Analyze the connection between businesses and society.

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Course Learning Outcomes for Unit II Upon completion of this unit, students should be able to:

1. Distinguish between the market and nonmarket environment of business by explaining the four Is of the nonmarket environment. 1.1 Analyze the connections between business and society. 1.2 Detail how the connections to society affect a specific organization.

8. Portray how business utilitarianism and ethical values apply to corporate social responsibility.

8.1 Examine the future of corporate governance globally.

Reading Assignment Chapter 3: Corporate Governance

Unit Lesson Corporate Governance Corporate governance is the formal system of accountability, control, and oversight for the decisions and resources of an organization. The concept of governance refers to a system of checks and balances that places restrictions on practices of employees and managers who are not complying with policies established by the board. Examples of such policies include strategic planning, compensation, financial planning and reporting, ethical and legal issues, and stakeholder interest. Corporations can be controlled both internally and externally by customers, employees, and communities who expect responsible behavior. Internally, upper management and the board of directors are responsible for the accuracy of financial reporting and financial decision-making. Externally, lawmakers and legislation also provide incentives for organizations to balance stakeholder interest. When companies act responsibly and take actions to prevent misconduct, they avoid the possibility of violation penalties. Historically, companies have been driven by the profit imperative as their sole area of interest. Increasingly, these market-driven interests have been balanced with more nonmarket interests of importance including environmental and community interests. As a context to this unit, it is important to have some understanding of the concept of business utilitarianism and ethical values. Initially, these concepts were developed by Jeremy Bentham (1748–1832). Essentially, Bentham viewed humans as simply being self-interested individuals. In fact, he believed that concepts such as community and social relations were useful social conventions, but fundamentally meaningless. The individual is the only unit of society, and no one individual is more or less important/valuable than another. In his view, individuals (and corporations) acted in their own self-interests (Driver, 2014). Clearly, the concept of utilitarianism is important as we explore models of corporate governance. Components of Social Governance First, let us examine internal governance. To understand the concept of corporate governance, one must recognize the four major groups that set the stage for compliance. These internal groups include shareholders, the board of directors, managers, and, finally, employees. A state charter is typically issued; this gives the corporation the right to exist and indicates the basic terms of existence. Shareholders are the owners of the corporation and maintain ultimate control over the corporation as authorized in corporate law. Owners are responsible for selecting the company’s board of directors. The

UNIT II STUDY GUIDE

Corporate Governance

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number of stock shares owned is important for determining the number of votes each shareholder can exercise. Because many organizations, especially larger ones, have many shareholders, the board of directors is elected to govern and oversee the management of business issues. One of the primary responsibilities of the board is to ensure that mangers put the interests of the owners first. The board of directors hires management to run the company on a daily basis. Upper-level management in conjunction with the board is responsible for overall strategic planning and policy development. Middle- and lower-level management are responsible for tactical planning to carry out the strategic plan and supervision of employees at the operational level. Members of management are considered as employees of an organization, and those who are not in management positions are referred to as non-managerial employees. Corporations are primarily managed under the guidance and direction of the appointed board of directors. These elected members have a fiduciary responsibility to both shareholders and society. A fiduciary responsibility, also known as duty of loyalty or duty of care, is a legal duty to act in another party’s interest. In situations regarding conflicts of interest, the duty of loyalty requires directors to act in the best interest of the corporation and shareholders. Evolution of Corporate Governance and the Classical Stakeholder Model The classical stakeholder model contends that publically traded firms should seek to maximize wealth for investors and owners. In this model, corporate governance will focus on improved performance between shareholders and the firm’s top-level management. When ownership and control of a business are separate, management decisions should be made in the best interest of the investors. As separate entities, managers and owners have unique values and goals with respect to a business. Ideally, these goals and values should be congruent; however, potential differences exist and influence the manner in which decisions are made. The concept of legitimacy is often associated with the term corporate governance. The word can be applied to organizations and corporate governance in the sense that organizations are legitimate as long as their activities are congruent with the values and goals within the system that they function. In essence, these activities must align with societal expectations and the corporate system. Over the years, social and ethical issues have raised attention to discrepancies between intended and actual rights, accountability, and roles and responsibilities among shareholders, board of directors, managers, and employees. For example, managers may have distinct motivations beyond shareholder value such as increased market share, compensation and bonuses, personal kickbacks, or affinity to particular products. In such cases, corporate governance is necessary to ensure that management and investor interests are closely aligned. Historically, owners were managers of corporations themselves and controlled all aspects of the business. In some instances, owners continued to control their businesses even when firms grew larger and managers were hired. In such cases, the owners were readily visible and on the scene to hold managers accountable for actions that were not congruent with values and goals of the organization. However, widely dispersed stock ownership held in a public corporation made it difficult for all owners to have such control. Hence, a separation of ownership from control became an important condition, and the board of directors was established to oversee management on behalf of the shareholders. The board’s independence from management is an important aspect of corporate governance. Best Practices for Good Governance In light of recent scandals, it is essential to define some important principles of an effective corporate governance program. A few key features of effective boards include a few broad practices. First, board of directors should be selected outside of the organization itself. While current managers may often fill board positions, outside member selection should be independent of the corporation. Second, shareholders should exercise more control over the selection of directors by holding open elections for board members either by placing their own candidates on the ballot, requiring 50% of votes to be elected, having members stand for election annually, or serving staggered terms. Appointing a leading director (board chairman) and holding regular meetings without the presence of the CEO (management) is also suggested. In other words, the independent chairman can hold elections without the presence of management that will allow the board to have candid discussions about business matters. Additionally, aligning director compensation with corporate performance is ideal to ensure that board members are paid according to how well the company performs.

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Finally, the performance of the board should be evaluated on a regular basis to ascertain the diligent performance of duties. In summary, there has been increasing attention paid to the operation of business. This represents a change from previous periods in which businesses were largely left to their own devices. Corporate governance is now an important concern for business. It is important that businesses understand how to make transparent decisions that meet the legal, regulatory, and political context within which they operate.

Reference Driver, J. (2014). The history of utilitarianism. Retrieved from https://plato.stanford.edu/entries/utilitarianism-

history/