Principles of Corporate Governance

The immediate need for good corporate governance arises due to the inherent potential conflicts between different stakeholders in a corporate structure. This is usually referred to as the principal–agent problem, the most prominent of which is the potential misalignment of interests between the ownership (principal) and management (agent) of a company. Corporate governance aims at minimizing the possibility of conflicts by increasing the transparency of decision making processes and the accountability of management by installing various control mechanisms (e.g. audit committee, board of directors, shareholder meetings). A good corporate governance framework is essential for the efficient allocation of capital. Through enhanced disclosure and transparency, such a framework provides market confidence, attracts long-term capital and supports market discipline. It thereby al so reduces the costs of issuing capital for companies. 

The OECD Principles of Corporate Governance

The corporate governance principles were first developed at the request of a 1998 ministerial level meeting of the Organization of Economic Cooperation and Development (OECD) and endorsed by OECD ministers in 1999. A revised set of principles was issued in 2004, following extensive consultations with OECD governments, business groups, and other stakeholders from OECD countries, as well as international organizations such as the IMF, the World Bank, the Basel Committee, and other groups invited on an ad-hoc basis. 

In the Preamble to the Principles, the OECD defines corporate governance as follows: “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring.”
The OECD Principles now consist of a set of 32 sub-principles organized into six broad categories, namely the (1) basis for an effective corporate governance framework, (2) rights of shareholders, (3) equitable treatment of shareholders, (4) role of stakeholders in corporate governance, (5) disclosure and transparency, and (6) responsibilities of the board. Following the revision of the Principles, a methodology for their assessment was released in December 2006 in order to facilitate the dialogue over their implementation.


Applicability of the Principles of Corporate Governance

The OECD Principles represent the minimum standard on which countries with different traditions could agree, without being unduly prescriptive. They are meant to be equally applicable to countries regardless of prevailing ownership structures, a civil or common-law tradition or the dominant model of board representation.
In a global context, dispersed ownership structures are the exception rather than the rule. Whether the norm are family-controlled companies, state-owned firms or financial-industrial groups with cross-shareholdings, every system creates different agency problems and therefore different corporate governance challenges. Another source of differences in corporate governance  perspectives stems from differing legal traditions that vary substantially, mainly between countries with common law and countries with civil law traditions. Research suggests that the less formalistic and more flexible nature of the common case law offers stronger protection of shareholder rights and are therefore characterized by the “outsider” system of dispersed ownership and strongly developed financial markets. Consequently, the primary governance focus in common law countries is on the shareholder. In civil law countries, control of shareholder interests has traditionally been achieved through the "insider system," of cross-shareholdings and dominant majority shareholders. Lastly, cultural differences play an important role. In contrast to the strong shareholder focus in common law countries, in civil law countries such as Japan and Germany with a different cultural/ societal legacy, the interests of other stakeholders are more prominent, resulting – for example – in the representation of employees on the board of directors.

These differences explain why countries will diverge in the focus of their corporate governance frameworks. Hence, the OECD acknowledges: “The Principles are non-binding and do not aim at detailed prescriptions for national legislation. Rather, they seek to identify objectives and suggest various means for achieving them. Their purpose is to serve as a reference point.” Moreover, the OECD Principles explicitly state that the "desirable mix between legislation, regulation, self-regulation, voluntary standards, etc. in this area will vary from country to country" (p. 29). The Principles and assessments against it focus on publicly-traded companies, but they are also a useful tool to improve corporate governance in privately-held and state-owned companies.

The World Bank benchmarks the corporate governance framework and company practices of countries against the OECD Principles as part of the "Reports on the Observance of Standards and Codes" (ROSC) initiative. Participation is voluntary. As of October 2007, ROSCs for 41 countries have been published on the World Bank website with the authorization of the respective country. Only low- and middle-income countries and economies in transition have been assessed. The European Bank for Reconstruction and Development (EBRD) uses the OECD Principles to analyze the state of corporate governance in the EBRD's countries of operations. The Institute of International Finance (IIF) publishes comprehensive assessment of countries against its own 2002 Corporate Governance Code, which differs from the broader OECD Principles in that they are more detailed and aimed at implementation, but do not diverge in substance. As of June 2007, the IIF has published reports for 17 emerging markets. In addition, there is a growing body of literature on corporate governance at the country level utilizing the OECD principles.