CHAPTER 2

Conceptual Foundations

Generally, a person is an entity distinctly responsible for his or her

deeds. Centuries ago, the law broadened the definition of a legal entity
to include corporations, that is, organizations that were incorporated
and thus existed separate from their owners. In a society, individuals,
groups, corporations, and other organizations build relationships that
require trust of the party that looks after their interests. For example,
two competing teams expect the referee to be objective and independent
without any bias toward the outcome of the match. Similarly, a deaf
person would expect that the translator responsible for conveying his
message to his doctor protects his interests by truthfully converting the
sign-language rendition into English.
An entity that, in a legal (or ethical) relationship with another, takes
care of the other entity’s money is called a fiduciary. The term fiduciary
is derived from the Latin word fiduciae, a relationship of trust. The
owner of a motel, for example, would trust the manager to take care of
his interests in the motel. This would translate into various behaviors:
ensure that all cash receipts are fully accounted for, that the motel
premises are safe and protected, patrons are satisfied in terms of facility
and services promised, etc. The manager is supposed to be competent in
performing his duties and should be independent. A hallmark of
independence is the absence of conflict of interest. As an example,
a manager could create a conflict of interest by signing a contract for
cleaning linens for the motel with a relative using better than market
rates for such services. The manager is accountable to the owner for
protecting the investment and for getting the best possible return on the

15
16 ■ Corporate Governance

FIGURE 2.1 Fiduciary duty.

motel. It is also the duty of the manager to maintain a high level of

transparency in disclosure and communication with the owner. To
illustrate, masking critical information or cooking the books and pre­
senting a biased financial picture would result in a violation of transpar­
ency. The nucleus of fiduciary duty is presented in Figure 2.1.

SHAREHOLDERS AS OWNERS
In corporate governance, a fiduciary relationship exists between share­
holders and the management of the company they own. As a separate
legal entity, the company still has a bond with its owners – the share­
holders. Owners have the residual rights to their stake in the business
and thus take on the risks of the business, although their liability is
limited to what they invest in the company. The owners’ bond with the
company is essentially a bond with its management; often, the company
and its management are referred to as synonyms, for the company is
run by the management and for practical purposes, management is
responsible for the company’s acts.
Over the past centuries, the share of influence between the share­
holders and management has shifted. The history of corporate govern­
ance has experienced three phases, beginning with what is called
entrepreneurial, transitioning to managerial, and more recently to
fiduciary governance. Early on it was the owner-entrepreneur who
 Conceptual Foundations ■ 17

wielded more influence over the business, and management was essen­
tially subordinate to the owner. This changed over time as the business
environment became more complex and businesses grew larger where
management expertise formed the core of business success. Top execu­
tives had a greater say on how the company was run while the owners
became more passive. This era of managerial capitalism waned over
time and the focus turned to fiduciary duties of management toward the
company’s owners. In this phase, it was clearly recognized that manage­
ment has the duty to protect owner interests and operates as an agent of
the owners. More recently, there has been an explicit recognition of
interests of other stakeholders, such as employees, in addition to the
affirmation of fiduciary duty toward the shareholders.
Those owning shares in a company change over time, and some
existing owners may change their level of ownership, that is, the number
of shares owned. At the launch of a company, investor subscription to
shares goes directly to the company as owner equity in return for shares
issued to the subscribers. Once the public offering of shares takes place,
the shares are then traded in the financial market through a designated
stock exchange, such as NYSE Euronext or NASDAQ. Resorting to the
stock market, any investor can liquidate ownership of shares by selling
them, in part or in full, and any investor can become a shareholder by
buying shares of the company in the open market.

