01-01-2013, 12:02 PM
Corporate Governance
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Corporate governance is the set of mechanisms used to manage the relationship among stakeholders that is used to determine and control the strategic direction and performance of organisations.
At it core, corporate governance is concerned with identifying ways to ensure that strategic decisions are made effectively. Governance can also be thought of as a means corporations use to establish order between parties whose interests may conflict.
Internal Governance Mechanisms
Ownership Concentration
Relative amounts of stock owned by individual shareholders and institutional investors
Board of Directors
Individuals responsible for representing the firm’s owners by monitoring top-level managers’ strategic decisions
Executive Compensation
Use of salary, bonuses, and long-term incentives to align managers’ interests with shareholders’ interests
Separation of Ownership and Managerial Control
The separation of ownership and managerial control allows shareholders to purchase stock, which entitles them to income from the firm’s operation after paying expenses.
This right however requires that they also take a risk that the firm’s expenses may exceed its revenues. To manage this investment risk, shareholders maintain a diversified portfolio by investing in several companies to reduce their overall risk.
As shareholders diversify their investments over a number of corporations, their risk declines. The poor performance or failure of any one firm in which they invest has less overall affect. Thus, shareholders specialize in managing their investment risk.
Agency Relationship
The separation between owners and managers creates an agency relationship. An agency relationship exists when one or more persons hire another person or persons as decision-making specialist to perform a service.
In addition to shareholders and top executives other examples of agency relationships are consultants and clients and insured and insurer.
Moreover within organisations an agency relationship exist between managers and their employees as well as between top executives and the firm’s owners.