detach a coupon from the bond and mail it to the corporation or government for an interest payment.Then the corporation or government would send a check to the bondholder.We show a coupon bond in Figure 3 with dated coupons at the bottom of the certificate.
    • Market interest rate rarely equals the bond's stated interest rate.If the market interest rate is lower than the coupon interest rate, then a corporation or government would never sell the bond for the face value because it would pay a higher interest rate than the marker.However, the government or corporation could sell the bond for a greater market price, reducing the investor's return.Higher market price means the bond issuer sold the bond for a premium.
    • A government or corporation could issue a bond that never matures, which we call a consul or perpetuity.Consequently, the bond has no maturity date, but the bondholder receives interest payments forever.A government or corporation rarely issues these bonds because most people and government like end dates for loans.However, this bond possesses nice mathematical properties.
    • Registered Bonds: Corporation registers the names and addresses of the bondholders.Most corporations register bonds because the registration protects the investors from loss or theft of the bonds.
    • Convertible Bonds: Bondholders have the right to exchange the corporate bonds into corporate stock on a specified date.

  • Formation of the Corporation

    • Historically, corporations were created by a charter granted by government .
    • Today, corporations are usually registered with the state, province, or national government, and regulated by the laws enacted by that government.
    • Generally, a corporation files articles of incorporation with the government, laying out the general nature of the corporation, the amount of stock it is authorized to issue, and the names and addresses of directors.
    • Once the articles are approved, the corporation's directors meet to create bylaws that govern the internal functions of the corporation, such as meeting procedures and officer positions.
    • If a corporation operates outside its home state, it is often required to register with other governments as a foreign corporation, and is almost always subject to the laws of its host state pertaining to employment, crimes, contracts, civil actions, and the like.

  • Corporations

    • A charter is a legal document from government that creates the corporation.By law, the corporation becomes an independent legal entity with rights similar to a person.A state government approves corporate charters in the United States.For example, several corporations choose the State of Delaware because the state charges the lowest fees to incorporate.
    • A corporation has limited liability.Stockholders own the corporation, and they are not liable for a corporation's debt.If a corporation fails, subsequently, the stockholders only lose their investment, the amount of common stock that they had purchased.
    • Stockholders do not have a mutual agency relationship, where the stockholders cannot bind a corporation to contracts.Stockholders have no say in the daily operation of the corporation even though they own the corporation.
    • Corporations have two disadvantages.First, government heavily regulates corporations.Corporations file many reports with government because corporations can expand into many countries, markets, and industries.Corporations may encourage regulations because bureaucratic red tape creates barriers to entry.Thus, new companies experience troubles entering the market with complex and arduous regulations.Second, government imposes taxes twice on corporations.Corporations pay taxes from their profits.Then stockholders receive profit from the corporation as dividends, and the dividends become income to the stockholder that a government also taxes.
    • Corporations can use subsidiaries to avoid regulations or avoid taxes.For instance, a parent corporation could relocate to the Bahamas or Cayman Islands.These countries are tax havens with low taxes, little regulations, and strong confidentiality laws.Consequently, corporations can shift assets and liabilities among subsidiaries to decrease their overall tax burden.At this point, we clarify some tax terminology.Tax evasion is a person or corporation owes a government for taxes, but refuses to pay it.Some activity created the tax liability, and the law requires them to pay taxes.Otherwise, government can assess fines or send the tax evaders to prison.However, corporations can use tax avoidance because they can afford to hire specialists.Tax avoidance is the managers careful plan the corporate activities and prevent the creation of tax liabilities.

  • Factors External to the Firm

    • Factors such as corporate tax rate, interest rate fluctuation, and conditions of the economy and markets are external factors of the WACC.
    • Corporate tax is federal, state, and sometimes local taxes levied on the income of entities treated as a corporation.
    • Corporate taxes cannot be controlled by a company, outside of lobbying governing bodies, and is therefore an external factor .

  • Corporate Fraud

    • The Enron Corporation declared bankruptcy in 2001 and became the universal symbol for corporate fraud.Enron managers created Special Purpose Entities (SPE) with the sole purpose to wipe debt and liabilities from Enron's financial statements.A Special Purpose Entity consists of a company or subsidiary of the corporation.A SPE could be a shell company, where the company does not physically exist, except on paper.
    • Almost everyone in the financial world overlooked the SPEs, including Enron's auditor, Arthur Anderson, Enron's law firm, and the regulators from the Securities and Exchange Commission (SEC).Then the U.S. government passed the Sarbanes-Oxley Act in 2002, which required CFOs and CEOs to sign their company's financial statements.Law's goal was to increase transparency.Transparency means outsiders can look at an organization, and know therules and can accurately assess a firm's true finances.Unfortunately, Enron was "a black box,"and only a few insiders knew Enron's genuine financial picture.On the other hand, a nontransparent government tends to be corrupt.For example, if government officials do not write down the laws and rules, or the laws and rules are vague, subsequently, the bureaucrats have wide discretion whether to approve a business license or activity, fueling corruption.
    • Countries differ in corporate structure and planning.The U.S. corporations usually focus on short-term profits, and thus, they have problems with corporate fraud.On the other hand, the Japanese plan long term and they form a Keiretsu, a conglomerate of many companies with a bank member.Consequently, the bank could grant low-interest loans to its partner companies, and the Keiretsu usually focuses on long-term profits and market shares.Furthermore, corporations in South Korea, Germany, and Russia also established conglomerates, which are similar to a Keiretsu.
    • Some governments become a shareholder in a company, which the former communistic countries often use.Government retains control over the company, and it attracts partners who bring technology and efficient management practices.Unfortunately, government as a shareholder becomes susceptible to corruption because a government can use its authority to protect the company and isolate it from competition.
    • A family who dominates a corporation could reduce the principal-agent problem.For example, the Walton family is the majority shareholders who actively manage the Wal-Mart Corporation.Microsoft was similar, when Bill Gates was both the CEO and majority shareholder.Consequently, they become both the agent and principal, and they have one united interest - to earn profits.Thus, these companies earned high returns, and managers have better vision and oversight over their corporations.

  • Is the Federal Reserve Independent of the U.S. Government?

    • For example, a new computer corporation is founded, and it creates new computers for a low price.
    • If consumers buy this computer, then the corporation earns profits.
    • However, if the corporation builds computers that nobody wants, subsequently, the corporation will bankrupt.
    • On the other hand, profits do not guide the government agencies, and no mechanism keeps a government agency in check.
    • Consequently, a government would suffer from a budget deficit that its treasury can finance by selling government bonds.