Shareholder or Stakeholder?
A great deal of debate surrounds the issue of whether corporate
governance should take shareholder perspective or stakeholder perspec­
tive. Shareholder perspective suggests that the company exists to max­
imize returns to the shareholder in the long run, while the stakeholder
view emphasizes that the company as a part of the economy has duties
to all of its stakeholders, including customers, employees, and the
community in which it is located. The former is labeled as an “ends”
approach and the latter, a “means” approach. This is because the former
focuses on the end goal, not explicitly considering how it is reached,
and the latter stresses the ways in which all contributors to the value
creation are recognized in the process of generating outcomes such as
growth in employment and new jobs, innovation, positive social out­
comes, and wealth creation.
18 ■ Corporate Governance

Some argue that the shareholder perspective emphasizes greed and

maximization of profit at any cost, thus suggesting that this is a narrow
path in direct conflict with morality. This appears to be a fallacy. To
serve the owners’ interests should not necessarily be in direct conflict
with ethical behavior. Whether one takes the “ends” approach or the
“means” approach, the ethical conduct of business is not suggested as
a compromise to be struck in the interest of the bottom line.
Whereas the debate surges on one or the other option, the reality is
that both are an integral part of today’s corporations. In the long run,
a firm cannot optimize its value without regard to the wellbeing of all
stakeholders. For example, if employees are unhappy at work, they
would not be quite as productive or participating to their best in the
innovation and growth of the firm. Even investors intuitively know this,
as evident in the investor interest in funds that focus on social respon­
sibility or ESG (environmental, social, and governance) concerns. As
a result, it is important to think of both perspectives as central to
a company’s success, although the degree to which the two are inte­
grated in a company may vary.
The recognition that all stakeholders are important to the long-term
success of the company is clearly delineated in a 2019 Statement on the
Purpose of a Corporation by Business Roundtable, an association of
CEOs of America’s leading companies, summarized in Table 2.1. How­
ever, given the history of successful large companies in America, it
appears that this articulation is symbolic of current practice rather than
a new commitment. While the broader stakeholder perspective is difficult
to argue against, there are limits to its implementation. First, the com­
pany needs to be profitable and should have the necessary resources to go
beyond some threshold of stakeholder recognition. Blake Mycoskie, a do­
gooder, realized that he had to have resources to provide for the needy on
a large scale. He therefore created TOMS, Shoes for Tomorrow, generated
profits and donated a pair of shoes to needy children for every pair the
company sold. Without resources, the desire to help stakeholders could
remain unsatisfied. Second, while there is some clarity on how to measure
shareholder value, the metric to measure benefit to stakeholders other
than shareholders is lacking; more research and experimentation is
necessary to determine satisfactory measures of stakeholder benefits.
This may only be a short-term handicap and not a hurdle in the long run.
 Conceptual Foundations ■ 19

TABLE 2.1 A statement on the purpose of a corporation

Statement on the Purpose of a Corporation of the Business Roundtable, an association of
CEOs of America’s leading companies:
The member CEOs of many large and reputable corporations share a fundamental
commitment to all their stakeholders:

• We will lead the way in meeting or exceeding customer expectations.

• We will compensate our employees fairly and provide important benefits,

including supporting them through training and education that help develop
new skills for a rapidly changing world. We foster diversity, inclusivity, dignity
and respect.

• We will deal fairly and ethically with our suppliers, and serve as good partners
to the other companies, large and small, that help us meet our mission.

• We support the communities in which we work. We respect the people in our

communities and protect the environment by embracing sustainable practices
across our businesses.

• We generate long-term value for shareholders, who provide capital for us to

invest, grow and innovate. We are committed to transparency and effective
engagement with shareholders.
Source: Adapted from www.businessroundtable.org.

It should be noted, however, that fair and ethical treatment of all

stakeholders is important, and thus cuts across all stakeholders, not just
suppliers. Also, fostering diversity, inclusivity, dignity, and respect is an
objective worth considering for all stakeholders, not just employees.
Transparency and effective engagement are important characteristics of
all communications, regardless of the stakeholder.
While the amalgamation of shareholder and stakeholder interests is
crucial in the destiny of a company, the law appears to focus mainly on
the shareholder perspective. The law and regulations essentially are driven
by the goal of shareholder protection and thus on the preservation and
growth of capital markets where asset allocations take place. While no
company does well without having good rapport with all stakeholders,
ultimately, what matters is the view of how the company performed. This
20 ■ Corporate Governance

view currently is heavily weighted on data like share price performance

and return on stockholders’ equity. The research on triple-bottom line –
social, environmental, and financial – has yet to produce acceptable overall
metrics that measure company performance. But senior management
motivation is tied to how their compensation is structured. Currently, all
efforts seem to have been called upon to maximize shareholder value and,
thereby, executive compensation.

