See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/228134164

An Overview of Corporate Governance: Some Essentials

Article  in  SSRN Electronic Journal · April 2011

DOI: 10.2139/ssrn.1817091

CITATION READS
1 9,122

2 authors, including:

Zulkarnain Muhamad Sori

International Centre for Education in Islamic Finance
102 PUBLICATIONS   556 CITATIONS   

SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Accounting and Governance for Crypto-Assets View project

Accounting Conceptual Frameworks: A Comparison of the IASB and the AAOIFI Approaches View project

All content following this page was uploaded by Zulkarnain Muhamad Sori on 17 October 2017.

The user has requested enhancement of the downloaded file.

 AN OVERVIEW OF CORPORATE GOVERNANCE: SOME
ESSENTIALS

Shamsher Mohamad and Zulkarnain Muhamad Sori

Department of Accounting and Finance, Faculty of Economics and Management,
University Putra Malaysia, 43400 UPM Serdang, Selangor Darul Ehsan, Malaysia

Abstract
Corporate governance is a function of governing a corporation. Good Corporate
governance promotes fairness, openness, and transparency in its responsibilities to
stakeholders Good corporate governance practices facilitates economic efficiency by
focusing on value-enhancing activities and aids efficient allocation of scarce resources.
This is achieved when firms efficiently employ their assets, attract low cost capital, meet
societal expectations and improve overall performance. This paper discusses the essential
issues in corporate governance that helps to achieve these desired objectives.

INTRODUCTION
The Oxford Dictionary define, ‘corporate’ is an adjective belonging to a corporation, while
‘governance’ is an act on function of governing. The term ‘governance’ derives from the
Latin gubernare, meaning ‘to steer’, which implies that corporate governance involves the
function of direction rather than control. Therefore, corporate governance is a function of
governing a corporation. The concept of corporate governance incorporates the question of
accountability, ethics and social responsibility to society and stakeholders, and it concerns
the structures and procedures associated with the direction in which an organization plans
to chart (Shamsher, 2002). Corporate governance promotes fairness, openness, and
transparency in its responsibilities to stakeholders. The rise in prominence of a
corporation's environmental reporting has been closely linked to the recognition that good
corporate governance requires consideration of the impact a corporation has on the wider
community and the environment. Irrespective of its definition, corporate governance
relates to the fundamental processes whereby ultimate corporate authority and
responsibility are shared and exercised by shareholders, directors and management to
ensure that corporate assets provided by investors are being put to appropriate and
profitable use.
Though the term corporate governance entail functions on how best to govern a
corporation in the interest of its stakeholders, the concept has different perspectives in
different countries. For example, in Anglo-Saxon countries such as the United States (US)
and United Kingdom (UK), corporate governance is focus on interests of shareholders. In
other countries such as Japan, Germany and France, corporate governance focuses on
wider perspective of stakeholders, including employees, customers as well as shareholders.
With increasing global competition, corporate governance has become essential for
enhancing ethical, honest and transparent ways to pursue corporate goals and survival in
global market competition. Good governance is an essential element for achieving a clean,
efficient, accountable and responsible work place. Socio-political changes in the last two
decades have indicated the necessity to promote good governance. For example, Asian

Electronic copy available at: http://ssrn.com/abstract=1817091

countries have engaged in financial liberalization and capital market development in the
last few decades and became examples for other developing countries to emulate.
However, the 1997/1998 financial crisis exposed their weaknesses to enforce effective
corporate governance practices (for example, poor transparency and disclosure, a weak
regulatory framework, under-developed market infrastructures, cronyism, nepotism and
moral hazard of politicians making economic decisions) during the good economic period.
Policy makers have learned that systematic failure of investor protection
mechanisms, combined with weak capital market regulation in systems that rely heavily on
‘crony capitalism’ can lead to failures of confidence that spread from individual firms to
entire nations. Insufficient financial disclosure and capital market regulation, lack of
minority shareholder protection, and failure of board and controlling shareholder
accountability all supported lending and investing practices based on relationships rather
than on a prudent analysis of risk and reward (Millstein, 1998). The lessons learned from
the crisis has lead many Asian countries to put in place structured corporate governance
requirements to help realign the confidence in their corporate sector.
In developed economies, the perspective of corporate governance systems extends
beyond these traditional aspects and includes good corporate citizenship. This incorporates
protection of the environment, a balanced consideration of the interests of all stakeholders,
and a commitment to innovation that will lead to more effective use of human and natural
resources. Companies that display superior standards of corporate governance through the
integration of social, environmental and economic principles into all decision support
systems are more likely to increase their long-term shareholder value through better
management of risks and opportunities.
In Malaysia, issue of corporate governance has received a committed focus from
the government, particularly after the financial crisis in 1997 and other corporate failures in
developed countries. The enforcement of the Malaysian Code on Corporate Governance in
2001 is the testimony to such commitment. All aspects of governance that can enhance
investor confidence in our corporate sector were given due attention and enforced.

