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Corporate governance is the collection of mechanisms, processes and relations used by various parties to control and to operate corporations.[1][need quotation to verify][2] Governance structures and principles identify the distribution of rights and responsibilities among different participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and include the rules and procedures for making decisions in corporate affairs.[3] Corporate governance is necessary because of the possibility of conflicts of interests between stakeholders,[4] primarily between shareholders and upper management or among shareholders.

Corporate governance includes the processes through which corporations' objectives are set and pursued in the context of the social, regulatory and market environment. These include monitoring the actions, policies, practices, and decisions of corporations, their agents, and affected stakeholders. Corporate governance practices can be seen[by whom?] as attempts to align the interests of stakeholders.[5][need quotation to verify][6][page needed]

Interest in the corporate governance practices of modern corporations, particularly in relation to accountability, increased following the high-profile collapses of a number of large corporations in 2001–2002, many of which involved accounting fraud; and then again after the financial crisis in 2008.[citation needed]

Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. In the U.S. these have included scandals surrounding Enron and MCI Inc. (formerly WorldCom). Their demise led to the enactment of the Sarbanes–Oxley Act in 2002, a U.S. federal law intended to improve corporate governance in the United States. Comparable failures in Australia (HIH, One.Tel) are associated[by whom?] with the eventual passage of the CLERP 9 reforms there (2004), that similarly aimed to improve corporate governance.[7] Similar corporate failures in other countries stimulated increased regulatory interest (e.g., Parmalat in Italy).

This could eventually put more pressure on the CE

This could eventually put more pressure on the CEOs of publicly listed companies, as "more than ever before, many [North American,] UK and European Union pension trustees speak enthusiastically about flexing their fiduciary muscles for the UN's Sustainable Development Goals", and other ESG-centric investment practices.[97]

In Britain, "The widespread social disenchantment that followed the [2008–2012] great recession had an impact" on all stakeholders, including pension fund board members and investment managers.[98]

Many of the UK's largest pension funds are thus already active stewards of their assets, engaging with corporate boards and speaking up when they think it is necessary.corporate boards and speaking up when they think it is necessary.[98]

Control and ownership structure refers to the types and composition of shareholders in a corporation. In some countries such as most of Continental Europe, ownership is not necessarily equivalent to control due to the existence of e.g. dual-class shares, ownership pyramids, voting coalitions, proxy votes and clauses in the articles of association that confer additional voting rights to long-term shareholders.[99] Ownership is typically defined as the ownership of cash flow rights whereas control refers to ownership of control or voting rights.[99] Researchers often "measure" control and ownership structures by using some observable measures of control and ownership concentration or the extent of inside control and ownership. Some features or types of control and ownership structure involving corporate groups include pyramids, cross-shareholdings, rings, and webs. German "concerns" (Konzern) are legally recognized corporate groups with complex structures. Japanese keiretsu (系列) and South Korean chaebol (which tend to be family-controlled) are corporate groups which consist of complex interlocking business relationships and shareholdings. Cross-shareholding is an essential feature of keiretsu and chaebol groups. Corporate engagement with shareholders and other stakeholders can differ substantially across different control and ownership structures.

Family control

Family interests dominate ownership and control str

Family interests dominate ownership and control structures of some corporations, and it has been suggested that the oversight of family-controlled corporations are superior to corporations "controlled" by institutional investors (or with such diverse share ownership that they are controlled by management). A 2003 Business Week study said: "Forget the celebrity CEO. Look beyond Six Sigma and the latest technology fad. One of the biggest strategic advantages a company can have, it turns out, is blood lines."[100] A 2007 study by Credit Suisse found that European companies in which "the founding family or manager retains a stake of more than 10 per cent of the company’s capital enjoyed a superior performance over their respective sectoral peers", reported Financial Times.[101] Since 1996, this superior performance amounted to 8% per year.[101]

Diffuse shareholders

Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from

Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. There are both internal monitoring systems and external monitoring systems.[103] Internal monitoring can be done, for example, by one (or a few) large shareholder(s) in the case of privately held companies or a firm belonging to a business group. Furthermore, the various board mechanisms provide for internal monitoring. External monitoring of managers' behavior occurs when an independent third party (e.g. the external auditor) attests the accuracy of information provided by management to investors. Stock analysts and debt holders may also conduct such external monitoring. An ideal monitoring and control system should regulate both motivation and ability, while providing incentive alignment toward corporate goals and objectives. Care should be taken that incentives are not so strong that some individuals are tempted to cross lines of ethical behavior, for example by manipulating revenue and profit figures to drive the share price of the company up.[82]

Internal corporate governance controls

External corporate governance controls the external stakeholders' exercise over the organization. Examples include:

  • competition
  • debt covenants
  • demand for and assessment of performance information (especially financial statements)
  • government regulations
  • managerial labour market
  • media pressure
  • takeovers
  • proxy firms

Financial reporting and the independent auditor

The board of directors has primary responsibility for the corporation's internal and external financial reporting functions. The chief executive officer and chief financial officer are crucial participants, and boards usually have a high degree of reliance on them for the integrity and supply of accounting information. They oversee the internal accounting systems, and are dependent on the corporation's accountants and internal auditors.