Agency Theory
As discussed in Chapter 1, when the company is separated from owners,
the interests of the owners are in the hands of those who manage the
company. Some call this a contractual relationship, while others view it
more broadly. Regardless, it is important for the owners, having yielded the
managing function, to put in place mechanisms that hopefully will restrain
management from (a) not doing a wrong thing (e.g., abuse of privileges for
personal gain) and (b) not performing at best levels (e.g., becoming
myopic). The owners are a principal and the management representing
the company, the agent. The principal-agent relationship and issues and
challenges involved in the relationship have been discussed extensively in
the literature as the agency theory. Often, several mechanisms deployed in
corporate governance can be traced to the agency theory.
The benefit of exercising control over management comes with costs of
monitoring. These include the principal’s monitoring costs, the agent’s
bonding costs, and residual loss. The principal’s monitoring costs include
outlays incurred in the supervision of management; a board member’s
compensation serves as an example. The agent’s bonding costs include any
costs of interaction with the shareholders; this would include any cost of
communication with the shareholders. The residual loss points to any losses
or deviation from expected performance that arises despite the attempts to
control management. Management’s decision to invest in a project with
risks abnormally high compared to shareholder intentions to take risks is an
example where a residual risk materializes if the project fails.
The agency theory identifies broadly the issue and challenges from the
separation of ownership and management. However, it does not specify
how this decoupling will be managed through oversight of management
in the interests of the owners and, as well, for the economy and society.
The theory shows why the challenges arise; however, it does not provide
 Conceptual Foundations ■ 21

a functional architecture to generate solutions to the agency problem in

today’s complex corporate environment. For this we need to turn to
corporate governance frameworks.
New expectations of corporate governance go far beyond addressing the
so-called principal-agent conflict. In governance of the firm, contextual
considerations lead to a more holistic framework. For example, the
governance risk of a company depends on factors such as the complexity
of the business model, how the company is structured, how it processes
information and, generally, how it copes with uncertainty. When all of the
factors relevant to GRC are considered, a holistic framework of corporate
governance emerges.

CORPORATE GOVERNANCE FRAMEWORK

In corporate governance, as in many other cases, a one-size-fits-all
approach does not work. Many variables are likely to impact governance
in a particular company. The culture of the domicile country, life-cycle
stage of the firm, industry to which it belongs, diversification and
globalization of the company, and the applicable laws and regulations –
these are some of the variables that would make up the overall picture of
governance in the company. The nature and mix of governance measures
and practices is likely to change over the life of the company, as it moves
from initiation to contagion, to control, and finally to maturity stage.
Presumably, the age of the company is one of the factors that determines
the maturity of the governance process in the company. For example, the
dynamics of governance at Uber, a ride-sharing company, are quite
different from those at IBM, an information services giant.
This governance mosaic must have an overarching platform upon
which the governance plan would rest. Without it, there would be no
basis for a company to assess if its approach to governance is cohesive,
integrated, and focused. Companies need a framework or a set of
principles to build a robust governance program. Almost all professions
rely on frameworks to design, validate, and operate a plan of action. For
example, internal and external auditors may depend on the COSO
(Committee of Sponsoring Organizations of the Treadway Commission)
framework to execute or evaluate a system of internal controls, and if
the presence of information technology in the organization is pervasive,
they may trust the COBIT (Control Objectives for Information and
22 ■ Corporate Governance

Related Technologies) framework to build trust in the system. One such

framework in the corporate governance arena is the ACG, or Aspira­
tional Corporate Governance framework.

