Internal and External Corporate Governance

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Corporate Governance > Best Practices > Internal and External Corporate Governance

Internal and External Corporate Governance
Jaap de Jonge, Editor, Netherlands
Corporate Governance (CG) can be viewed as the system by which companies are directed and controlled. Also companies can be held accountable by CG, limiting managerial discretion in order to protect the interests of outsiders in the corporation.
These 'outsiders' can be shareholders, stakeholders, other interested parties or even society as a whole.
Any CG 'system' consist of a large number of mechanisms. We can broadly categorize CG mechanisms into two groups:

1. Internal Corporate Governance
Internal corporate governance encompasses the controlling mechanisms between various actors inside the firm: the company’s management, its board and the shareholders.
In this form, the shareholders and other constituents 'delegate' the controlling function to internal entities or mechanisms, such as the Supervisory Board (in case of two-tier board) or the Board of Directors (one-tier) and/or special committees.

Examples of internal corporate governance mechanisms:
Internal and external corporate governance2. External Corporate Governance
External governance encompasses the influences from outside the firm on the governance of the firm. These can originate from a number of external sources.

Examples of external corporate governance mechanisms:
  • Markets:
    • Labour market (for executives and for employees)
    • Product / services markets in which the firm operates, competition
    • Capital market (debt, equity)(opinions of investment analysts, credit rating agencies, financial media, institutional investors)
    • Market for corporate control (hedge funds)
  • Legal and Supervision
    • National laws and regulations
    • Supranational laws and regulations
    • Corporate governance codes (SOX, OECD)(voluntary or required)
    • Supervisory authorities (central banks)
  • Service Providers
    • Independent auditors, external accountants (annual reports, financial statements)
    • Investment banks (credit facilities, flotation, prospectus)
    • Private equity
    • M&A (takeovers)
    • Legal advice, insurance (Directors and Officers liability)
  • Media (watchdog, guard dog)
  • Relationship with unions
1. Some aspects can be considered internal, external or even both, depending on the organization, governance type and jurisdiction.
2. Depending on the country, the focus on the two mechanisms can differ, for example:
  • In the US and other Anglo-Saxon countries we can generally see a bigger trust in markets/shareholders (shareholder value perspective) with a resulting focus on external corporate governance.
  • Europe and Japan generally rely more on relations/networks/stakeholders (stakeholder value perspective) and consider internal CG-mechanisms as more important.

Corporate Governance - The Role of the Customer
Ashok Asthana, Consultant, India, Member
I feel customers play a very important role in influencing internal governance, since a company, without a customer is nothing. As per the old dictum "the customer is king", he plays a major role in framing internal governance.
Editor: In corporate governance, the customers are indicated with the "Market" for Product or Services. This is one of the 4 'markets' that are all part of external CG.
All external CG mechanisms by definition influence the firm and its CG mechanisms.

Keep Corporate Governance as Simple as Possible
Hazem Yassin, Manager, Saudi Arabia, Member
Dear Jaap your article was very good, concentrated and short with clear idea. In our company we already have a CG manual in place, but unfortuntily we have no specific controller for this one expect so we have hired an external party to audit the CG complaince.
We discovered that the mechanisms that are established in the company are too big for our current size and business activities, so we decides to revise this CG manual with another simpler one.
Editor: Thanks for your interesting CG case. CG is complex because so many interests, issues and legal requirements have to be taken care of. On then other hand I agree we should not make it more complex than necessary (especially in small/medium size companies). That was also the background of my article.

Internal and External Corporate Governance
D P BABU, Strategy Consultant, India, Member
The effectiveness in counterbalancing internal and external corporate governance mainly rests with the disclosure philosophy of the company (corporate transparency) about its indoor management such that outsiders' dealings with the company shall not result in acts ultra vires the memorandum and articles of association.

Corporate Governance Mechanisms (Intern and Extern)
alim sale, Strategy Consultant, Kenya, Member
Thanks for the interesting analysis of all elements that influence good corporate practices.
Good CG practices within our organisations are crucial.
The triple bottom line is now more important than only the profit that we are all buried in. And CG will ultimately make the difference between those corporates that do well and those that don't.
Jaap, you have given a good outline of how all the elements fit together.

Are Sub-consulting Firms part of Internal Governance?
Greenhow, Consultant, Sweden, Member
Your examples of external governance mechanisms seem to be external actors who influence the behaviour of the firm. Am not sure where to put sub-contracting firms in which "my" firm demands/expects them to respect and follow certain of my firm's governance policies. i.e. cases where internal governance mechanisms are imposed on external actors. Are they considered internal because we contract them... Or is this another category of governance?
Editor: As I mentioned in the notes of this article, sometimes it is not very clear if some mechanism should be considered internal or external. Do not worry about that too much. The nature of this distinction is not legal (most legislations do not use the term internal/external CG). Grouping them just helps to understand the many mechanisms more easily.
In your case, first of all such sub-consulting firms are only part of CG if they have a function in the system of how your company is directed and controlled (and held accountable). That may or may not be the case with this sub-contractor.
If they have indeed such a role, it depends on what kind of work they do and for what (and whose) purpose. The fact that your firm contracts them is an indication, but not enough by itself, to conclude they are part of internal governance.

