Corporate Governance

By Celine Ng What Is Corporate Governance?

Corporate governance is the system by which companies are directed and controlled. As distinct from the day-to-day management of the company, corporate governance refers to the broad rules, policies, and resolutions which direct the behaviour of particular companies.

These rules and policies outline factors such as a company’s management and internal control, its strategic aims and values, and the relationships between its stakeholders. For instance, such rules might dictate the duties, liabilities, and composition of a company’s board of directors.

Sources and Content of Corporate Governance Principles

When a company registers, it needs to provide 2 documents - the memorandum of association and the articles of association. The company’s corporate governance principles are largely contained in the latter.

The memorandum of association is a legal statement signed by all initial shareholders or guarantors agreeing to form the company.

The articles of association are written rules about running the company agreed by the shareholders or guarantors, directors and the company secretary. Some examples of model articles of association are available on the UK government website.

The actual content of corporate governance principles is influenced by multiple sources. For instance, the Companies Act 2006 in the UK contains several legal powers and obligations such as the power of directors to bind a company.

The UK Corporate Governance Code, published by the Financial Reporting Council, applies to all companies with a premium listing and outlines several non-obligatory best practices. For example, it recommends that a company’s board of directors should seek to understand the viewpoints of stakeholders such as the company’s employees and outline these views in its annual report.

The UK Stewardship Code sets out good practices for institutional investors when engaging with UK listed companies.

Why Is Corporate Governance Important?

Corporate governance is important for six reasons:

Firstly, it facilitates desirable business practices. For instance, auditing and reporting requirements ensure (in theory) that businesses are run transparently. Rules about decision-making by majority or unanimity provide a clear system for resolving conflicts in a company’s leadership.

Secondly, it provides reassurance to shareholders. Major decisions, such as a company’s approach to remunerations and incentives, are implemented through resolutions of the board of directors. Rules of corporate governance provide assurance to shareholders that such decisions will be made subject to specified limitations. One example might be a rule which prohibits directors from partaking in special remuneration programmes unless they have written approval from their shareholders.

Thirdly, it has practical internal implications. A company must abide by its corporate governance rules and this has knock-on effects. For instance, a company contemplating an employee share option scheme should ensure that the scheme complies with its stock ownership guidelines. Under the UK Corporate Governance Code, companies are expected to either abide by the principles contained in that Code or explain any deviations therefrom to their shareholders.

Fourthly, it is required by the listing rules. A company which lists its shares or securities for sale to the public must comply with the listing rules. These rules include requirements relating to aspects of corporate governance such as disclosure requirements and adherence to the “explain or comply” approach under the UK Corporate Governance Code.

Fifthly, it intersects with legal obligations. Corporate governance overlaps with company law, largely contained in the Companies Act 2006. Breaches of the Companies Act attract legal sanctions such as personal liability to the company, criminal liability, and disqualification from directorship.

Sixthly, it affects a company’s reputation and appeal to investors. Sound corporate governance reflects on the strategy and integrity of a company, which may affect public goodwill. Moreover, investors are increasingly making their decisions on the basis of Environmental, Social, and Governance (ESG) criteria.

What roles do law firms play?

The roles of corporate governance lawyers largely fall into two broad categories:

Firstly, facilitating compliance. Corporate governance lawyers discharge an advisory function. For instance, they keep abreast of changes in corporate governance regulations and outline how these will affect a business; they also advise on securities and stock exchange listing issues. In addition, they draft and amend important constitutional documents such as the articles of association. Finally, they provide corporate secretarial services such as advising on meetings, resolutions, and filings.

Secondly, managing disputes. Corporate governance lawyers advise their clients on how to navigate disputes, such as investigations by regulatory authorities, the consequences of breaches of duty, and conflicts within senior management.

Case Studies

Vanguard votes against pay at Alphabet, Uber and Ocado – (September 2020) The world’s second largest asset manager voted against executive remuneration packages at Alphabet, Uber and Ocado. In particular, Vanguard expressed the need for closer links between remuneration and performance. Pressure on the firm to take a more active stance on corporate governance issues has increased as rival asset managers such as BlackRock have declared their commitment to pursuing higher ESG standards.

Norway’s $1tn oil fund sharpens focus on corporate governance – (June 2020) The world’s largest sovereign wealth fund has already articulated principles relating to anti-corruption and board composition which it expects potential investment targets to adhere to. Carine Smith Ihenacho, chief of corporate governance, recently expressed a heightened emphasis on corporate governance issues fuelled by the COVID-19 pandemic.

WeWork overhauls corporate governance in bid to save IPO – (September 2019) In response to investor pressure, WeWork promised to add a new director to its board and reduce the voting power of co-founder Adam Neumann. This was an attempt to allay corporate governance concerns ahead of its initial public offering.