Aspirational Corporate Governance

J. R. Galbraith, a profound researcher in organization design, put forth
a proposition that greater uncertainty requires a greater amount of informa­
tion processing between decision makers during the execution of the task in
order to achieve a set level of performance. Because uncertainty limits the
organization’s ability to preplan, the organizations resort to various, usually
complex, structures to increase their ability to preplan, to improve upon the
flexibility to adapt to their inability to preplan, or to decrease the level of
performance required for continued viability. More than 50 years since his
publication, we realize how complex the corporate structures, processes,
and practices have become to address today’s complicated issues and
challenges faced by companies.
Facebook, for example, has launched a new business segment in
cryptocurrency. To accommodate its vastly different nature of business
and high levels of uncertainty surrounding it, the company created
a separate business entity called Calibra, led by experts in macroeco­
nomics, monetary policies, electronic payment ecosystems, and infor­
mation technology. This high uncertainty project requires the leadership
of the company to recruit on its team of collaborators almost 100
established companies whose interests are tied to new developments in
cryptocurrency. As a result, the company will have access to multiple
organizations in a loosely networked form to address uncertainty as it
unfolds. Calibra’s separate identity within Facebook allows it to move
fast and adapt quickly to changes unfolding over time. To facilitate this,
the variety in the organization structure has to align with what the
organization has set out to achieve while dealing with uncertainty.
For an organization to adapt, that is, to control its destiny, it must
respond to changes in its environment. For this, organizations design,
operate, and evaluate control mechanisms guided by a control frame­
work. The control mechanism has to have the flexibility to respond to
new out-of-control situations; otherwise, it would be ineffective in
dealing with deviations from expectations. Resorting to the concept of
requisite variety, organizations attempt to ensure that in the repertoire
 Conceptual Foundations ■ 23

of controls there is at least one response to every out-of-control situa­

tion. The requisite variety in control mechanisms is complementary to
the organization design. The alignment between the two ensures adapt­
ability of the organization to its dynamically changing environment.
In proposing a corporate governance framework called Aspirational
Corporate Governance (ACG), Turnbull identifies three parameters:
requisite organization to address company complexity, requisite variety
in control mechanisms to address uncertainty, and adaptive capacity to
provide for self-adjustment.

• Requisite organization parameter warrants that capability of the

organization must be matched with the company complexity.
• Requisite variety to address uncertainties implies that there is
flexibility in the company’s control mechanisms to respond to an
out-of-control situation. In other words, there is at least one
corrective step for every deviation from the expected behavior.
A viable control system should be able to handle the variability of
its environment.
• Adaptive capacity provides complementary means by which ACG
systems can respond to empower stakeholders to reduce their
uncertainty or to transfer risks away from stakeholders to make
uncertainty acceptable.

For example, Facebook patrons were exposed to “deep fakes” or videos

that have been digitally manipulated in misleading ways. Facebook
recognizes its responsibility to protect online discourse on topics of
interest to the society (e.g., elections), and to give users control over
their data and experience on the Facebook platform. With proper policy
changes and their implementation, the company can deliver appropriate
governance objectives. Its vast resources ensure much more capacity to
respond than smaller rivals like Twitter and Reddit. The company
effectively adapts to moderating of content and protecting proper
public discourse from rogue users.
The ACG framework provides a high-level understanding of corpo­
rate governance in action. The framework recognizes that uncertainty is
a primary source of risk and risk mitigation begins with uncertainty.
24 ■ Corporate Governance

The greater the uncertainty, the greater the likelihood that the affected
organization has the appropriate complex structure to address the
uncertainty dynamically. The example of third-party risk management
(TPRM) illustrates this well. If your company has several thousand
suppliers spread around the world and connected to your network,
they become active connections to your company’s networks and infra­
structure and their risks are then inherited by your company to some
degree. The assessment of third-party risks to your company and
addressing those risks is a critical step in your company’s governance.
Because of differences in nature, types, and criticality of uncertainty
faced by organizations, there exists a wide variety of organization
structures and control mechanisms to adapt to uncertainty.

PRINCIPLES OR PRESCRIPTIONS?
While helpful, the ACG framework does not translate into precise prescrip­
tions for governance. The ACG fulfills an important role as a framework;
however, much needs to be done to arrive at a specific corporate governance
strategy. This leap from framework to policies and practices of a company is
significant and the guidance to navigate from the framework to
a governance plan is at best vague and negligible. It is likely that governance
principles were derived in isolation of or without considering a framework.
For example, it is difficult to ascertain whether a specific principle, say,
director independence, is borne out of a governance framework. It appears
that the most commonly suggested principles, such as the requirement of
independence, are identifiable with agency theory rather than the ACG
framework.
There are, however, parts of the ACG framework that apply toward the
articulation and execution of governance. For example, the concept of
requisite variety is clearly related to the design of effective internal
controls. The lack of attention to the need for requisite variety could
result in controls with significant deficiency and thus could cause more
problems instead of mitigating targeted risk. Nevertheless, the ACG does
not translate into prescriptions; however, it may allow one to identify
certain principles. Arguably as a bridge to principles of corporate govern­
ance, the ACG framework is not helpful in charting specific actions.
Considerable discussion ensues in the literature regarding the goals
and objectives of governance and the corresponding board role, which
 Conceptual Foundations ■ 25

