Chapter 10: Corporate Governance 311
particularly those of shareholders, is a primary objective of corporate governance. Thus,
corporate governance involves oversight in areas where owners, managers, and mem-
bers of boards of directors may have conflicts of interest. Processes used to elect
members of the firm’s board of directors, the general management of CEO pay and more
focused supervision of director pay, and the corporation’s overall strategic direction are
examples of areas in which oversight is sought.^4 Because corporate governance is an
ongoing process concerned with how a firm is to be managed, its nature evolves in light
of the types of never-ending changes in a firm’s external environment that we discussed
in Chapter 2.
The recent global emphasis on corporate governance stems mainly from the apparent
failure of corporate governance mechanisms to adequately monitor and control top-level
managers’ decisions (as exemplified by the growing focus on governance issues among
activist investors in the Opening Case). In turn, undesired or unacceptable consequences
resulting from using corporate governance mechanisms cause changes such as electing
new members to the board of directors with the hope of providing more effective gov-
ernance. A second and more positive reason for this interest comes from evidence that a
well-functioning corporate governance system can create a competitive advantage for an
individual firm.^5
As noted earlier, corporate governance is of concern to nations as well as to individ-
ual firms.^6 Although corporate governance reflects company standards, it also collec-
tively reflects the societal standards of nations.^7 For example, the independence of board
members and practices a board should follow to exercise effective oversight of a firm’s
internal control efforts are changes to governance standards that have been fostered in
Singapore.^8 Efforts such as these are important because research shows that firms seek
to invest in nations with national governance standards that are acceptable to them.^9
This is particularly the case when firms consider the possibility of expanding geograph-
ically into emerging markets.
In the chapter’s first section, we describe the relationship on which the modern
corporation is built—namely, the relationship between owners and managers. We use the
majority of the chapter to explain various mechanisms owners use to govern managers
and to ensure that they comply with their responsibility to satisfy stakeholders’ needs,
especially those of shareholders.
Three internal governance mechanisms and a single external one are used in the
modern corporation. The three internal governance mechanisms described in this
chapter are
- ownership concentration, represented by types of shareholders and their different
incentives to monitor managers; - the board of directors; and
- executive compensation.
We then consider the market for corporate control, an external corporate governance
mechanism. Essentially, this market is a set of potential owners seeking to acquire
undervalued firms and earn above-average returns on their investments by replacing
ineffective top-level management teams.^10 The chapter’s focus then shifts to the issue
of international corporate governance. We briefly describe governance approaches
used in several countries outside of the United States and United Kingdom. In part,
this discussion suggests that the structures used to govern global companies compet-
ing in both developed and emerging economies are becoming more, rather than less,
similar. Closing our analysis of corporate governance is a consideration of the need for
these control mechanisms to encourage and support ethical and socially responsible
behavior in organizations.