Corporate Governance and Risk Management in Developing Market: A Logic Analysis and Proposal

By Xiaoyan, Wang | Canadian Social Science, May 1, 2013 | Go to article overview

Corporate Governance and Risk Management in Developing Market: A Logic Analysis and Proposal


Xiaoyan, Wang, Canadian Social Science


Abstract

The lessons from financial crisis illustrate the importance of risk management; corporate governance is increasingly being considered as an important part of risk management. In this paper, the author discusses the role of corporate governance in risk management in developing markets from shareholders vote, board of directors, top management, and auditors. This paper also presents recommendations to improve corporate governance in order to strengthen risk management.

Key words: Corporate risk; Corporate governance; Risk management

INTRODUCTION

The frequent financial crisis has seen the collapse of numerous businesses internationally, illustrating that no industry or jurisdiction is immune from inadequate or inappropriate risk management. All businesses should have the capacity to develop policy with a full appreciation of risk and the development of a suitable set of operating procedures in order to respond to changing circumstances in a timely manner. The lessons from financial crisis illustrate the need for appropriate risk management, planning, control and the need for companies to reassess their governance structure to ensure adequate risk management.

Meanwhile, corporate governance has attracted considerable attention over the past decades, leading to recommended codes of practice, conceptual models, and empirical studies. A growing number of empirical studies have demonstrated that good corporate governance contributes to better investor protection, lower costs of capital, reduced earnings manipulations, increased company market value, improved stock returns, and even economic growth. Corporate governance has been seen at the forefront of establishing standards of corporate ethics aimed at reducing unscrupulous corporate practices while preserving a fair business environment. Corporate governance is also increasingly being considered as an important part of corporate risk management and the logic is poor. Corporate governance is viewed as risky, whereas creditors and investors view good corporate governance as a sign of strength in a corporation.

In this paper, the author discusses the relationship between corporate governance and risk management, and puts forward recommendations to improve governance structure to manage corporate risk.

1. THE ROLE OF CORPORATE GOVERNANCE INSTRUMENTS IN AFFECTING CORPORATE RISK

The governance structure can be divided into the internal governance and external governance, which can affect corporate risk. Economic and financial theory suggests the instruments mentioned below affect corporate risk.

1.1 Shareholders Votes

The shareholders' votes play an important role in risk prevention, and there should be a negative relationship between corporate risk and shareholders rights. Each shareholder has been delegated with a vote to play a role in the operations of a firm and can use their vote in removing and appointing the board of directors. They can make decisions about the compensation of employees in a firm and can also participate in financial decisions of a firm, including the rules of financial risk management.

The shareholders enjoy the right to represent themselves on the board. They are also allowed to gain all kinds of information from the officials of the firm such as analysts, board of directors and employees. The easy access to public and private information by the shareholders can reduce the information asymmetry between the shareholders and managers, reduce the agency cost and result in improvement in unfortunately, the majority shareholders are negative in affecting risk management in developing market (China as an example). The controlling shareholder equity is highly concentrated. The equity interest of minority shareholders is highly fragmented, it is difficult to check and balance between the shareholders. The controlling shareholder can easily manipulate the shareholders' meeting resolution. ; It is more likely for the largest shareholder to occupy the interests of minority shareholders. …

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