can be described in bipolar form as (1) compliance or (2) performance,

that is, (1) the company’s ability to comply with applicable laws, rules,
and regulations and (2) the company’s capacity to achieve performance
goals. It seems the ACG framework is targeted more at the performance
objective rather than compliance. In directing and controlling perfor­
mance, the context is central to the task and each company’s plan of
action would likely be unique. A comparison across companies on
performance is far more difficult than a determination of compliance.
The real world of governance seems to overweight the compliance
requirements. Of course, even an exceptional level of performance may
not be worth much if the compliance requirements are not met.
Finally, it is important to note that in practice, two approaches to
governance are common: principles or prescriptions. In some regions of
the world, the corporations are asked to follow the principles and
explain if they deviate from them in practice. This places a much greater
burden of proof on those in charge of governance; they cannot hide
behind any rules. In contrast, some other regions set the governance
requirements in the form of rules. In the USA, compliance with set
rules dominates the minds of directors. Such compliance is considered
satisfactory, but may not result in effective governance of the company.
While rules make things simple, they do not necessarily result in
adherence to the spirit of governance. Since one size does not fit all,
setting rules that apply across the universe of companies makes little
sense; it gets easier to monitor, but it does not get easier to produce
results! A holistic governance requires customization of directing and
controlling actions to the company’s needs.

GOVERNANCE PRINCIPLES
Several authoritative bodies have attempted to pronounce their own sets
of governance principles. It is important to understand the meaning and
significance of each principle, which may be more fully possible if the
methods used to derive the principles was discussed in the literature for
the benefit of those interested in the field. The reason why a particular
principle was promulgated brings conviction and a greater degree of
trust in the principle. Often, however, the discussion of groundwork
that lays out the principles is minimal or missing.
26 ■ Corporate Governance

OECD Principles
The Organization for Economic Cooperation and Development devel­
oped a set of corporate governance principles (see Table 2.2). Ensuring
the basis for an effective corporate governance is central to the deploy­
ment of all other principles. A key beneficiary of the governance efforts
is the shareholders, who must be treated equitably, without bias and
with complete transparency. Stakeholders are recognized as role players
in the company governance and may in turn benefit from the com­
pany’s governance. Due to the information asymmetry between the
company and its owners, disclosure and transparency are important
pillars of communication with shareholders. Finally, the board of
directors forms the hub of company governance, so it is important to
articulate responsibilities of the board.

NACD Principles
The National Association of Corporate Directors (NACD) narrowly
focuses on the governance principles with a view to guide directors on
their duty to direct and control the company. As a result, the first
principle in the NACD list is the final principle in the OECD list. Table
2.3 lists the NACD principles. The remaining nine principles in the
NACD list essentially articulate the board’s qualifications and role in
governance. Principles 3, 4, 5, and 6 point to the director competencies,
skills, and requirements of integrity, ethics, and independence. Principle
9 addresses the need for shareholder input in director selection, usually
facilitated through proxy votes and sometimes shareholder proposals.

