Internal and External Corporate Governance

Internal and External Corporate Governance

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:

• The Corporate Charter of the firm (also called: Articles of Association , Articles of Association)(voting rights and restrictions, preferred stock, anti-takeover mechanisms, staggered board of directors, etc.)
• Board of Directors
• Supervisory Board (if two-tier board). Roles: employer of management, supervising management, advising management), Structure, Remuneration)
• Special Committees (Audit Committee, Compensation Committee, Nominating Committee, Governance Committee)
• (Other) internal control procedures (Sarbanes-Oxley Act 404, COSO, Code of Conduct, whistle-blowers, etc.)
• Executive compensation (fixed/variable, money/shares/options, short/long term targets)
• The capital structure of the firm (equity, debt)
• Employee participation
• Etc.

2. 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

Notes:
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.

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