What is corporate governance and why is it important?

Back in 2002 following a series of corporate scandals, the US government enacted the Sarbanes-Oxley Act to improve corporate governance in the United States.  Australia enacted similar reforms such as CLERP 9. Today, businesses continue to put their corporate governance under the microscope – and for good reason. Why is corporate governance so important and how can business implement good corporate governance?

What is corporate governance, why is it important and who is responsible?

Corporate governance is a system of policies, processes and rules that direct and control a business’s behaviour. It is the framework that defines the relationship between shareholders, management, the Board of Directors and other key stakeholders. Corporate governance policies need to be enforceable and applied consistently.

Good corporate governance fosters a culture of integrity and leads to a positive performing and sustainable business. Good governance signals to the market that an organisation is well managed and that the interests of management are aligned with other stakeholders. As such, it can provide businesses with a competitive advantage.

The Board of Directors plays a vital role in the development of corporate governance policies. It needs to engage with the management of the business to provide clarity of strategic purpose. Developing and setting a clear strategy and then implementing it effectively are vital to any organisation’s success.  Shareholders also play an important role in governance as they need to ensure the right directors are appointed to their Board.

Ten ways to implement good corporate governance

Good corporate governance can be difficult to implement in totality, but ten aspects to consider include:

1. Ensure a balanced, competent and diverse Board   Business should strive for directors who are qualified, understand the business and can offer a fresh perspective. Studies show Boards with greater gender diversity result in improved financial performance.
2. Review your Board composition on a regular basis to identify any shortcomings and make timely improvements.
3. Build solid foundations for oversight   Establish, monitor and evaluate the roles and responsibilities of the Board and management. The Board needs to have visibility of management actions and key decision making.
4. Gear key performance indicators towards long term value creation not just in the short term.
5. Prioritise risk management   Establish an effective risk management and internal control framework and periodically review its effectiveness. Developing a disaster recovery plan is essential.
6. Ensure integrity in corporate reporting including safeguards such as conducting external audits of the business.
7. Provide timely and balanced information   Providing transparency to key stakeholders both in the good and bad times promotes stakeholders’ confidence in the business.
8. Emphasise integrity, promote ethical behaviours and consult different categories of stakeholders on their interests.
9. Treat shareholders equitably and respect their rights.
10. Ensure adequate disclosures around related parties’ transactions and director’s other interests. This is especially important where a director may have external financial interests that could influence his decision.

How should small-to-medium businesses apply corporate governance?

For small to medium businesses, a full Board of Directors and corporate governance regulation are often not necessary, nonetheless some corporate governance should be in place.

• For small and early stage businesses where there are multiple shareholders, set regular board meetings and nominate an informal ‘chair’ to keep strategies on track, aid in reaching consensus and avoiding biases.
• Where a business is family owned, it is a good idea to establish a family governance framework to foster coordination amongst family members and structure the relationship between family and business.
• As the business grows, evaluate the Board composition to ensure it is appropriate for the next phase of the business development. At this stage, it can be effective to put in place an advisory panel which is like a formal board except not all the members are the directors of the business. Introducing external experts with a particular skillset can help achieve your business growth goals.  External experts such as your business accountant often make good advisory panel members due to their experience in issues such as governance, mergers and tax strategies.

Our audit and assurance advisors regularly assist clients with their corporate governance, often as an outcome of an audit engagement.  Please don’t hesitate to contact us if we can assist with your corporate governance.