TABLE 2.2 OECD principles

1. Ensuring the basis for an effective corporate governance framework

2. The rights of shareholders and key ownership functions

3. The equitable treatment of shareholders

4. The role of stakeholders in corporate governance

5. Disclosure and transparency

6. The responsibilities of the board

 Conceptual Foundations ■ 27

TABLE 2.3 NACD principles

1. Board responsibility for governance

2. Corporate governance transparency

3. Director competency and commitment

4. Board accountability and objectivity

5. Independent board leadership

6. Integrity, ethics, and responsibility

7. Attention to information, agenda, and strategy

8. Protection against board entrenchment

9. Shareholder input in director selection

10. Shareholder communication

Principles 3 and 10 refer to disclosure and transparency in communica­

tion with shareholders. Principle 9 draws attention to the execution of
corporate governance measures through the dissemination and discus­
sion of relevant information, deliberate agenda setting to achieve effec­
tive governance, and assistance in and monitoring of execution of the
company strategy.
Table 2.4 presents a comparative view of the OECD and NACD
principles. The former is a high-level view of corporate governance,
while the latter is a distillation of broad principles in terms of what they
mean to company directors and the board. The OECD list does not
include director qualifications, for these are relatively granular and
focused on the director roles only. The NACD principles omit fair
treatment of shareholders and recognition of the role of stakeholders
in governance, perhaps because these are assumed in the development
of specific board-related aspects of governance. In sum, it is fair to say
that NACD articulation of board-specific principles are nested in the
OECD principles.
28 ■ Corporate Governance

TABLE 2.4 A comparison of OECD and NACD principles

Classification OECD principle NACD principle
Framework or Ensuring the basis for an effective Protection against board
parts of it corporate governance framework entrenchment
Shareholder The rights of shareholders and key Shareholder input in
rights and duties ownership functions director selection
Fairness The equitable treatment of shareholders
Information Disclosure and transparency Corporate governance
asymmetry transparency
Shareholder
communication
Stakeholder The role of stakeholders in corporate
roles governance
Director Director competency and
qualifications commitment
Independent board
leadership
Integrity, ethics, and
responsibility
Board duties The responsibilities of the board Board responsibility for
governance
Board accountability and
objectivity
Attention to information,
agenda, and strategy

Transparency
Included in the discussion above is a relatively rarely encountered
concept of transparency. Intuitively, it makes general sense but the
specificity of the concept and how it plays out in practice is unclear.
Table 2.5 provides a brief discussion of the concept.

FRAMEWORKS AND PRINCIPLES IN REGULATION

It is difficult to say whether lawmakers and government enforcement
agencies, such as the SEC, pay attention to frameworks, principles, or
research studies in the area of corporate governance and their likely role in
crafting legislation. They probably do. And yet, in the process of
TABLE 2.5 The concept of transparency.
The meaning of the multidimensional, umbrella term “transparency” is unclear.
According to Michener and Bersch (2011), the scholarly exuberance in research pursuits
concerning transparency have not been underpinned by any collective understanding of
“transparency,” much less any debate on what constitutes transparency, what does not,
and how to go about assessing its quality. Therefore, the role of transparency remains
opaque and potentially results in organizations’ and individuals’ failure to be effective,
despite possible good intentions.
The vagueness of the concept causes uncertainty in developing a sound approach to
addressing important questions. For example, how should Yum Brands have
communicated the Chinese government’s launch of an investigation of allegedly
improper antibiotics used by suppliers of chicken to their KFC business unit in China?
How much information regarding the health of Steve Jobs should have been revealed by
Apple Corporation when he took an indefinite leave of absence from the company’s CEO
position? Barring a few exceptions, it is hard to argue against being transparent. And yet,
it seems impossible to stake a claim of being transparent.
Transparency touches deeply on the following three dimensions:

• Openness (honesty): Openness involves judgments about what it is that would

affect the stakeholder’s decisions and its consideration about content to be
disclosed. Information must be reasonably complete and found with relative ease
and must facilitate inference.
• Communication: adequate and timely communication in order for the stake­
holder to benefit from information on hand.
• Accountability: information that is disclosed is reliable and a truthful represen­
tation of reality.