IS CORPORATE GOVERNANCE INDISPENSABLE?

As markets become globally competitive, most countries are placing greater reliance on the
private sector to catalyze their economic growth. Corporate governance becomes an
indispensable guide to help economic entities to employ assets efficiently, attract low cost
capital, meet societal expectations and improve overall performance.
Good corporate governance should allow management to act in the best interest of
the corporation, and contribute to business prosperity through transparency and
accountability. From the firm’s perspective, the relevance of corporate governance seems
to increase shareholders’ wealth through better stock selections (McKinsey, 2002).
Ganesan (2003) suggests five key contributions of good corporate governance to a
corporation: (i) creation and enhancement of a corporation’s competitive advantage; (ii)
providing protection to shareholders’ interest; (iii) affecting the valuation of an enterprise;
(iv) enabling a corporation to perform efficiently and preventing fraud; and (v) ensuring
compliance with laws and regulations.
Irrespective of the corporate objective, effective governance ensures that boards
and managers are accountable for all decisions relating to the desired objective. Effective
corporate governance will encourage efficient use of scarce resources for the production of
goods and services most in demand, and consequently maximize stakeholders’ wealth.

Electronic copy available at: http://ssrn.com/abstract=1817091

 For corporations to succeed in competitive markets, corporate managers must
improvise new strategies to meet changing demands. This requires managers to have some
level of discretion in making decisions within the context of existing laws, regulations and
expectations of the stakeholders. This requires a structured and independent mechanism to
monitor of management decisions; transparency of corporate performance, ownership and
control; and participation in certain fundamental decisions by shareholders. Thus corporate
governance can be an effective measure of oversight and hold boards and managers
accountable in their management of corporate assets. This oversight and accountability
combined with the efficient use of resources, improved access to lower cost capital and
increased responsiveness to societal needs and expectations should lead to improved
corporate performance. Corporate governance may not guarantee improved corporate
performance at the individual company level, as there are too many other factors that have
impact on performance. But it should make it more likely for the company to respond
rapidly to changes in business environment, crisis and the inevitable periods of decline. It
should help reduce managerial complacency and help them focus on improving firm
performance, with the clear understanding that they will be replaced if they fail their
obligations.
Effective corporate governance will mitigate corruption in business dealings. Poor
corporate governance becomes the premise to breed corrupt practices in business and
political circles. Good corporate governance facilitates early identification and elimination
of such practices, thereby providing a more conducive cost effective environment for
foreign and domestic investments.

ESSENTIALS OF CORPORATE GOVERNANCE

In developed countries, the discussion of corporate governance is usually in the context of
the rule of law designed to facilitate economic growth. Governance is seen from the
perspective of laws that recognize shareholders as the legitimate owners of the corporation
and require the equitable treatment of minority and foreign shareholders; enforcement
mechanisms through which these shareholder rights can be protected; securities, corporate
and bankruptcy laws to prevent bribery that enable corporations to transform; anti-
corruption laws to prevent bribery and protections against fraud on investors; sophisticated
courts and regulators; an experienced accounting and auditing sector, and significant
corporate disclosure requirements. Developed countries are also more likely to have well-
developed private sector institutions, such as organizations of institutional investors, and
professional associations of directors, corporate secretaries and managers, as well as rating
agencies, security analysts and a sophisticated financial press to facilitate good practices.
Most developing and emerging market nations (including Malaysia) have yet to
improve on their market micro-infrastructure such as the legal and regulatory systems,
enforcement capacities and private sector institutions required to support effective
corporate governance. Therefore, corporate governance reform efforts in these nations
often need to focus on the fundamental framework. Reform needs vary, but often include
basic stock exchange development, the creation of systems for registering share ownership,
the enactment of laws for basic minority shareholder protection from potential self-dealing
by corporate insiders and controlling shareholders, the education and empowerment of a
financial press, the improvement of audit and accounting standards, and a change in culture
and laws against bribery and corruption as an accepted way of doing business (Gregory
and Simms, 1999).

