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p. 20 of 58 BACK | NEXT Purpose and Structure of the Toolkit Part One: Introduction and Overview Part Two: Preconditions and Infrastructure for Financial Sector Development I. Preconditions for Financial Sector Development II. Institutional and Market Infrastructure A. Insolvency B. Corporate Governance C. Financial Information D. Payment and Settlement E. Market Functioning Part Three: Financial Regulation and Supervision Part Four: Regional Financial Integration Part Five: ADB's Intervention in the Financial Sector Bibliography Glossary and List of Abbreviations Acknowledgements

Financial Sector Legal and Regulatory Toolkit : Part Two: Preconditions and Infrastructure for Financial Sector Development

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B. Corporate Governance

1. International Standards
2. Principles of Corporate Governance
3. Implementation

Corporate governance has been defined as the set of relationships between shareholders, board, management, and other constituencies of a company. As a starting point, improving corporate governance will improve the efficiency and attractiveness of the markets for capital, following from the successful development of dispersed ownership of public corporations in the United States (the "Berle and Means corporation").

The essential problem in these type of companies is well-known: Companies often suffer from the classic agent-principal conflict of interest between shareholders and management. This conflict is most obvious in situations involving widely dispersed share-ownership and the potential conflict between the interests of management (those in control) and owners (the shareholders), most typical of markets in the United States and United Kingdom (the Anglo-American model of corporate ownership, control, and governance). The focus here is typically on the rights of minority shareholders.

The problem with a family-controlled or state-controlled company, which are commonly found in Asia, is that ownership and control are combined to a large extent, thereby reducing the capacity of non-controlling shareholders to influence management. The end result is a potential conflict of interest between controlling shareholders and non-controlling shareholders. So long as the interests of the controlling shareholders (whether family or state) are identical to those of the corporation, both models can be quite effective under many circumstances. Problems occur in situations where the interests of the controlling shareholders diverge from those of the corporation, and they are able to use the corporation for personal benefit and to the detriment of the interests of the company as a whole. To the extent that non-controlling shareholders feel that their interests are not being served, they will feel less inclination to invest in such companies. The end result is a potential governance problem, which feeds into lower share prices, higher costs of capital, and decreased confidence, thereby reducing the potential scope and efficiency of the financial system and reducing the rate of economic growth.

The basic significance of good corporate governance is premised on corporate performance. Investors are willing to pay increased prices for shares in companies with good governance (a corporate governance premium). Increased share prices reduce cost of capital and therefore increase company competitiveness across a given market. Higher share prices also increase the attractiveness of a given market to both domestic and international investors. Further, good governance increases confidence in the market. Investors will be more likely to invest in companies and markets with good governance. This enhances the transfer of funds through the financial system, thereby increasing the scale and efficiency of the financial system, which in turn spurs economic growth.

International Standards

While the debate about corporate governance has been going on for some years, it has recently become an issue of considerable concern following financial crises over the past decade. As a result of this concern, the G-7 mandated the OECD to develop a comprehensive set of corporate governance principles [ PDF ] to serve as the primary guidance in this area.

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Principles of Corporate Governance

The OECD has developed a set of non-binding principles that embody the views of member countries on this issue. These principles are:

1. Ensuring the basis of an effective corporate governance framework. The first principle addresses the underlying basis for corporate governance, including incentive structures, legal and regulatory requirements consistent with the rule of law, transparency and enforceability, clear articulation of regulatory responsibilities, and related transparency, independence, and accountability.
2. The rights of shareholders and key ownership functions. The second principle concerns the protection of shareholder rights and the ability of shareholders to influence the behavior of the corporation. Basic rights include rights to: secure ownership and registration, convey and transfer shares, obtain relevant information, share in residual profits, participate in basic decisions and at general shareholder meetings, and fair and transparent transfers of control.
3. The equitable treatment of shareholders. The third principle on the equitable treatment of shareholders emphasizes that all shareholders, including foreign shareholders, should be treated equitably by controlling shareholders, boards, and management. Insider trading and abusive self-dealing are to be prohibited. The principle calls for disclosure of material interests that board members and management might have in transactions that affect the corporation.
4. The role of stakeholders. A company's competitiveness and success is the result of teamwork that embodies contributions from a range of different resource providers, including employees. Active cooperation between corporations and stakeholders can create wealth and employment and contribute to sustainable and financially sound enterprises.
5. Disclosure and transparency. The fifth principle calls for timely and accurate disclosure on all material matters regarding the corporation including its financial situation, performance, ownership, and governance. High quality standards of accounting, disclosure, and audit should be followed and high quality internationally recognized accounting and audit standards should be developed. An annual independent audit is required. Channels for disseminating information should provide for fair, timely, and cost-efficient access to information by users.
6. Responsibilities of the Board. The sixth principle calls for the effective monitoring of management by the board and the board's accountability to the company and the shareholders. Accordingly, board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interests of the company and shareholders. The Board should also take into account the interests of other stakeholders.

   Other responsibilities of board members include: reviewing strategy and planning, managing potential conflicts of interest, ensuring compliance with the law, and assuring the integrity of the company's accounting, reporting, and communications. The Board should be able to exercise objective judgment independent of management, and have access to accurate, relevant, and timely information to fulfil its responsibilities.

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Implementation

The OECD has established a Steering Group on Corporate Governance, which includes delegates from all OECD member countries, that guides and coordinates the Organization's work on corporate governance. An important part of its work is to oversee the global outreach activities. These activities are carried out in cooperation with the World Bank, and also aim to encourage the use and implementation of the OECD Principles in non-member countries.

ADB has also been involved in the promotion of good corporate governance in Asia. ADB has co-sponsored the various Asian roundtables together with OECD and the World Bank discussing the issue of the state of corporate governance in the region, the role of disclosure in strengthening corporate governance, the role of boards and stakeholders in corporate governance and the shareholders right including the issue of equitable treatment of shareholders.

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