Lainie Petersen (2008) extends the scope of true transparency beyond what we do and
into the domain of who we are. The intention here is to define transparency as
intrinsic, not just a behavioral phenomenon. You can’t be transparent to the outside
world and not be transparent internally (to yourself), for it has to do with “who we
are,” not just “what we do.” Thus, clarity in the practice of transparency could lead to
a code of conduct based on ethical precepts.
Weber (2008, p. 344) asserts that transparency is seen as an important component of good
governance. But Michener and Bersch (2011) conclude that transparency is used as a means
of describing, not explaining, and this has resulted in a rainbow of meanings assigned to the
term transparency. It seems that a large degree of variance characterizes the meaning of the
term.
Normally, transparency enhancements depend on “the purposes for which information
is sought, the capacity and incentives of actors to provide that information, and the
(Continued )
30 ■ Corporate Governance

TABLE 2.5 (Cont.)

strategies adopted to foster transparency” (Mitchell, 1998, pp. 109–110). Weber (2008,
p. 344) differentiates between procedural, decision-making, and substantive transparency,
and Heald (2006, pp. 27–28) proposes directions of transparency (upward, downward,
outward, and inward).
With improved understanding of transparency, it would be feasible to sharpen the
language of code of conduct, improve employee training, write more effective policies,
and communicate effectively with stakeholders.
Adapted from: Raval, V. and Draehn, R. L. 2019. Transparency in Corporate
Governance: A Bibliometric Mapping of the Concept and Related Terms, a working
paper, Creighton University.

introducing a bill, lawmakers do not seem to publicly disclose what might

shed light on why certain provisions were enacted and what consequences,
if any, they would have on effective corporate governance. For example,
one regulation regarding executive compensation has to do with disclosure
of pay ratio – the ratio of the CEO compensation to the median wage of
employees in the company. While this statistic may be exciting or politi­
cally appealing, it does little to enhance governance. There may be
a number of reasons why this ratio may be high or low compared to the
company’s peers. Much of change in regulatory requirements seems driven
by political motives, such as appeasing one’s constituency, rather than
framing a logically sound and holistic body of legislation. If laws and
regulations were perfect, we wouldn’t see so many corporate frauds.
A similar argument can be made regarding recent trends toward the
rollback of regulations. Again, it is not clear if such rollbacks are
heuristically identified or analytically traced to determine if their value
is less than what it costs to comply. In some cases, it may be difficult to
isolate the cost-effectiveness of a single regulation since the regulation
may be working in consonance with other related provisions.
Finally, the laws and regulations address only the conformance, not
performance, requirements. It is perhaps obvious that one cannot
regulate company performance. However, this slant in regulation could
give a wrong impression that all that effective corporate governance
entails is compliance. If anything, to achieve best possible results for the
shareholders is equally important for the company.
 Conceptual Foundations ■ 31

Principles and Best Practices

Over time, lessons learned from the field combined with research findings
have generated voluminous data on corporate governance mechanisms. To
the extent that such findings are not part of regulations, the message is
considered as the best practice rather than a principle. Best practices are not
a requirement and therefore may not be adopted by the responsible party,
such as the board, in its governance of the company. Arguably, the difference
between principle and best practice centers on the specific context of the
company. A principle is in the spirit of a mandate, while a best practice is
one that is best suited to a specific firm. Consequently, best practice has to be
considered on a case-by-case basis, while principles apply across the board
without regard to the contextual circumstances of the company.
Because companies operate in their own, unique way, it is difficult to
frame some of the best practices into principles. For example, how the
firm chooses its organization structure, what business model it adopts,
what business strategy it selects, what risk mitigation approach it decides
to implement, and how the firm positions itself to cope with uncertainty –
these are questions uniquely addressed by each firm. This sort of custo­
mization is difficult to carve into a principle, although theories and
paradigms are available for the firm to use in such decision making.
An example of best practice is that the board chair should be a person
separate from the one who serves as the CEO of the same company. Often,
in evaluating whether a best practice could be viable without any negative
consequences, individual case facts may make a difference, requiring
judgment as to what path to take. However, handing the two very power­
ful roles to one person creates a major single point of failure. For example,
management overrides of control become more probable as separation of
duties at the very top of the hierarchy is ignored. Conceptually, one could
ask: how could the CEO who represents management be allowed to
represent shareholders also? Perception today is that in some cases, the
separation of the board chair from the CEO could negatively impact the
company and its performance. This may be because the chairman is also
founder of the business who envisioned the opportunity and created
a thriving company by implementing the vision. For instance, could
Tesla be the same without its visionary, Elon Musk? It is highly unlikely.
32 ■ Corporate Governance

Given such scenarios, the separation of the board chair and the CEO is
suggested as only a best practice and not a principle.
Principles generally are cornerstones of governance, and therefore
cannot be disregarded in governance decisions, although they likely do
not have the power of the law. As empirical evidence converges and
experience signals that a best practice is probably a sound thing to
follow by everyone, it likely would convert into a principle and may
even be considered for inclusion in the law or regulation. For example,
in the matter of chairman and CEO roles, the SEC now requires
companies to disclose in their proxy statement whether the two roles
are combined and the reason for choosing to do so.

