According to corporate training provider CFI, “Corporate governance is a system that guides the conduct of the people within an organization, as well as the direction of the organization itself.” The following video further defines corporate governance.
The board of directors (BOD) steers the company in a particular direction. They may make decisions about things like strategic risk and planning, financial reporting, high-level talent management, and future leaders. These matters are separate from the decisions that must be made regarding day-to-day operations.
While the BOD is responsible for many matters related to company direction, it must answer to shareholders and make all decisions based on their best interest. Any board appointments must be subject to a BOD vote. However, pressure has been growing for boards to consider a wider range of interested parties known as stakeholders, which includes anyone who is impacted by the company’s activities.
In the following sections, we explore the types of governance and which may be best for your business based on your mission. We also discuss how to develop a governance model.
What Are the Types of Governance?
For operational decision-making, corporate governance can be centralized or decentralized. Within a centralized model, decisions are made by those in high-level positions, led by the CEO. Front-line employees and managers are responsible for carrying out the actions needed to support those decisions. High-level decision-makers may elicit feedback and suggestions from lower-level team members, though they may not go directly to customers for input.
Within a decentralized model, front-line employees and managers have the authority to make decisions and act on them. This model tends to foster a more collaborative and nimbler environment that allows companies to shift processes based on market forces, competitive moves, customer demand, and other factors outside the influence of the team.
Nonprofit governance models may differ from those of corporations. According to board advisory firm OnBoard, they include the options listed below. Boards can also be a hybrid of two or more of these models.
- Advisory model. The CEO runs the organization with advisory help from the board. Board members are industry experts. This board may be formed in addition to the standard BOD.
- Cooperative governance model. In the cooperative model, there is no CEO or president overseeing the organization’s activities. It may be used when the organization doesn’t necessarily need a board but must have one to meet legal requirements.
- Patron governance model. Members of this type of board provide financial support personally and through fundraising efforts. These board members are typically wealthy and wield great influence within the field of interest.
- Policy board model. With this popular model, the board trusts the CEO and takes a back seat to that person in decision-making. Board members may serve as backup leaders but typically work in tandem with the CEO.
- Management team model. In this model, board members divide into departments to help guide specific areas of the nonprofit, such as HR, fundraising, planning, and public relations.
Why Is the Model of Governance Important?
Going back to the issue of shareholders versus stakeholders, the question is, which group has what is known as primacy? That is, which group must be considered first as the board or employees make decisions? Different answers to that question can produce very different results. Specifically, shareholder primacy forces board members and other leaders into short-term thinking that can prevent organizations from making long-term investments that could pay off bigger down the road.
CFI states, “Opponents of purified shareholder primacy are…quick to point out that short-term thinking and profit-maximizing forms of governance lead to generally ‘bad’ corporate behavior….” On the other hand, stakeholder primacy takes into consideration the needs of employees, customers, vendors, local communities, and the world.
While neither approach is necessarily right or wrong, a company must choose a governance model that fits its mission. Strong corporate governance, through keeping the company on track and building a good reputation, ensures longevity and resiliency for the company.
How to Develop a Governance Model
Determining a governance model is a multi-step process. Experts recommend that companies include the following components:
- Code of ethics. These standards of behavior for board members spell out what is expected and what is not tolerated. They may include how to manage conflicts of interest, the company culture, harassment policies, a whistleblower’s policy, and so on.
- Procedures for shareholder voting. Shareholders vote on such things as new board members, approving mergers and acquisitions, and approving executive salaries and benefits. Processes might include how and when to vote and how the BOD will communicate with shareholders about these matters.
- Rules governing director independence. This component is more complicated than it might seem. A director might be independent by one measure but not by another. Also, a director’s independence status might change over time. There can be doubt about a director’s independence in cases of self-interest, relationships with interested parties, and similar situations.
- Guidelines for financial reporting. The guidelines for financial reporting vary greatly from industry to industry. Directors must familiarize themselves with the appropriate local, state, federal, and international requirements, as well as those of organizations that issue compliance standards.
- Compliance monitoring. Compliance monitoring is another area in which needs vary greatly between industries. But all companies must develop a policy for ensuring that compliance standards are met. Necessary actions might include audits, training for employees, or the use of specific equipment.
The Benefits of Strong Corporate Governance
The right governance model and components are critical to the well-being of a company. With good governance, companies improve compliance, efficiency, risk mitigation, decision-making, strategic and technology planning, reputation, and more. Weak governance can lead to problems in these areas. Given the foundational importance of governance, leaders should take the responsibility seriously to ensure the company’s strength.