Corporate governance refers to the set of customs, laws, institution and processes concerning the way a corporation is directed, controlled or administered. It also refers to the relationship between the company and its stakeholders, who have an interest in the way the corporation is being governed. There are internal and external stakeholders. The external stakeholders of a company include stockholders, creditors, debt holders, suppliers, customers and even the local community, all of which are affected by the company's activities. The internal stakeholders are the executives, board of directors and employees.
Corporate governance is a multifaceted system. An important aspect of corporate governance is the extent to which particular individuals in the company are held accountable, and the mechanisms that try to reduce, if not eliminate entirely, the principal-agent problem. Another aspect deals with the impact of corporate governance on economic efficiency, with a strong focus on shareholders' welfare.
The goals and objectives when creating company law and corporate governance in Europe were:
· To provide the same level of protection both for shareholders and other parties involved with companies
· To guarantee the prerogative to establish companies throughout the European Union (EU)
· To encourage competitiveness and efficiency in business
· To promote cooperation across borders between companies in different EU states
· To promote stimulating discussions between US members on the modernization of rules that regulate companies
Modernization of these rules as well, as accounting and audits, is essential to maintaining a single market for financial services and markets. In recent years the European Commission has been trying diligently to create a harmonious regulatory framework for national governance models known as "Europeanization." The potential political consequences, as well as the trend to consolidate corporate governance in Europe, is a subject of great debate and discussion.
The EU commissioned a major project to study the effectiveness and the functioning of European corporate governance. It analyzed how corporate governance codes are viewed by directors of companies in all the EU member states. It investigated how directors perceived the effectiveness, or otherwise, of national governance codes. The study widespread support for this comply or explain mechanism in companies all over Europe.
A very important component of European governance code is the use of the principle of "comply or explain." This principle states that companies do not have to adhere to laws that are contained in national corporate governance codes. However, they are obliged to disclose any departures from those codes in their annual reports. The EU formalized this approach in legislation passed in 2006.
However, a consensus is emerging that the comply and explain mechanism is not functioning perfectly. In many cases, companies have not provided satisfactory explanations for deviating from the codes. In addition, institutional shareholders are often lax in monitor those explanations. Nevertheless, the comply and explain principle, which can accommodate the various circumstances in which companies find themselves, is preferable to enacting new and stricter regulations.
Unlike corporate governance in Europe, corporate governance in the United States is about alleviating conflicts of interest that exist between the dispersed small shareholders and the managers who control the company. It addresses the consequences of the separation between control and ownership. Most company shareholders are small shareholders, although there are a few companies that are controlled by block shareholders, and these do attract less attention in corporate governance discussions.
In Europe, on the other hand, only a minority of listed companies have their stock widely held by many shareholders. Instead, a typical company listed on the stock exchange has one dominant shareholder. This shareholder is often an individual or a family in control of most of the stocks, and hence the bulk of the votes. Often, without being the owner of a large portion of the cash flow rights, this controlling shareholder can exercise control by using what is called pyramidal ownership, dual classes of shares and shareholder agreements.
Variations in the structure of ownership have clear consequences for corporate governance. The dominant shareholders have the motivation and the power to admonish management for things they feel are not being done correctly or to their liking. However, it is also true that the concentration of ownership mean that conditions could be created that could breed many problems, as the interests of the minority shareholders and the controlling shareholders are far from being the same.