Principles or Prescriptions?
Conceptually, there are two ways to seek compliance: rely on integrity
(principles driven) or spell out the rules (compliance driven). The former
emphasizes that integrity is reflected in principles defined to guide behavior;
the latter considers compliance as conformance to rules that suggest satisfac­
tory behavior. Most legal mandates lead to specific requirements or rules;
besides, the organization may set its own additional rules of behavior. The
integrity approach requires that the overall tone of conduct is set for the firm
and, from this, compliance will follow. The integrity-based approach should
meet the legal requirements, but may even rise above such dictates.
It is easy to understand why compliance in a strictly legal sense
matters. If the laws and regulations are not complied with, enforcement
actions from government agencies, including the SEC, may trigger. Mired
in the enforcement actions, management may not be able to give its full
attention to the real business on hand. Thus, company performance slips
while the cleanup from noncompliance takes priority. Legal compliance is
thus the lowest common denominator of any governance. Without it, the
company will have difficulty surviving.
A rules-based approach makes it easier to defend the firm’s actions and
thus is a convenient way to justify what is done. However, too much
reliance on rules may create the tone of legal absolutism. Satisfactory
implementation of rules would increase the cost of doing business and
may even marginalize the essence of good governance. A principles-driven
approach requires that the actions are defined by what is essential for
corporate governance. Compared to a rules-based approach, it is a higher
 Conceptual Foundations ■ 33

order solution. However, the challenge is in having members of the firm

learn how to effectively translate principles into appropriate actions.
The actions that result in compliance may not result in operational
performance; for example, it may not increase revenues or decrease
employee turnover. Compliance invokes the thoughts of having costs,
but little value in return. In contrast, the organization’s tone at the top,
the code of conduct and how it is implemented, and the clarity in how
ethical lapses are treated – these are the actions that speak louder and set
the firm on a more robust path. Without integrity in the leadership that
percolates through every layer of corporate hierarchy, the focus may
simply turn to asking what is expected and then delivering just that.
Rules are, or should be, drawn from what is the right thing to do.
However, a rule may drift from the spirit behind it, rendering it
irrelevant and valueless. Besides, complex systems, by nature, are diffi­
cult to administer using rules. Therefore, actions that are grounded in
ethical principles are preferred since no predefined rule is followed;
thus, the energy is focused on the right thing to do. Compared to
a rules-based approach, the integrity-driven approach sits on higher
grounds and likely delivers compliance as a principled exercise.
The two approaches are not mutually exclusive. In fact, compliance
could be meaningfully achieved if both approaches – rules and principles –
are combined in the best possible way. In the long run, this should lower
the compliance costs and put the organization on a more reliable path.

Role of Regulation and Regulatory Authorities

Laws and regulations provide the lowest common denominator for the
actions of the company and its management. To survive, the require­
ments promulgated under these laws and regulations must be met. Both
laws of the state in which a company is incorporated and the federal
laws apply. Broadly, the applicable state laws concern the requirements
for incorporation, while the federal laws pertain to the governance of all
U.S. corporations. Moreover, the requirements of the stock exchange
where the securities of the company are traded comprise another set of
rules, which often are congruent with the state and federal laws and the
SEC regulatory requirements. The discussion of laws and regulations is
embedded in the coverage of different topics throughout the book.
34 ■ Corporate Governance

Underpinning Governance
A large majority of precepts are derived from the foundations of govern­
ance. Without an understanding of foundations of corporate governance,
it would be difficult to grasp why certain requirements exist and how they
fit in the overall picture. Therefore, this early chapter in the book
provides a foundation for the comprehension of specific governance
requirements discussed in the remaining chapters.

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