Corporate governance involves the relationship among the various participants involved in determining the strategy and performance of corporations. The major participants include the firm's shareholders (including large institutions), the management team, and the board of directors. Corporate governance encompasses: corporate performance, succession/nomination, relations between the board and the chief executive officer (CEO), and relations with shareholders and stakeholders.


The ultimate control of the corporation rests with the shareholders. The shareholders elect the members of the board of directors, who set overall policy for the corporation, and appoint the officers. The directors elect a chairperson. The board also appoints the CEO, who manages the day-to-day affairs of the corporation. Being a director is a part-time position that provides compensation in the form of an annual stipend plus a fee for meetings attended.

Most large corporations have boards that are composed of notable corporate executives of other major firms. The directors are typically not aware of the company's daily workings and rely on management to provide this information. They provide, however, an overall direction to the corporation and approve major decisions and proposed structural changes to the firm. Increasingly, boards are expected to be proactive, and are becoming more involved in replacing executives of underperforming corporations.

A board of directors generally consists of both inside members and outside members. Insiders include some of the corporation's senior management, whereas outside directors do not have direct managerial responsibilities over the firm's day-to-day activities. Boards of publicly held companies consist of approximately 9 to 15 members, most of whom are outside directors. The Securities and Exchange Commission (SEC) and several major institutions would like to see a greater proportion of outside directors on the boards of public companies.

Many issues, such as attempts at takeovers, are usually required to be brought up before the board of directors. The board determines requirements and may recommend that the issue be taken to a shareholder vote. The compensation of the senior executive officers of the corporation is also set by the board of directors. The directors usually appoint a compensation committee that is charged with recommending executive compensation to the board as a whole.


In 1950 institutional investors held less than 3 percent of the publicly traded stock of U.S. corporations. By 1991, however, they controlled 53 percent. As a result, institutional investors, particularly large pension and mutual funds, now have the power to directly influence managerial decisions in many corporations.

The collapse of the takeover market in the early 1990s led institutional investors to seek other means of protecting their investment interests. They began introducing shareholder resolutions at annual meetings. Critics of this trend express concern that institutional investors will pressure management to support or increase stock prices, preventing management from undertaking long-term strategic initiatives that will make U.S. corporations competitive in the global marketplace.

In October 1992 the SEC adopted rules that reformed the proxy solicitation process. The new amendments made it easier for institutional stockholders to communicate with each other. Previously, shareholders who desired to communicate with more than ten other shareholders were required to have their comments approved by the SEC before the comments could be circulated. Under the new rules, the SEC no longer serves as editor/sponsor of the material; the only requirement is that the materials be filed with the SEC.

The increased activity of institutional investors has in turn led to a greater emphasis on shareholder value creation. Management now places greater priority on the impact of decisions on its shareholders rather than on other stakeholders such as bondholders, employees, customers, and communities. In addition, companies are actively attempting to communicate important corporate developments to the Wall Street community (and institutional shareholders) through press releases and meetings with Wall Street security analysts and institutional shareholders.


Senior managers are beginning to embrace key equity investors through a process known as relationship investing. Relationship investing consists of an established committed link between a company and one or more shareholders. Under this model, large investors will have greater knowledge about the portfolio companies and play a more significant role in corporate governance and oversight. Accordingly, relationship investing should better align the interests of shareholders and corporations, and increase the probability that the firm will realize the benefits associated with independent oversight of corporate affairs.

In the relationship investing model, representatives of large shareholder groups meet with the company's board of directors on a regular basis to discuss the company's long-term strategy to gain market share and profits and press for change when needed. Armed with greater knowledge, these investors are more likely to work with management and invest for the long term rather than seeking short-term trading profits. Advocates of the relationship investing concept contend that it would bring the corporate governance process in the United States closer to the models employed in Germany and Japan.

Relationship investing comes in two major forms—negotiated and nonnegotiated transactions. In nonnegotiated investments, large institutional shareholders—typically pension funds—offer suggestions about corporate policy to the firm's senior managers.

This usually occurs when the investor has held a stock in his or her portfolio that has declined in value, and resolves to take corrective action. In negotiated transactions, the investor makes a large, long-term financial commitment to a company in return for a voice in the way it is managed.

Relationship investing is not without its pitfalls. Investors with sizable stakes may demand constant updates on major corporate decisions, irrespective of their skill levels or ability to effectively manage the corporation. Thus, a CEO could potentially spend all of his or her time communicating with a relationship investor, and not enough time managing the corporation. Moreover, the constant scrutiny of a powerful investor might force a CEO to become more risk averse.

Critics of relationship investing also suggest that nothing fundamentally changes with the firm. In fact, they argue that the extended evaluation period, often stretching from one year to three years, ties up capital longer, and drives up the required rate of return. The strategy of taking small, minority stakes in companies makes the funds more vulnerable to poor managerial decisions than funds that take control of investee companies. In addition, relationship investing may not allow funds the ability to take immediate corrective action if an investment deteriorates, nor determine the timing of the exit strategy for their investments.


The corporate governance systems in Japan and Germany differ quite markedly from those in practice in the United States. In Japan and Germany, companies benefit from the long-term holdings of banks and other financial institutions, and are less subject to short-term performance pressures.

The boards of Japan's major corporations represent the collective interests of the company and its employees rather than the interests of the firms' shareholders. Almost all directors are senior executives or former employees of the company. Most companies have no outside board members. In large corporations, the outside directors are typically major bank lenders.

Japanese shareholders are passive owners. In Japan, there are overlapping boards of directors, and companies maintain close formal and informal ties with shareholders, customers, suppliers, and employees. These constituent groups overlap in Japan whereas in the United States they are generally independent of one another.

The members of the Japanese kereitsu are usually organized around the leadership of a major financial institution. The shares held by business partners and institutional investors are rarely sold, thus forming blocks of friendly and stable shareholders. This all but prevents the possibility of a hostile takeover attempt being successful in Japan.

Companies in Germany have two boards: a supervisory board and an executive board. The supervisory board typically includes professional advisers to the company, such as lawyers, accountants, and bankers. In turn, the supervisory board appoints the executive board. The most important decisions of the executive board have to be ratified by the supervisory board. In addition, plants with more than five employees are required to have a works council, which must be consulted prior to changes in work practices and dismissals.

In Germany, only a small number of multinational firms have a diversified share ownership. Institutions exert relatively little influence over board policy. As in Japan, corporate cross shareholdings are common. Also, the major universal banks exert substantial control over companies.

[ Robert T. Klelman ,

updated by Ronald M Horwitz ]


Davies, Adrian. A Strategic Approach to Corporate Governance. Gower Pub., 1999.

Keasey, Kevin, and Mike Wright, eds. Corporate Governance: Responsibilities, Risks, and Remuneration. New York: John Wiley & Sons, 1997.

Kleiman, Robert T., Nathan, Kevin, and Joel M. Shulman. "Are There Payoffs for Patient Corporate Investors?" Mergers and Acquisitions, March/April 1994, 34-41.

Monks, Robert A. G., and Nell Minnow. Watching the Watchers: Corporate Governance for the 21st Century. Blackwell, 1996.

Also read article about Corporate Governance from Wikipedia

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