3
 In addition to differences in the market micro-infrastructure to effectively enforce
good governance practice, nations differ widely in cultural values that mould the
development of their financial infrastructure and corporate governance. These differences
in culture require improvising the enforcement of governance practices to palliate with
local requirements.
Ultimately, corporate governance and the framework that supports it must have
relevance to a nation's own unique legal environment. While common elements of
effective governance can be identified to enable national systems to attract global capital
and heighten investor confidence and some market driven convergence of systems might
be inevitable but must be in compliance with each nation and the private sector’s
requirement.
Millstein Report (1998) suggests that government’s support in corporate
governance is essential in the following areas to instill investor confidence and attract
foreign investment: (i) ensuring the protection of shareholder rights, including the rights of
minority and foreign shareholders, and ensuring the enforceability of contracts with
resource providers (fairness); (ii) requiring timely disclosure of adequate, clear and
comparable information concerning corporate financial performance, corporate governance
and corporate ownership (transparency); (iii) clarifying governance roles and
responsibilities, and supporting voluntary efforts to ensure the alignment of managerial and
shareholder interests, as monitored by boards of directors (accountability); and (iv)
ensuring corporate compliance with the other laws and regulations that reflect the
respective society's values (responsibility).

CORPORATE GOVERNANCE AND ECONOMIC EFFICIENCY

Corporate governance can help improve economic efficiency by helping to focus on value-
enhancing activities and therefore governance helps allocate resources more efficiently and
engage in activities that improve the ex-post bargaining in their favor. As Shleifer and
Vishny (1989) argue, a manager will be inclined to focus on activities that he is best at
managing because his marginal contribution is greater, and this consequently increases his
share of ex-post rents, or his bargaining power for residual control rights.
Another area where governance may improve economic efficiency is in the ex-post
bargaining phase for rents. That is, governance may affect the level of coordination costs
or the extent to which a party is liquidity-constrained. If residual control rights are assigned
to a large, diverse group, the existence of free-riders in the group may create an inefficient
bargaining system. Also, if a party wishes to engage in a transfer of control rights but he is
liquidity-constrained, inefficient bargaining may again occur as the transaction may not be
agreed upon (Zingales, 1995).
A third way that governance may effect overall economic efficiency is through the
level and distribution of risk. Assuming that the engaged parties have different risk
aversions, corporate governance can then act to efficiently allocate risk to those who are
least risk-averse (Fama and Jensen, 1983), which improves the total surplus for the parties
involved.
In general, it is also important to recognize that strong governance in a developed
capital markets promotes an efficient medium for allocation of scarce resources between
savers and borrowers and also provides some measure of security for lenders of capital.
The nature of the firm requires that financiers, or lenders of capital, will indeed lend their
money to managers who will in turn run a firm and hopefully create a return for the

4
financiers. If the financiers are not confident of receiving their capital back at some point
in the future, they would not be inclined to provide managers with capital and, as a result,
innovation and industrial progression would be at stake. Strong governance helps to
maintain investors’ confidence in the capital markets and helps to improve overall
efficiency in this manner.

CONCLUSION
Corporate governance is a set of process, rules and regulations that give effect on the way
business is run and operated. In a simple word, corporate governance is how managers run
business in an efficient and effective manner. This paper discusses the importance and the
essential issues in corporate governance. It also deliberates on the important elements of
good governance practices in developed and developing economies and the role of
governance in improving economic efficiency.
There has been renewed interest in corporate governance both internationally as
well as in Malaysia due to the spate of corporate scandals. The Asian Financial Crisis in
1997/1998 has shown how fragile the Malaysian corporations are to changes in capital
market and their failures attributed to weak corporate governance practices. Governments
around the globe are giving serious attention to this issue and have taken various measures
to ensure that the trust and confidence in their respective capital markets. The Malaysian
government has initiated various measures like introducing the Malaysian Code on
Corporate Governance and the revamping of the Bursa Malaysia Listing Requirements to
accommodate governance requirements.
Consistent with the general public expectation of fairness in business dealings,
transparent financial reporting, management accountability and socially responsible
corporate, good corporate governance will help in ensuring proper and effective system in
place that facilitate efficient use of scarce resources to increase long term shareholders
value.

