Study Session 12: Corporate Finance (1)
Study Session 11: Corporate Finance (2)

Identify potential risks of poor corporate governance and stakeholder management and identify benefits from effective corporate governance and stakeholder management

Effective management of conflicts of interest between different stakeholders and implementation of adequate controls results in better relationships with stakeholders, increased efficiency and profitability.

Risks of poor governance and stakeholder management

 A poor corporate governance structure may create various risks for a company and its stakeholders such as weak control system, ineffective decision making, legal, regulatory and reputational risks, and default and bankruptcy risks. 

  • A weak control system may allow one stakeholder to benefit at the expense of other stakeholders or the company. 
  • When there is information asymmetry, i.e. when the board and shareholders do not have access to information which management has, management may benefit themselves at the expense of shareholders and other stakeholders. It might lead to management taking too little or too many risks. Management might be overcompensated, they may focus on short-term, and/or enter into related party transactions to the detriment of the company and its shareholders.
  • Compliance weaknesses and lack of proper reporting may expose a company to legal, regulatory and reputational risks. This is because in today’s markets, information flows rapidly.
  • Poor corporate governance can affect a company’s financial position leading it to default on its debt related obligations which may potentially force a company into bankruptcy. 

Benefits of effective governance and stakeholder management

Effective governance framework results in improved efficiency, improved control, better operating and financial performance, and lower default risk and lower cost of debt.

  • An effective governance framework defines responsibilities across company which ensures that corporate decisions are properly monitored to mitigate risks and improve efficiency.
  • Improved control mechanisms (enhanced through effective audit systems) may help manage legal and regulatory risks and their associated costs at early stages. Adoption of formal procedures about conflicts of interest allow companies to promote fairness in its relationships.
  • Effective corporate governance can help a company improve its operating and financial performance by avoiding investment losses and legal costs, responding quickly to market changes, setting fair and proper remuneration, etc.
  • Proper function of audit systems, improved transparency and reporting and control of information asymmetries can help in the management of conflict of interest with creditors, reduce default risk and enable a company to access debt capital at low cost.