Corporate governance refers to the mechanisms, processes, practices, and relations by which corporations are controlled and operated by their boards of directors, managers, shareholders, and stakeholders.

This meta definition accommodates both the narrow definitions used in specific contexts and the broader descriptions that are often presented as authoritative. The latter include the structural definition from the Cadbury Report, which identifies corporate governance as "the system by which companies are directed and controlled" (Cadbury 1992, p. 15); and the relational-structural view adopted by the Organization for Economic Cooperation and Development (OECD) of "Corporate governance involves a set of relationships between a company's management, board, shareholders and stakeholders. Corporate governance also provides the structure and systems through which the company is directed, and its objectives are set, and the means of attaining those objectives and monitoring performance are determined" (OECD 2023, p. 6).

Examples of narrower definitions in particular contexts include:

  • "a system of law and sound approaches by which corporations are directed and controlled focusing on the internal and external corporate structures with the intention of monitoring the actions of management and directors and thereby, mitigating agency risks which may stem from the misdeeds of corporate officers."
  • "the set of conditions that shapes the ex post bargaining over the quasi-rents generated by a firm."

The firm itself is modelled as a governance structure acting through the mechanisms of contract.

Principles

Contemporary discussions of corporate governance tend to refer to principles raised in three documents released since 1990: The Cadbury Report (UK, 1992), the Principles of Corporate Governance (OECD, 1999, 2004, 2015 and 2023), and the Sarbanes–Oxley Act of 2002 (US, 2002). The Cadbury and Organisation for Economic Co-operation and Development (OECD) reports present general principles around which businesses are expected to operate to assure proper governance. The Sarbanes–Oxley Act, informally referred to as Sarbox or Sox, is an attempt by the federal government in the United States to legislate several of the principles recommended in the Cadbury and OECD reports.

  • Rights and equitable treatment of shareholders: Organizations should recognize that they have legal, contractual, social, and market driven obligations to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policymakers.
  • Role and responsibilities of the board: The board needs sufficient relevant skills and understanding to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment.
  • Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing corporate officers and board members. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making.
  • Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

Principal–agent conflict

Some concerns regarding governance follows from the potential for conflicts of interests that are a consequence of the non-alignment of preferences between: shareholders and upper management (principal–agent problems); and among shareholders (principal–principal problems), although also other stakeholder relations are affected and coordinated through corporate governance.

In large firms where there is a separation of ownership and management, the principal–agent problem can arise between upper-management (the "agent") and the shareholder(s) (the "principals"). The shareholders and upper management may have different interests. The shareholders typically desire returns on their investments through profits and dividends, while upper management may also be influenced by other motives, such as management remuneration or wealth interests, working conditions and perquisites, or relationships with other parties within (e.g., management-worker relations) or outside the corporation, to the extent that these are not necessary for profits. Those pertaining to self-interest are usually emphasized in relation to principal-agent problems. The effectiveness of corporate governance practices from a shareholder perspective might be judged by how well those practices align and coordinate the interests of the upper management with those of the shareholders. However, corporations sometimes undertake initiatives, such as climate activism and voluntary emission reduction, that seems to contradict the idea that rational self-interest drives shareholders' governance goals.

An example of a possible conflict between shareholders and upper management materializes through stock repurchases (treasury stock). Executives may have incentive to divert cash surpluses to buying treasury stock to support or increase the share price. However, that reduces the financial resources available to maintain or enhance profitable operations. As a result, executives can sacrifice long-term profits for short-term personal gain. Shareholders may have different perspectives in this regard, depending on their own time preferences, but it can also be viewed as a conflict with broader corporate interests (including preferences of other stakeholders and the long-term health of the corporation).

Principal–principal conflict (the multiple principal problem)

The principal–agent problem can be intensified when upper management acts on behalf of multiple shareholders—which is often the case in large firms (see Multiple principal problem). As a result, there may be free-riding in steering and monitoring of upper management, or conversely, high costs may arise from duplicate steering and monitoring of upper management. Conflict may break out between principals, and this all leads to increased autonomy for upper management. To solve the problem of governing upper management under multiple shareholders, corporate governance scholars have figured out that the straightforward solution of appointing one or more shareholders for governance is likely to lead to problems because of the information asymmetry it creates. Shareholders' meetings are necessary to arrange governance under multiple shareholders, and it has been proposed that this is the solution to the problem of multiple principals due to median voter theorem: shareholders' meetings lead power to be devolved to an actor that approximately holds the median interest of all shareholders, thus causing governance to best represent the aggregated interest of all shareholders. This has resulted in a literature focused on economic analysis. A comparative assessment of corporate governance principles and practices across countries was published by Aguilera and Jackson in 2011.