Corporate Governance and Local Government Service
Adam Mohammed Baba, Director, Ghana, Member
As an employee of local government (LG) service, your article has made me see what I will call internal and external CG in the Ghana LGs.
- Some of the internal CG is the law makers (assembly members who may be considered as board of directors), local government act of 1993 that established district assemblies (local parliament), standing orders that regulate the conduct of meetings of the parliament, the mayor and his employees, the code of conduct of employees, etc.
- The external CG can be seen as the constitution of the republic, other relevant laws and regulations, the national government, service providers and those who benefit from lgs services, the media, the international donors, the electorate and many others.
Both internal and external CG influence performance of the LG agencies in Ghana. Perhaps this is what strategic management expects refers to as internal and external environment of an organization.
Editor: indeed also for non-profit organizations we can speak of internal and external governance. Of course the word 'corporate' in corporate govenance indicates we are dealing with governance of corporations (companies). So it's advisable not to speak about internal or external corporate governance in the case of local, regional or national government services.

Corporate Governance
Madan Gopal Agarwal, Business Consultant, India, Member
Excellent articulation and perspective, Jaap. The key is self-realisation and willingness of the board/company/owners etc. that they are accountable to others.
Accountability is the key denominator in the whole matter of CG.

Corporate Governance and Joint Ventures
Douglas Ferguson, Consultant, Member
How might this structure be applied in joint ventures where there is a 50-50 ownership stake between the partners? In addition, the jv is designed to leverage the resources of both countries when pursuing specific initiatives in order to keep the jv from creating redundant costs. Any case examples in the jv world that you think are particularly illuminating?
Editor: applying this categorization to 50/50 joint ventures will be particularly helpful to understand the more complex government mechanisms in this situation. Both for the JV, that will have internal and external governance (the last one includes the double legal systems) and for the parent organizations. See also Special Purpose Vehicles and Joint Ventures for more information.

Corporate Governance and Local Government Service
Adam Mohammed Baba, Director, Ghana, Member
@Adam Mohammed Baba : Thank you Jaap for the excellent comment on my submission. You have added more insight into my understanding of cg as far as regional, local and national governments are concerned. However as a practitioners we often adopt private sector strategies where appropriate to run lgs organizations. We are compelled to do so because lgs organizations are operating within a space in which they are competing with corporate bodies in an environment that is becoming more dynamic and complex. This require lgso to adapt to market oriented practices in some cases to be able to survive.
Editor: Hi Adam, I can see that it might make sense to adopt private sector strategies in local government organizations, just don't call it 'corporate' governance but just governance.

External Influences and CG Mechanisms
Greenhow, Consultant, Sweden, Member
I'd appreciate clarification of some of the external "mechanisms". Are you using mechanism as synonymous with influence? I can see how legislation with its control institutions is a mechanism imposing requirements on CG. But markets and service providers seem to me to have an entirely different kind of influence on governance issues.
Editor: good question. Well, they are not synonyms, but rather external influences lead to CG mechanisms: outside entities that influence a corporation (in a substantial way) are likely to result in, or even require some CG mechanism as a response.
You are correct to say that the various external influences (for example legislation and various markets and service providers) are different and need other CG mechanisms to deal with them.

Transparency in Internal and External CG
AIDA ACUBA, Professor, Philippines, Member
@D P Babu: I agree with your opinion... I believe there must be transparency in good corporate government. With that outsiders will have no doubt and suspicion in the way the company operates and lead and controlled via its CG.

Corporate Governance is More of Internal Value Than for External Control
Suleiman C. Muttani, Consultant, Tanzania, Member
I would thank the Mr de Jonge for this interesting topic. I simply define governance as a striking balance between internal performance and external relationship. A company or organization with its set goals and objectives are to accomplish certain missions (and not in isolation) but in relation to outside world. We are looking for black spots that anyone in the company may see, but that was perhaps silenced by what is called an organizational culture.
For example, one may reprimand a co-worker by saying "don't ask that question, as this may cause problems", or: "The CEO will not be happy to hear this happened..."
Or we use consultants, external evaluators, or any name you call them. Or we use other platforms acting as an external eye.
I believe internal experts are best positioned to strike the above said balance that may supplement the conduct of the good corporate governance. It is the organizational performance that will attract its external or customer value that may be viewed as external controls too.

Good Ethics in Internal and External Corporate Governance
Kumsha, Student (MBA), Sao Tome and Principe, Member
@Madan Gopal Agarwal: I agree with you Madan, I also believe that ethics and ethical leadership play a central role in the realization of good corporate governance. When leaders and employees understand the importance of upholding good ethics, such an environment is conducive to doing the right things right.

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