Academic journal article Indian Journal of Economics and Business

The Development of Corporate Governance Index Using Internal Control Mechanisms: A Study on FTSE 100 Companies, U.K

Academic journal article Indian Journal of Economics and Business

The Development of Corporate Governance Index Using Internal Control Mechanisms: A Study on FTSE 100 Companies, U.K

Article excerpt

Abstract

There has been resistance in developing a Corporate Governance Index to measure the level of governance practices in a company due to its complex nature. Attempts have been made to develop corporate governance indices in most countries by consultants and academics. However, this study attempts to develop its own index to ensure that there is a better coverage in areas relating to ownership structure, board structure, board committee and remuneration structure. This paper will be discussing the different stages that are involved in the process of developing the Corporate Governance Index which involves obtaining feedback from experts in the area of governance, development of the questions and variable measures.

I. INTRODUCTION

In the 1990's, there was little academic interest in corporate governance and most research tended to concentrate on either takeovers or shareholders from the viewpoints of business, accounting, economics, finance, law and political science. Now corporate governance is considered to be one of the most topical areas because many organisations are becoming exposed to "unbridled greed, appalling management and [are] deemed to possess inadequate governance". Therefore, corporate governance is being implemented to ensure organisations are governed in a proper manner (Keasey et al., 1997).

There has been an ongoing debate on the definition of corporate governance. It has faced criticism due to the ambiguous language and lack of understanding of the definitions provided. Corporate governance is a broad concept used by regulators, investors, accountants and boards of directors. It involves a set of principles adopted or practised by organisations in order to ensure that there is corporate direction, responsibility and accountability. Good governance strikes the proper balance between enterprise and accountability (Charkham, 1994).

Good corporate governance is able to create value for companies by maximising the value to the shareholders through good corporate performance. Low (2002) developed four crucial pillars that need to be entrenched in ensuring good governance practices in organisations: accountability, transparency, minority investor protection measures and enforced regulation.

The first pillar of accountability stresses that the management is accountable to its shareholders in that it must deploy the company's resources in the most efficient and desirable manner without exercising any personal interest. By developing and nurturing this sense of responsibility, a reliable system needs to be in place to monitor for any oversights, i.e., by having an independent board of directors. A board of directors is required to ensure that the management is fulfilling its role (Low, 2002). The second pillar, transparency, is necessary for the existence of a fair market where information should be made available to all players and the rules governing the market need to be known to all. Also, timely and accurate disclosures need to be made on all relevant matters regarding the company (Low, 2002). Merely having transparency and accountability is not sufficient if minority investors are not treated fairly due to faulty basic measures. Also, it is important to note that the corporate governance problem is a world wide problem that does not only occur in countries practising the Anglo American model but also in Asian countries. In most Asian countries, shareholder activism is relatively low and investors invest on a short-term basis compared to investors in the West that tend towards long-term investments in, for example, pension funds, college endowments and life insurance funds. Finally there is a need to practise enforcement by issuing penalties for non-compliance (Low, 2002). This last pillar can only be implemented if the three earlier pillars of corporate governance are implemented (Low, 2002).

One of the main reasons corporate governance is seen to be crucial in the U. …

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