💳Principles of Finance Unit 2 – Corporate Structure and Governance

What's This All About?

• Corporate structure and governance involve the organization, management, and oversight of a company
• Ensures that a company operates efficiently, ethically, and in the best interests of its stakeholders (shareholders, employees, customers, and society)
• Encompasses the rules, practices, and processes that guide decision-making and resource allocation within a company
• Aims to balance the interests of various stakeholders while pursuing the company's goals and objectives
• Plays a crucial role in determining a company's long-term success, reputation, and sustainability
• Helps to prevent corporate scandals, fraud, and mismanagement by establishing checks and balances
• Facilitates effective communication and collaboration among different levels of management and departments

Key Players in Corporate Structure

• Shareholders are the owners of the company who invest capital in exchange for ownership rights
  • They have the right to vote on important matters and elect the board of directors
  • They are entitled to a portion of the company's profits in the form of dividends
• Board of Directors is responsible for overseeing the management of the company on behalf of the shareholders
  • They set the company's strategic direction, hire and oversee the CEO, and ensure compliance with laws and regulations
  • They have a fiduciary duty to act in the best interests of the company and its shareholders
• Chief Executive Officer (CEO) is responsible for the day-to-day management of the company
  • They implement the strategies set by the board and make operational decisions
  • They are accountable to the board and shareholders for the company's performance
• Management team consists of executives who report to the CEO and oversee various departments and functions
  • They are responsible for executing the company's plans and achieving its goals
• Employees are the workforce of the company who carry out the tasks necessary for the company to operate
  • They are important stakeholders whose well-being and productivity are critical to the company's success
• Customers and suppliers are external stakeholders who interact with the company through transactions
  • They are affected by the company's actions and decisions and can influence its reputation and success

Types of Business Structures

• Sole Proprietorship is a business owned and operated by a single individual
  • It is the simplest and most common form of business structure
  • The owner has complete control over the business but also assumes all the risks and liabilities
• Partnership is a business owned and operated by two or more individuals who share profits and losses
  • Partners have a fiduciary duty to act in the best interests of the partnership
  • Partnerships can be general (all partners have equal management rights and liabilities) or limited (some partners have limited involvement and liability)
• Corporation is a legal entity separate from its owners, with its own rights and liabilities
  • Owners (shareholders) have limited liability, meaning they are not personally responsible for the company's debts and obligations
  • Corporations can raise capital by issuing stock and have a more complex management structure
• Limited Liability Company (LLC) combines features of partnerships and corporations
  • Owners (members) have limited liability but can choose to be taxed as a partnership or corporation
  • LLCs offer flexibility in management structure and profit distribution
• Nonprofit Organization is a business that operates for a charitable, educational, religious, or public purpose
  • Profits are not distributed to owners but are reinvested in the organization's mission
  • Nonprofits may be exempt from certain taxes and can receive tax-deductible contributions

Corporate Governance Basics

• Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled
• It involves the distribution of rights and responsibilities among different participants in the company, such as the board of directors, managers, shareholders, and other stakeholders
• The main objectives of corporate governance are to ensure transparency, accountability, and fairness in a company's dealings with its stakeholders
• Good corporate governance helps to align the interests of management with those of shareholders and other stakeholders
• It also helps to prevent conflicts of interest, insider trading, and other unethical or illegal practices that can harm the company and its reputation
• Key principles of corporate governance include:
  • Board independence and diversity
  • Separation of the roles of CEO and Chairman
  • Establishment of board committees (audit, compensation, nomination)
  • Regular performance evaluations of the board and management
  • Transparent disclosure of financial and non-financial information
  • Protection of shareholder rights and engagement with shareholders
• Corporate governance codes and guidelines, such as the Sarbanes-Oxley Act and the OECD Principles of Corporate Governance, provide frameworks for best practices in corporate governance

Board of Directors: The Big Shots

• The board of directors is the highest governing body of a corporation, elected by the shareholders to represent their interests
• The main responsibilities of the board include:
  • Setting the company's strategic direction and overseeing its implementation
  • Hiring, evaluating, and compensating the CEO and other top executives
  • Ensuring the company's financial integrity and compliance with laws and regulations
  • Identifying and managing risks to the company's operations and reputation
  • Approving major transactions, such as mergers, acquisitions, and capital expenditures
• The board is typically composed of a mix of inside directors (executives of the company) and outside directors (independent experts)
  • The ideal board size and composition depend on the company's size, industry, and complexity
  • Diversity in terms of skills, experience, gender, and ethnicity is increasingly recognized as beneficial to board effectiveness
• The board operates through committees that focus on specific areas, such as audit, compensation, and nomination
  • The audit committee oversees the company's financial reporting and internal controls
  • The compensation committee sets the pay and benefits of top executives
  • The nomination committee identifies and recommends candidates for board membership
• The board is accountable to the shareholders and must act in their best interests (fiduciary duty)
  • Board members can be held liable for breaches of their fiduciary duties, such as conflicts of interest or negligence
• Effective boards are characterized by:
  • Independence from management
  • Active engagement and constructive debate
  • Regular self-evaluation and refreshment
  • Alignment with the company's values and culture

