Definition, key principles, core areas of corporate governance , and professional resources for attorneys
Legal glossary · Corporate law · Corporate governance
Corporate governance refers to the rules, practices, and processes by which a corporation is directed and controlled. It creates the mechanism through which the corporation achieves its objectives, which aligns with the interests of shareholders, management, employees, customers, and the broader public.
The board of directors is responsible for directing and controlling the organization. However, management carries out the more practical work of corporate governance, which executes the directions of the board. The increased emphasis on corporate governance has highlighted the role of legal professionals as they advise on legal compliance and regulatory complexities, ensuring effective risk management and strategic decision-making.
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What are the key principles of corporate governance
Nominating and Corporate Governance Committee
Shareholder rights and engagement
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Corporate governance works within a framework guided by principles that help in decision-making while enforcing the corporation’s legal and ethical compliance and ensuring the stakeholders’ interests.
The following are the key principles of corporate governance that are widely recognized:
Transparency
The board of directors is expected to document and report on everything happening in the corporation. Transparency includes financial statements and all related matters of the corporate entity, such as conflicts of interest, risks to the company, and other relevant aspects.
Accountability
Corporate accountability extends beyond regulatory compliance. It requires that the management and the board of directors should take ownership of their decisions and actions.
The board of directors is answerable to shareholders, while senior management remains accountable to the board for strategic and operational execution.
Responsibility
This principle covers directors and executives’ duty to shareholders in corporate governance.
It mandates that they act in good faith and with due diligence to achieve the corporation’s and its stakeholders’ best interests.
The principle of accountability goes hand in hand with the principle of responsibility. Directors make strategic and financial decisions, accountable to stakeholders for their actions.
Fairness
This principle mandates equitable treatment of shareholders and other stakeholders, ensuring no disadvantage to minority shareholders and equal access to corporate information.
Awareness
An essential strategy for survival is complete awareness of the market’s dynamics.
The board is always aware of the environment and manages its challenges. The real trick of this principle is for the board of directors to identify which risks and challenges can be avoided or reduced and to be prepared for their mitigation.
Board of directors
A company’s board of directors is a body of elected or appointed members who jointly oversee the functions and direction of the entity.
They have fiduciary duties to work in the company’s shareholders’ best interest. The duty of care requires directors to act with diligence, prudence, and competence when making decisions.
The number of directors in a company range from 3 to 15 or more. The size is usually mentioned in the company’s certificate of incorporation, which mentions the range of the number of directors that can be kept in the company. Any change to the number of directors requires amending the company’s constitutional documents in accordance with the relevant legal provisions.
The corporate governance committee should consider seeking gender, age, and racial or ethnic diversity for the board of directors.
In Delaware Cty. Employees Ret. Fund v. Sanchez, 124 A.3d 1017 (Del. 2015), the Delaware Supreme Court analyzed the relationship between Director Alan Jackson and Chairman A.R. Sanchez, Jr. The court noted that the director had a close friendship of over half a century with the interested party, and that his primary employment, as well as that of his brother, was at a company significantly influenced by Sanchez.
The court held that such a relationship could create a reasonable doubt regarding the director’s ability to act in the corporation’s best interests, highlighting the importance of director independence.
Further, the majority of directors should be independent of the influence of the company’s management. Regulatory frameworks, such as stock exchange listing requirements, mandate that most board members be independent to ensure a balance between executive and non-executive directors. This helps mitigate conflicts of interest and promotes objective governance.
Nominating and Corporate Governance Committee
The Nominating and Corporate Governance Committee is referred to by different names under various rules. For example:
- SEC calls it the Nominating Committee
- NYSE refers to it as the Nominating/Corporate Governance Committee
- Nasdaq uses the term Nominations Committee
- It may also be known as the Corporate Governance Committee
Pertaining to the size of the committee, it can have any number of members. Generally, there are at least three members on this committee. These members are not strictly required to be independent, but it is recommended under the corporate governance best practice that they be independent.
However, Nasdaq allows the company to include at least one non-independent member. The committee may need to hold four or more meetings annually to achieve the following:
- Identifying and evaluating the candidates for director.
- Developing, recommending, and overseeing corporate governance practices.
- Assisting in board or any committee evaluations
Shareholder rights and engagement
Shareholders influence the company’s decisions through their voting rights. The number of votes a shareholder has corresponds to the number of shares they own. Companies have strict disclosure requirements to ensure transparency and maintain investor confidence.