REFERENCES
Fama, E.F. and Jensen, M. C. (1983). Agency problems and residual claims. Journal of
Law and Economics, 26, 327–49.
Ganesan (2003). Internal audit and corporate governance. Accountants Today, December
2003.
Gregory, H.J. and Simms, M.E. (1999). Corporate governance: what it is and why it
matter title. Paper presented in the 9th. International Anti-Corruption Conference
(IACC), 10-15 Oct 1999, Durban, South Africa.
McKinsey (2002). Corporate governance is at the heart of investment decisions. Global
investor opinion survey: key findings, July 2002 (www.mckinsey.com/governance)
Millstein, I.M. (1998). The basics of a stable global economy. The Journal of Commerce,
Nov. 30, 1998.
Mohd Saad, Siti Shaharatulfazzah, Evans, Jonathan Gerard and Muhamad Sori,
Zulkarnain, Senior Managers' Perceptions on Audit Committee Composition and
Effectiveness: Some Evidence from Malaysia (August 2006). Available at SSRN:
http://ssrn.com/abstract=924140
Mohd Saad, Siti Shaharatulfazzah, Evans, Jonathan Gerard , Muhamad Sori, Zulkarnain
and Abdul Hamid, Mohamad Ali , Audit Committee Authority and Effectiveness:

5
 The Perceptions of Malaysian Senior Managers (August 2006). Available at SSRN:
http://ssrn.com/abstract=924130
Mohd Saad, Siti Shaharatulfazzah, Evans, Jonathan Gerard , Muhamad Sori, Zulkarnain
and Abdul Hamid, Mohamad Ali , Audit Committee Resources, Appointment and
Future Scope: Some Evidence from Malaysia (August 2006). Available at SSRN:
http://ssrn.com/abstract=924129
Muhamad Sori, Zulkarnain, Mohamad, Shamsher and Mohd Saad, Siti Shaharatulfazzah,
Audit Committee Practices in Malaysian Large Firms (November 1, 2007). Available
at SSRN: http://ssrn.com/abstract=1031076
Muhamad Sori, Zulkarnain and Karbhari, Yusuf, Audit Committee and Auditor
Independence: Some Evidence from Malaysia (January 16, 2006). Available at
SSRN: http://ssrn.com/abstract=876410
Muhamad Sori, Zulkarnain and Karbhari, Yusuf, Non-Audit Services and Auditor
Independence: Some Evidence from Malaysia (December 2005). Available at SSRN:
http://ssrn.com/abstract=871137
Muhamad Sori, Zulkarnain, Abdul Hamid, Mohamad Ali and Nassir, Annuar, Attributes of
an Effective Audit Committee: Evidence from an Emerging Capital Market (August
2006). Available at SSRN: http://ssrn.com/abstract=924101
Muhamad Sori, Zulkarnain and Karbhari, Yusuf, The Impact of Selected Corporate
Governance Programmes to Auditor Independence: Some Evidence from Malaysia
(December 2005). Available at SSRN: http://ssrn.com/abstract=871139
Muhamad Sori, Zulkarnain, Mohamad, Shamsher and Abdul Hamid, Mohamad Ali ,
Compliance of Audit Committee Requirements: A Brief Review of the Practice.
Journal of Malaysian Institute of Accountants, Vol. 14, No. 5, pp. 4-7, 2001.
Available at SSRN: http://ssrn.com/abstract=609802
Muhamad Sori, Zulkarnain and Karbhari, Yusuf, The Wealth Effect of Announcement of
Audit Committee Formation: Evidence From Malaysian Listed Firms. Available at
SSRN: http://ssrn.com/abstract=596181
Shamsher Mohamed (2002). Corporate governance: The Malaysian perspective. Chartered
Secretary Malaysia, December 2002, 19-21.
Shleifer, A. and Vishny, R. (1989). Management entrenchment: the case of manager-
specific investments. Journal of Financial Economics, 25, 123-140.
Zingalas, L. (1995). What determines the value of Corporate? Quarterly Journal of
Economic, 110, 1075-1110.

View publication stats