Shareholder Rights and Responsibilities

• Shareholders are the owners of a corporation and have certain rights and responsibilities
• The main rights of shareholders include:
  • The right to vote on important matters, such as the election of directors and approval of mergers
  • The right to receive dividends, if declared by the board
  • The right to inspect the company's books and records
  • The right to sue the company or its directors for wrongdoing (derivative lawsuit)
• Shareholders also have the responsibility to:
  • Stay informed about the company's performance and governance
  • Vote their shares in a way that promotes the long-term interests of the company
  • Hold the board and management accountable for their actions
• Shareholder activism refers to the efforts by shareholders to influence the company's policies and practices
  • Activist shareholders may engage with the board and management through dialogue, proxy contests, or public campaigns
  • Common issues of concern for activist shareholders include executive compensation, board composition, and environmental and social responsibility
• Shareholder engagement refers to the ongoing communication between the company and its shareholders
  • Effective engagement helps to build trust, align interests, and prevent misunderstandings
  • Companies can engage with shareholders through annual meetings, investor conferences, and other channels
• Shareholder agreements are contracts among shareholders that govern their rights and obligations
  • These agreements can cover issues such as voting, transfer of shares, and dispute resolution
• Shareholder value creation is the ultimate goal of corporate governance
  • It involves maximizing the long-term value of the company for the benefit of all shareholders
  • Factors that contribute to shareholder value creation include profitable growth, efficient use of capital, and strong corporate governance

Corporate Ethics and Social Responsibility

• Corporate ethics refers to the moral principles and values that guide a company's behavior and decision-making
  • Ethical companies act with integrity, fairness, and responsibility towards all stakeholders
  • Unethical behavior, such as fraud, discrimination, or environmental damage, can harm a company's reputation and financial performance
• Corporate social responsibility (CSR) refers to a company's commitment to contributing to the well-being of society and the environment
  • CSR involves going beyond legal requirements to address social and environmental issues relevant to the company's operations
  • Examples of CSR initiatives include charitable giving, employee volunteering, sustainable sourcing, and carbon footprint reduction
• Stakeholder theory posits that companies have a responsibility to consider the interests of all stakeholders, not just shareholders
  • Stakeholders include employees, customers, suppliers, local communities, and the environment
  • Balancing the needs and expectations of different stakeholders can be challenging but is essential for long-term success
• Business ethics programs help companies to embed ethical values and behaviors into their culture and operations
  • These programs typically include a code of conduct, training, reporting mechanisms, and enforcement measures
  • Effective ethics programs can prevent misconduct, enhance employee morale, and improve the company's reputation
• Corporate philanthropy refers to a company's voluntary contributions to charitable causes and community development
  • Philanthropy can take the form of cash donations, in-kind contributions, or employee volunteering
  • Strategic philanthropy aligns a company's charitable giving with its business goals and stakeholder interests
• Sustainability refers to a company's ability to meet the needs of the present without compromising the ability of future generations to meet their own needs
  • Sustainable companies integrate economic, social, and environmental considerations into their strategies and operations
  • Sustainability reporting, such as through the Global Reporting Initiative (GRI) framework, helps companies to measure and communicate their sustainability performance to stakeholders

Real-World Examples and Case Studies

• Enron scandal (2001) highlighted the importance of corporate governance and ethics
  • Enron, an energy company, collapsed due to accounting fraud, insider trading, and other unethical practices
  • The scandal led to the Sarbanes-Oxley Act, which strengthened financial reporting and internal control requirements for public companies
• Volkswagen emissions scandal (2015) demonstrated the consequences of unethical behavior and poor corporate governance
  • Volkswagen, a German automaker, admitted to installing software that cheated emissions tests in millions of its diesel vehicles
  • The scandal resulted in significant financial penalties, reputational damage, and leadership changes for the company
• Patagonia's commitment to sustainability and corporate social responsibility
  • Patagonia, an outdoor clothing company, is known for its strong environmental and social values
  • The company uses sustainable materials, donates 1% of its sales to environmental causes, and advocates for public lands protection
• Microsoft's successful transition to a more diverse and independent board
  • In 2014, Microsoft appointed Satya Nadella as CEO and John Thompson as independent Chairman, separating the two roles
  • The company also added more diverse and independent directors to its board, improving its governance and strategic direction
• BlackRock's emphasis on stakeholder capitalism and ESG (environmental, social, and governance) investing
  • BlackRock, the world's largest asset manager, has been a vocal proponent of stakeholder capitalism and ESG investing
  • The company has called on its portfolio companies to address climate change, diversity, and other sustainability issues
• Ben & Jerry's social mission and activism
  • Ben & Jerry's, an ice cream company, is known for its progressive values and social activism
  • The company has taken stands on issues such as racial justice, LGBTQ+ rights, and climate change, aligning its business with its values
• Salesforce's stakeholder-centric approach and corporate philanthropy
  • Salesforce, a cloud software company, has a strong commitment to stakeholder capitalism and corporate philanthropy
  • The company has a 1-1-1 model, donating 1% of its product, equity, and employee time to charitable causes
• Unilever's Sustainable Living Plan and focus on purpose-driven brands
  • Unilever, a consumer goods company, has a Sustainable Living Plan that aims to decouple its growth from its environmental footprint and increase its positive social impact
  • The company has also focused on purpose-driven brands, such as Dove's Real Beauty campaign and Lifebuoy's handwashing education program