Models

Different models of corporate governance differ according to the variety of capitalism in which they are embedded. The Anglo-American "model" tends to emphasize the interests of shareholders. The coordinated or multistakeholder model associated with Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community. A related distinction is between market-oriented and network-oriented models of corporate governance.

Continental Europe (two-tier board system)

Some continental European countries, including Germany, Austria, and the Netherlands, require a two-tiered board of directors as a means of improving corporate governance. In the two-tiered board, the executive board, made up of company executives, generally runs day-to-day operations while the supervisory board, made up entirely of non-executive directors who represent shareholders and employees, hires and fires the members of the executive board, determines their compensation, and reviews major business decisions.

Germany, in particular, is known for its practice of co-determination, established under the German Codetermination Act of 1976, through which workers are granted seats on corporate boards as stakeholders, separate from those allocated to shareholder equity.

United States, United Kingdom

The so-called "Anglo-American model" of corporate governance emphasizes the interests of shareholders. It relies on a single-tiered board of directors that is normally dominated by non-executive directors elected by shareholders. Because of this, it is also known as "the unitary system". Within this system, many boards include some executives from the company (who are ex officio members of the board). Non-executive directors are expected to outnumber executive directors and hold key posts, including audit and compensation committees. In the United Kingdom, the CEO generally does not also serve as chairman of the board, whereas in the US having the dual role has been the norm, despite major misgivings regarding the effect on corporate governance. The number of US firms combining both roles is declining, however.

In the United States, corporations are directly governed by state laws, while the exchange (offering and trading) of securities in corporations (including shares) is governed by federal legislation. Many US states have adopted the Model Business Corporation Act, but the dominant state law for publicly traded corporations is Delaware General Corporation Law, which continues to be the place of incorporation for the majority of publicly traded corporations. Individual rules for corporations are based upon the corporate charter and, less authoritatively, the corporate bylaws. The American system has long been based on a belief in the potential of shareholder democracy to efficiently allocate capital.

Japan

The Japanese model of corporate governance has traditionally held a broad view that firms should account for the interests of a range of stakeholders. For instance, managers do not have a fiduciary responsibility to shareholders. This framework is rooted in the belief that a balance among stakeholder interests can lead to a superior allocation of resources for society. The Japanese model includes several key principles:

  • Security the rights and equal treatment of shareholders
  • Appropriate cooperation with stakeholders (other than shareholders)
  • Ensuring appropriate information disclosure and transparency
  • Responsibility of the board
  • Dialogue with shareholders

Founder centrism

An article published by the Australian Institute of Company Directors called "Do Boards Need to become more Entrepreneurial?" considered the need for founder centrism behaviour at board level to appropriately manage disruption.

Regulation

Corporations are created as legal persons by the laws and regulations of a particular jurisdiction. These may vary in many respects between countries, but a corporation's legal person status is fundamental to all jurisdictions and is conferred by statute. This allows the entity to hold property in its own right without reference to any real person. It also results in the perpetual existence that characterizes the modern corporation. The statutory granting of corporate existence may arise from general purpose legislation (which is the general case) or from a statute to create a specific corporation. Now, the formation of business corporations in most jurisdictions requires government legislation that facilitates incorporation. This legislation is often in the form of Companies Act or Corporations Act, or similar. Country-specific regulatory devices are summarized below.

It is generally perceived that regulatory attention on the corporate governance practices of publicly listed corporations, particularly in relation to transparency and accountability, increased in many jurisdictions following the high-profile corporate scandals in 2001–2002, many of which involved accounting fraud; and then again after the 2008 financial crisis. For example, in the U.S., these included scandals surrounding Enron and MCI Inc. (formerly WorldCom). Their demise led to the enactment of the Sarbanes–Oxley Act in 2002, a U.S. federal law intended to improve corporate governance in the United States. Comparable failures in Australia (HIH, One.Tel) are linked to with the eventual passage of the CLERP 9 reforms there (2004), that similarly aimed to improve corporate governance. Similar corporate failures in other countries stimulated increased regulatory interest (e.g., Parmalat in Italy). Also see

In addition to legislation the facilitates incorporation, many jurisdictions have some major regulatory devices that impact on corporate governance. This includes statutory laws concerned with the functioning of stock or securities markets (also see Security (finance), consumer and competition (antitrust) laws, labour or employment laws, and environmental protection laws, which may also entail disclosure requirements. In addition to the statutory laws of the relevant jurisdiction, corporations are subject to common law in some countries.