Current accounting rules under International Accounting Standards and U.S. GAAP allow managers some choice in determining the methods of measurement and criteria for recognition of various financial reporting elements. The potential exercise of this choice to improve apparent performance increases the information risk for users. Financial reporting fraud, including non-disclosure and deliberate falsification of values also contributes to users' information risk. To reduce this risk and to enhance the perceived integrity of financial reports, corporation financial reports must be audited by an independent external auditor who issues a report that accompanies the financial statements.

One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management. The power of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and dismiss accounting firms contradicts the concept of an independent auditor. Changes enacted in the United States in the form of the Sarbanes–Oxley Act (following numerous corporate scandals, culminating with the [citation needed]

External corporate governance controls the external stakeholders' exercise over the organization. Examples include:

  • competition
  • debt covenants
  • demand for and assessment of performance information (especially financial statements)
  • government regulations
  • managerial labour market
  • media pressure
  • takeovers
  • proxy f

    The board of directors has primary responsibility for the corporation's internal and external financial reporting functions. The chief executive officer and chief financial officer are crucial participants, and boards usually have a high degree of reliance on them for the integrity and supply of accounting information. They oversee the internal accounting systems, and are dependent on the corporation's accountants and internal auditors.

    Current accounting rules under International Accounting Standards and U.S. GAAP allow managers some choice in determining the methods of measurement and criteria for recognition of various financial reporting elements. The potential exercise of this choice to improve apparent performance increases the information risk for users. Financial reporting fraud, including non-disclosure and deliberate falsification of values also contributes to users' information risk. To reduce this risk and to enhance the perceived integrity of financial reports, corporation financial reports must be audited by a

    Current accounting rules under International Accounting Standards and U.S. GAAP allow managers some choice in determining the methods of measurement and criteria for recognition of various financial reporting elements. The potential exercise of this choice to improve apparent performance increases the information risk for users. Financial reporting fraud, including non-disclosure and deliberate falsification of values also contributes to users' information risk. To reduce this risk and to enhance the perceived integrity of financial reports, corporation financial reports must be audited by an independent external auditor who issues a report that accompanies the financial statements.

    One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management. The power of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and dismiss accounting firms contradicts the concept of an independent auditor. Changes enacted in the United States in the form of the Sarbanes–Oxley Act (following numerous corporate scandals, culminating with the Enron scandal) prohibit accounting firms from providing both auditing and management consulting services. Similar provisions are in place under clause 49 of Standard Listing Agreement in India.

    Increasing attention and regulation (as under the Swiss referendum "against corporate rip-offs" of 2013) has been brought to executive pay levels since the financial crisis of 2007–2008. Research on the relationship between firm performance and executive compensation does not identify consistent and significant relationships between executives' remuneration and firm performance. Not all firms experience the same levels of agency conflict, and external and internal monitoring devices may be more effective for some than for others.[86][108] Some researchers have found that the largest CEO performance incentives came from ownership of the firm's shares, while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. The results suggest that increases in ownership above 20% cause management to become more entrenched, and less interested in the welfare of their shareholders.[108]

    Some argue that firm performance is positively associated with share option plans and that these plans direct managers' energies and extend their decision horizons toward the long-term, rather than the short-term, performance of the company. However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants as documented by University of Iowa academic Erik Lie[109] and reported by James Blander and Charles Forelle of the Wall Street Journal.[108][110]

    Even before the negative influence on public opinion caused by the 2006 backdating scandal, use of options faced various criticisms. A particularly forceful and long running argument concerned the interaction of executive options with corporate stock repurchase programs. Numerous authorities (including U.S. Federal Reserve Board economist Weisbenner) determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests. These authors argued that, in part, corporate stock buybacks for U.S. Standard & Poor's 500 companies surged to a $500 billion annual rate in late 2006 because of the effect of options.[111]

    A combination of accounting changes and governance issues led options to become a less popular means of remuneration as 2006 progressed, and various alternative implementations of buybacks surfaced to challenge the dominance of "open market" cash buybacks as the preferred means of implementing a share repurchase plan.

    Separation of Chief Executive Officer and Chairman of the Board roles