Corporate Governance Overview and Stakeholder Groups | CFA Level I Corporate Issuers
Welcome to the first lesson in the Corporate Finance course where we’ll dive into Corporate Governance and ESG (Environmental, Social, and Governance). Though it may seem a bit dry at first, bear with me as we cover essential concepts you’ll need for the CFA exam.
Today, we’ll discuss the definition of corporate governance and the various stakeholder groups involved in the process.
What is Corporate Governance?
Corporate governance is the response to high-profile company failures caused by weak governance. Regulations have been introduced to protect financial markets and investors, who have also become more attentive to environmental and social issues related to a company’s operations. This brings us to ESG, which we’ll discuss later on.
According to the CFA Institute:
- Corporate governance is a framework for a listed company
- It defines the rights, roles, and responsibilities of various groups
- Conflicting interests between groups exist
- A system of checks, balances, and incentives should be arranged to minimize and manage the conflicts
Shareholder Theory vs. Stakeholder Theory
There are two main theories for corporate governance:
- Shareholder Theory: Primarily focuses on the interests of the firm’s shareholders, which is to maximize the value of the firm’s common stock. Under this theory, corporate governance is primarily concerned with the conflict of interest between the firm’s managers and the shareholders.
- Stakeholder Theory: Considers the conflicts among the several groups that have an interest in the activities and performance of the company, including shareholders, board of directors, management, employees, suppliers, creditors, and others.
Key Stakeholder Groups and Their Interests
Let’s take a closer look at each stakeholder group and their interests:
- Shareholders: As company owners, shareholders’ claims are on the net assets of the company after liabilities are settled. They have voting rights for electing the board of directors and other important matters, giving them control of the firm and its management. Shareholders seek ongoing profitability and growth to increase the value of their shares.
- Board of Directors: Responsible for protecting shareholders’ interests, hiring/firing/compensating senior managers, setting the company’s strategic direction, and monitoring financial performance. The board typically includes executives and non-executive members. Some countries use a one-tier board structure, while others use a two-tier system with a supervisory board overseeing a management board.
- Management: Executives receive compensation through salary, performance-based bonuses, and perks. They’re interested in continued employment and higher compensation. Bonuses are usually tied to company performance, giving them a strong interest in meeting performance targets.
- Employees: Interested in the sustainability and success of the firm, as their job security and bonuses can be influenced by company performance. They also seek career advancement, training, and good working conditions.
- Creditors: Banks and bondholders who have made loans to the company. They don’t have voting rights or participate in firm growth, but they’re interested in timely interest and principal repayments, which can be protected by collaterals and covenants.
- Suppliers: Interested in preserving their relationship with the firm and the profitability of their deals. As short-term creditors, they also care about the firm’s solvency and financial strength.
- Customers: Expect reliable delivery, ongoing support, product guarantees, and after-sale service. Long-term customers are more likely to be interested in the company’s stability.
- Government and Regulators: Responsible for protecting the public’s interests and ensuring economic well-being. They also rely on corporate taxes as a significant revenue source.
In our next lesson, we’ll examine the conflicts of interest between these various stakeholder groups. See you then!