In most jurisdictions, corporations also have some form of a corporate constitution that provides individual rules that govern the corporation and authorize or constrain its decision-makers. This constitution is identified by a variety of terms; in English-speaking jurisdictions, it is sometimes known as the corporate charter or articles of association (which also be accompanied by a memorandum of association).

Country-specific regulation

Australia

Primary legislation

Incorporation in Australia originated under state legislation but has been under federal legislation since 2001. Also see Australian corporate law.

Other significant legislation includes:

Canada

Primary legislation

Incorporation in Canada can be done either under either federal or provincial legislation. See Canadian corporate law.

The Netherlands

Primary legislation

Dutch corporate law is embedded in the ondernemingsrecht and, specifically for limited liability companies, in the vennootschapsrecht.

Corporate Governance Code 2016–2022

In addition The Netherlands has adopted a Corporate Governance Code in 2016, which has been updated twice since.

In the latest version (2022), the Executive Board of the company is held responsible for the continuity of the company and its sustainable long-term value creation.

The executive board considers the impact of corporate actions on People and Planet and takes the effects on corporate stakeholders into account.

In the Dutch two-tier system, the Supervisory Board monitors and supervises the executive board in this respect.

Poland

Primary legislation

Polish Corporate Law is regulated in Code of Commercial Companies. The code regulates most of the aspects of corporate governance, incl. rules of incorporation and liquidation, it defines rights, obligations and rules of operations of corporate bodies (Management Board, Supervisory Board, Shareholders Meeting).

UK

Primary legislation

The UK has a single jurisdiction for incorporation. Also see United Kingdom company law

Other significant legislation includes:

Bribery Act 2010

The UK passed the Bribery Act in 2010. This law made it illegal to bribe either government or private citizens or make facilitating payments (i.e., payment to a government official to perform their routine duties more quickly). It also required corporations to establish controls to prevent bribery.

US

Primary legislation

Incorporation in the US is under state level legislation, but there important federal acts. in particular, see Securities Act of 1933, Securities Exchange Act of 1934, and Uniform Securities Act.

Sarbanes–Oxley Act

The Sarbanes–Oxley Act of 2002 (SOX) was enacted in the wake of a series of high-profile corporate scandals, which cost investors billions of dollars. It established a series of requirements that affect corporate governance in the US and influenced similar laws in many other countries. SOX contained many other elements, but provided for several changes that are important to corporate governance practices:

  • The Public Company Accounting Oversight Board (PCAOB) be established to regulate the auditing profession, which had been self-regulated prior to the law. Auditors are responsible for reviewing the financial statements of corporations and issuing an opinion as to their reliability.
  • The chief executive officer (CEO) and chief financial officer (CFO) attest to the financial statements. Prior to the law, CEOs had claimed in court they hadn't reviewed the information as part of their defense.
  • Board audit committees have members that are independent and disclose whether or not at least one is a financial expert, or reasons why no such expert is on the audit committee.
  • External audit firms cannot provide certain types of consulting services and must rotate their lead partner every 5 years. Further, an audit firm cannot audit a company if those in specified senior management roles worked for the auditor in the past year. Prior to the law, there was the real or perceived conflict of interest between providing an independent opinion on the accuracy and reliability of financial statements when the same firm was also providing lucrative consulting services.

Foreign Corrupt Practices Act

The U.S. passed the Foreign Corrupt Practices Act (FCPA) in 1977, with subsequent modifications. This law made it illegal to bribe government officials and required corporations to maintain adequate accounting controls. It is enforced by the U.S. Department of Justice and the Securities and Exchange Commission (SEC). Substantial civil and criminal penalties have been levied on corporations and executives convicted of bribery.

Codes and guidelines

Corporate governance principles and codes have been developed in different countries and issued from stock exchanges, corporations, institutional investors, or associations (institutes) of directors and managers with the support of governments and international organizations. As a rule, compliance with these governance recommendations is not mandated by law, although the codes linked to stock exchange listing requirements may have a coercive effect.