Under Securities law, SEC mandates companies to provide shareholders with financial statements, executive compensation details, and any material risks that affect the company through various filings, which include Form 10-K annual reports, Form 10-Q quarterly reports, and Form 8-K current reports.
Shareholders have the right to elect the directors, and the following are some of the methods through which they make an impact:
Proxy access — allows eligible shareholders to include director nominees proposed by the shareholders on the company’s proxy card and in the company’s proxy statement for its annual meeting under certain circumstances. Proxy access requires the shareholder to hold at least 3% of the company’s outstanding shares and hold them for at least three years. Under this, the shareholders can nominate only up to 20% of the company’s board members.
The corporate laws of states — provide that the director nominee who receives the highest number of affirmative votes cast will be elected whether or not such votes constitute a majority of the votes cast — known as plurality voting.
This has been objected by the stockholders because a director who receives more votes against his election than in favor, or even who gets a few votes in favor, can still be elected to the board.
Companies are now addressing this by adopting either of the following ways:
- They maintain the plurality vote but adopt a policy requiring the director who receives more withheld votes than votes in favor will be required to resign from the board, or
- Adopt the concept of majority voting, which means that the director nominee who receives the majority votes is elected, and whoever receives less than a majority must resign from the board.
Executive compensation
Executive compensation is the total remuneration for executives, particularly high-ranking executive officers. This includes monetary and non-monetary benefits such as salaries, bonuses, stock options, and other incentives.
As part of corporate governance, the company is required to structure executive compensation to align with the shareholders’ interests. Executive pay packages are influenced by the compensation committee, which typically includes the firm’s directors. A compensation committee is responsible for setting the pay levels and structures, reviewing and approving incentive plans, etc.
The compensation committee’s decisions impact the company internally and affect shareholder perception and trust. To ensure transparency and accountability, many companies hold a “Say-on-Pay” vote, which allows shareholders to express their approval or disapproval of executive compensation practices.
Although this vote is non-binding, a significant negative response from shareholders can signal dissatisfaction, prompting the company to reconsider its compensation policies to maintain positive investor relations.
Compliance and ethics
A corporate entity may establish a compliance committee as a part of the compliance department that oversees compliance with legal, regulatory, or ethical expectations and best practices as per corporate governance standards.
This committee ensures that corporate governance standards are upheld at every stage and that compliance-related risks are managed effectively. It includes whistleblower policies that allow employees to report unethical behavior without fearing retaliation.
Risk management
Following the 2008 financial crisis, companies began to place greater emphasis on risk management.
Inadequate risk management practices contributed to the crisis, with boards of directors often held accountable for failing to oversee risk management processes properly. As a result, corporate governance practices evolved to include risk management as an integral component.
The board of directors is responsible for ensuring that risk management processes are effective and aligned with the company’s interests. Boards may adopt various structures for risk oversight, including:
Audit Committee Oversight — The audit committee of NYSE-listed companies typically reviews financial risk policies while assigning broader risk oversight responsibilities.
Risk management committee — The board may establish a dedicated risk management committee solely focused on evaluating and monitoring risk policies.
Decentralized approach — Risk oversight responsibilities are distributed among existing board committees based on their areas of expertise, promoting specialized risk management.
Full board oversight — Some companies choose to have the entire board oversee risk management, ensuring comprehensive accountability and collective decision-making.
Hybrid approach — A combination of these structures can be beneficial. For instance, a dedicated risk committee might oversee risk management and report to the audit committee, fulfilling NYSE requirements and providing recommendations to the entire board.
Risks may arise from financial, operational, legal, and reputational domains. Effective risk management allows corporations and their boards to assess potential exposures across all business activities, supporting sound decision-making and governance.
One such way of risk management is through enterprise risk management, a holistic approach requiring communication and coordination between business units to identify and manage risks across the entire organization.
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Practice Notes
- Corporate Governance Standards: Overview
- Corporate Governance Practices: Commentary
- Corporate Governance Standards: Nominating and Corporate Governance Committee
- Corporate Governance Standards: Board of Directors
- Corporate Governance Standards: Compensation Committee
- Corporate Governance Standards: Audit Committee
Standard Documents
- Going Public: Periodic Reporting and Disclosure Obligations and Corporate Governance Standards: Presentation Materials
- Nominating and Corporate Governance Committee Charter
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