Organisation for Economic Co-operation and Development principles

One of the most influential guidelines on corporate governance are the G20/OECD Principles of Corporate Governance, first published as the OECD Principles in 1999, revised in 2004, in 2015 when endorsed by the G20, and in 2023. The Principles are often referenced by countries developing local codes or guidelines. Building on the work of the OECD, other international organizations, private sector associations and more than 20 national corporate governance codes formed the United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) to produce their Guidance on Good Practices in Corporate Governance Disclosure. This internationally agreed benchmark consists of more than fifty distinct disclosure items across five broad categories:

  • Auditing
  • Board and management structure and process
  • Corporate responsibility and compliance in organization
  • Financial transparency and information disclosure
  • Ownership structure and exercise of control rights

The OECD Guidelines on Corporate Governance of State-Owned Enterprises complement the G20/OECD Principles of Corporate Governance, providing guidance tailored to the corporate governance challenges of state-owned enterprises.

Stock exchange listing standards

Companies listed on the New York Stock Exchange (NYSE) and other stock exchanges are required to meet certain governance standards. For example, the NYSE Listed Company Manual requires, among many other elements:

  • Independent directors: "Listed companies must have a majority of independent directors ... Effective boards of directors exercise independent judgment in carrying out their responsibilities. Requiring a majority of independent directors will increase the quality of board oversight and lessen the possibility of damaging conflicts of interest." (Section 303A.01) An independent director is not part of management and has no "material financial relationship" with the company.
  • Board meetings that exclude management: "To empower non-management directors to serve as a more effective check on management, the non-management directors of each listed company must meet at regularly scheduled executive sessions without management." (Section 303A.03)
  • Boards organize their members into committees with specific responsibilities per defined charters. "Listed companies must have a nominating/corporate governance committee composed entirely of independent directors." This committee is responsible for nominating new members for the board of directors. Compensation and Audit Committees are also specified, with the latter subject to a variety of listing standards as well as outside regulations.

Other guidelines

The investor-led organisation International Corporate Governance Network (ICGN) was set up by individuals centred around the ten largest pension funds in the world in 1995. The aim is to promote global corporate governance standards. The network is led by investors that manage US$77 trillion, and members are located in fifty countries. ICGN has developed a suite of global guidelines ranging from shareholder rights to business ethics.

The World Business Council for Sustainable Development (WBCSD) has done work on corporate governance, particularly on accounting and reporting. In 2009, the International Finance Corporation and the UN Global Compact released a report, "Corporate Governance: the Foundation for Corporate Citizenship and Sustainable Business", linking the environmental, social and governance responsibilities of a company to its financial performance and long-term sustainability.

Most codes are largely voluntary. An issue raised in the U.S. since the 2005 Disney decision is the degree to which companies manage their governance responsibilities; in other words, do they merely try to supersede the legal threshold, or should they create governance guidelines that ascend to the level of best practice. For example, the guidelines issued by associations of directors, corporate managers and individual companies tend to be wholly voluntary, but such documents may have a wider effect by prompting other companies to adopt similar practices.

In 2021, the first ever international standard, ISO 37000, was published as guidance for good governance. The guidance places emphasis on purpose which is at the heart of all organizations, i.e. a meaningful reason to exist. Values inform both the purpose and the way the purpose is achieved.

History

United States

Robert E. Wright argued in Corporation Nation (2014) that the governance of early U.S. corporations, of which over 20,000 existed by the Civil War of 1861–1865, was superior to that of corporations in the late 19th and early 20th centuries because early corporations governed themselves like "republics", replete with numerous "checks and balances" against fraud and against usurpation of power by managers or by large shareholders. (The term "robber baron" became particularly associated with US corporate figures in the Gilded Age—the late 19th century.)

In the immediate aftermath of the Wall Street crash of 1929 legal scholars such as Adolf Augustus Berle, Edwin Dodd, and Gardiner C. Means pondered on the changing role of the modern corporation in society. From the Chicago school of economics, Ronald Coase introduced the notion of transaction costs into the understanding of why firms are founded and how they continue to behave.

US economic expansion through the emergence of multinational corporations after World War II (1939–1945) saw the establishment of the managerial class. Several Harvard Business School management professors studied and wrote about the new class: Myles Mace (entrepreneurship), Alfred D. Chandler, Jr. (business history), Jay Lorsch (organizational behavior) and Elizabeth MacIver (organizational behavior). According to Lorsch and MacIver "many large corporations have dominant control over business affairs without sufficient accountability or monitoring by their board of directors".

In the 1980s, Eugene Fama and Michael Jensen established the principal–agent problem as a way of understanding corporate governance: the firm is seen as a series of contracts.

In the period from 1977 to 1997, corporate directors' duties in the U.S. expanded beyond their traditional legal responsibility of duty of loyalty to the corporation and to its shareholders.

In the first half of the 1990s, the issue of corporate governance in the U.S. received considerable press attention due to a spate of CEO dismissals (for example, at IBM, Kodak, and Honeywell) by their boards. The California Public Employees' Retirement System (CalPERS) led a wave of institutional shareholder activism (something only very rarely seen before), as a way of ensuring that corporate value would not be destroyed by the now traditionally cozy relationships between the CEO and the board of directors (for example, by the unrestrained issuance of stock options, not infrequently back-dated).

In the early 2000s, the massive bankruptcies (and criminal malfeasance) of Enron and Worldcom, as well as lesser corporate scandals (such as those involving Adelphia Communications, AOL, Arthur Andersen, Global Crossing, and Tyco) led to increased political interest in corporate governance. This was reflected in the passage of the Sarbanes–Oxley Act of 2002. Other triggers for continued interest in the corporate governance of organizations included the 2008 financial crisis and the level of CEO pay.

Some corporations have tried to burnish their ethical image by creating whistle-blower protections, such as anonymity. This varies significantly by justification, company, and sector.

East Asia

The 1997 Asian financial crisis severely affected the economies of Thailand, Indonesia, South Korea, Malaysia, and the Philippines through the exit of foreign capital after property assets collapsed. The lack of corporate governance mechanisms in these countries highlighted the weaknesses of the institutions in their economies.

In the 1990s, China established the Shanghai and Shenzhen Stock Exchanges and the China Securities Regulatory Commission (CSRC) to improve corporate governance. Despite these efforts, state ownership concentration and governance issues such as board independence and insider trading persisted.

Saudi Arabia

In November 2006 the Capital Market Authority (Saudi Arabia) (CMA) issued a corporate governance code in the Arabic language. The Kingdom of Saudi Arabia has made considerable progress with respect to the implementation of viable and culturally appropriate governance mechanisms (Al-Hussain & Johnson, 2009).

Al-Hussain, A. and Johnson, R. (2009) found a strong relationship between the efficiency of corporate governance structure and Saudi bank performance when using return on assets as a performance measure with one exception—that government and local ownership groups were not significant. However, using rate of return as a performance measure revealed a weak positive relationship between the efficiency of corporate governance structure and bank performance.

Stakeholders

Key parties involved in corporate governance include stakeholders such as the board of directors, management and shareholders. External stakeholders such as creditors, auditors, customers, suppliers, government agencies, and the community at large also exert influence. The agency view of the corporation posits that the shareholder forgoes decision rights (control) and entrusts the manager to act in the shareholders' best (joint) interests. Partly as a result of this separation between the two investors and managers, corporate governance mechanisms include a system of controls intended to help align managers' incentives with those of shareholders. Agency concerns (risk) are necessarily lower for a controlling shareholder.

In private for-profit corporations, shareholders elect the board of directors to represent their interests. In the case of nonprofits, stakeholders may have some role in recommending or selecting board members, but typically the board itself decides who will serve on the board as a 'self-perpetuating' board. The degree of leadership that the board has over the organization varies; in practice at large organizations, the executive management, principally the CEO, drives major initiatives with the oversight and approval of the board.

Responsibilities of the board of directors

Former Chairman of the Board of General Motors John G. Smale wrote in 1995: "The board is responsible for the successful perpetuation of the corporation. That responsibility cannot be relegated to management." A board of directors is expected to play a key role in corporate governance. The board has responsibility for: CEO selection and succession; providing feedback to management on the organization's strategy; compensating senior executives; monitoring financial health, performance and risk; and ensuring accountability of the organization to its investors and authorities. Boards typically have several committees (e.g., Compensation, Nominating and Audit) to perform their work.

The OECD Principles of Corporate Governance (2025) describe the responsibilities of the board; some of these are summarized below: Directors, workers and management receive salaries, benefits and reputation, while investors expect to receive financial returns. For lenders, it is specified interest payments, while returns to equity investors arise from dividend distributions or capital gains on their stock. Customers are concerned with the certainty of the provision of goods and services of an appropriate quality; suppliers are concerned with compensation for their goods or services, and possible continued trading relationships. These parties provide value to the corporation in the form of financial, physical, human and other forms of capital. Many parties may also be concerned with corporate social performance.

"Absentee landlords" vs. capital stewards

In 2016 the director of the World Pensions Council (WPC) said that "institutional asset owners now seem more eager to take to task [the] negligent CEOs" of the companies whose shares they own.

This development is part of a broader trend towards more fully exercised asset ownership—notably from the part of the boards of directors ('trustees') of large UK, Dutch, Scandinavian and Canadian pension investors: