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  • Principles of corporate governance: a practical guide to ensuring ensure business growth
Publication:

Principles of corporate governance: a practical guide to ensuring ensure business growth

20 May 2021

By dispelling the belief that good corporate governance practices place an unnecessary burden on a company, the implementation of corporate governance principles in a sustainable company creates a rich potential for growth and the achievement of goals.

The importance of effective corporate governance has been discussed in recent years, as evidenced by both the G20 / OECD Principles of Corporate Governance endorsed by the Organization for Economic Co-operation and Development [1] and the Corporate Governance Code developed by the Corporate Governance Advisory Board last year [2].

Corporate governance, also known in practice as governance policy or multi-level governance, is a set of guidelines that can be used to build a corporate governance system. It plays an important role in setting and achieving the company's goals, monitoring and managing risks, as well as improving internal processes.

Covering such a wide range of issues, corporate governance guidelines can be grouped into three categories:

  • the policies and procedures to be implemented in the company, which determine the responsibilities of the employees, the board and the council, the responsibility in various issues of the company's activities;
  • implementation of the principles of mutual communication and cooperation between the company's management institutions - the board, council, participants, or shareholders;
  • promoting the transparency of decisions and actions.

Implementing corporate governance principles

Contrary to a popular belief, the implementation of corporate governance principles is not the sole prerogative of large companies or corporations with public functions. Regardless of the size of the company, its activities in the field of public or private law, and other considerations, the sustainable operation of any company requires good governance.

The implementation of corporate governance principles is most often relevant for capital companies founded by public persons, financial institutions, listed companies, as well as any other company who wants to attract investments and whose activities affect the national or regional economy.

It does not matter what is the legal form of the company (joint-stock company or limited liability company) and whether a council has been set up - the principles of corporate governance are adaptable to the characteristics and size of each company.

Step by step: solutions for strengthening corporate governance

The Corporate Governance Code introduces 17 principles that, if properly implemented and complied with, will increase the long-term value of the company, ensure efficient management and transparency of decisions. In the opinion of the authors of the Code, adherence to the principles is mandatory according to the type of company - it is useful both for informing investors and for coordinating the cooperation between the board, council, and shareholders. Considering the objectives of the Code, we offer an insight into the solutions to the problems provided by the correct implementation of the principles of corporate governance in practice.

 1. The strategy of the company

 A problem. A company without a strategy is a ship without a captain - it lacks specific, measurable business goals and a plan to achieve those goals. If a company does not have a clear vision of the future, it will lose competitiveness quite quickly.

In practice, it is often the case that a company has developed a strategic plan, but the implementation of its goals has become slow - the answer to this situation is that the strategy must not only determine the desired result but also provide general development goals for achieving it.

For example, when management sets a goal of “We want to be in the top three in our industry,” it is not enough to hope that setting a goal will bring the expected result. In turn, determining that, for example, “increasing the volume of exports to the Baltic States”, the company will take much more definite steps to achieve the strategic goal.

Solution. Development of a strategy or company management plan, determining the achievable operational goals and the period for the implementation of these goals. When developing a strategic action plan, the current situation in the company and the experience of achieving the goals so far are taken into account, trends and risks in the industry are assessed. The plan summarizes the company's vision of the direction of development, sets priorities and officials’ responsibility for their implementation.

 2. Company's internal culture and ethical standards

 A problem. The belief that the purpose justifies the means is incompatible with good corporate practice; on the contrary, clear rules of the game promote fair competition and respect between partners, investors, employees, the board, and the shareholders. Ethical standards regulate a company's internal processes during the preparation of products or services before they fall into the hands of clients.

Ethical violations such as misappropriation, violence and mobbing, unproductive e-mail exchanges, nepotism, and professional arrogance affect productivity and the quality of results. Over time, these factors affect the company's reputation and create additional costs, therefore the causes of such problems must be addressed on time.

Solution. Development of a company's internal culture and ethical code of conduct, setting guidelines for the actions of the board, council, and employees both in the performance of duties and in communication with other persons. The ethical guidelines set out the requirements for communication and professional attitude, provide for responsibility for actions that do not comply with the guidelines, and promote a conscientious process, as well as the set of ethical values ​​that characterize the company. The effectiveness of the Code will be ensured if individuals can report violations and the perpetrators are held accountable for the consequences of their actions.

 3. ​Internal control system

 A problem. To strengthen the fight against money laundering, the SRS supervised entities are obliged to establish an internal control system to manage the risk of sanctions by the Law on the Prevention of Money Laundering and Terrorist and Proliferation Financing.

Solution. Development of internal control system. The system allows to identify, assess, understand and manage the risks of international and national sanctions inherent in its operations or customers and to decide on cooperation with customers. A modern company develops an internal control system so that all customer control steps are transparent, including using the possibilities provided by technology and integrating control inspection systems into internal processes. When developing the internal control system, the regulatory enactments applicable in the industry are taken into account, the risk profile and risk assessment guidelines are developed, the criteria for the person responsible for risk management are determined, the information flow procedure, as well as the reporting procedure, is determined.

 4. Risk management policy

 A problem. Although the opinion has been expressed in the media that entrepreneurship in Latvia is suitable only for optimists, foresighted action is to identify potential risks or problem situations that may affect the company's operations or the achievement of strategic goals. Unforeseen circumstances can have a significant impact on a company's service delivery, from last-minute work and exceeding the budget threshold to dissatisfied partners, losses, fines, and damage to the company's reputation.

Solution. Development of risk management plan. The identified risks must be related to the company's overall operations or specific objectives, determine the impact of the risk, its possible consequences, and actions in the event of its occurrence, to assure the achievement of the company's strategic objectives.

 5. Internal audit plan

 A problem. Global events, including the impact of the COVID-19 pandemic on the business environment, have had lasting consequences, so it is up to companies to decide how quickly to adapt to change and to look at how successful they have already been in adapting to the new circumstances. Failure to conduct an internal process audit on time risk that the company does not achieve its pre-determined results, fail to notice red flags and lose its reputation due to sudden deficiencies or irregularities. The implementation of the strategic plan is a dynamic process that requires a periodic understanding of whether they will be achieved, therefore the audit will be a guide to whether the chosen methods are in line with the plan.

Solution. Development of an internal audit plan. During the development of the plan, the stages of risk management, internal control, and other management processes will be determined, the evaluation of which will eliminate their possible shortcomings, as well as the frequency of inspections, responsible officials, and reporting procedures. By carrying out an internal process audit by the plan, the final report prepared will be a valuable insight into the shortcomings identified to decide on further actions to address them.

 6. ​Periodic implementation of external audit

 A problem. The regulatory enactments impose an obligation on several business entities to perform statutory audits periodically to review the accuracy of financial accounting. When it is established that it is necessary to perform a statutory audit in the company, it is necessary to ensure the involvement of an independent auditor. The auditor's independence and other professional qualities are a guarantee that the audit report will be objective, substantiated, and its conclusions will be significant.

Solution. Development of auditor selection criteria that will prevent risks of conflict of interest or other threats to the auditor's independence. BDO Latvia's professional consulting services include, among other things, the provision of independent auditor services, while BDO Law lawyers provide legal advice by preparing a contracts and other documents. The purpose of these measures is to ensure good cooperation between the board, the council, and the auditor by providing the necessary information, determining the scope of the auditor's work, the audit plan, and the remuneration for the service.

 7. Supervisory board members selection, removal, and agenda

 A problem. When faced with risk situations or negative publicity, the public gaze turns to the company's management and supervisory board , rhetorically asking "what have the council members done so far?" To prevent the risks expected as a result of the lack of effective management, the company must ensure promptly that its management structure will be an institution that will control the work of the board, and thus also decision-making. Carefully selected supervisory board members are characterized by knowledge, practical experience, teamwork skills, strategic thinking, and responsibility for their actions.

To put the necessary competencies into practice, it is important to determine what decision-making process the supervisory board will be involved in. In the Baltic States, it is optimal to form a council with 3-9 supervisory board members, so it would be in the company's interest to determine which issues fall within the competence of each supervisory board member. The time spent on the work of the supervisory board can be saved by planning meetings - knowing when the meeting is expected, the necessary information, draft decisions, and informative reports can be prepared in time.

Solution. Development of rules for the selection and removal of council members, which would determine the criteria for the selection of a professional and supervisory board candidate, determine the number of supervisory board members, and the basic principles of its composition. It is important to determine in advance which issues will be decided or evaluated by each member of the supervisory board to effectively perform the functions of the supervisory board. The selection rules should determine how the appointed members of the supervisory board take up their duties, become acquainted with the company and their responsibilities, as well as the irregularities or other considerations which may justify the removal of a member of the supervisory board.

Development of the supervisory board’s agenda regulations. The regulations must indicate the competence of each member of the supervisory board and report on issues that fall within its competence, develop the procedure for organizing the meetings of the supervisory board, develop their agenda, and minutes. For the work of the supervisory board to be transparent, the regulations must determine the procedure for decision-making and circulation of information, the frequency of meetings. The work of the supervisory board must be allocated funding - if additional expenses are incurred, the procedure for their compensation must be provided for in the regulations. To improve the work of the supervisory board, it is necessary to establish the procedure by which the supervisory board performs evaluation and elimination the identified shortcomings. The purpose of these documents is to ensure that the decisions taken by the board are reasoned and based on up-to-date information.

 8. Determination of the remuneration of the members of the supervisory board and       the board

A problem. Competitive remuneration, undoubtedly, allows to attract the best specialists and motivate for long-term cooperation. At the same time, to avoid the risks of commercial bribery or economically unreasonable decisions, it is necessary to consider the principles of determining the remuneration of the board and supervisory board. Over time, cash pay can become an insufficient motivator for work, so consideration should be given to modifying the elements of pay by granting bonuses - paid travel expenses, health insurance, various allowances. The reasonableness of the amount of remuneration allows investors to ascertain how the company's funds are directed and how active the board and the supervisory board are in performing their duties.

Solution. Development of the remuneration policy of the Supervisory Board and the Management Board, taking into account the company's field of activity, strategic goals, and long-term interests. The remuneration policy defines the elements of remuneration - fixed and variable remuneration, additional benefits, etc. types of remuneration -, the procedure for granting the elements of remuneration, the procedure for evaluating the personal contribution, the methodology for evaluating the work of the board and supervisory board to determine the remuneration to be granted has been determined. Looking at long-term development, the company may consider the introduction of staff shares or stock options, thus motivating executives or the board to maintain loyalty to the company.

Development of the company's anti-corruption policy - especially relevant in the construction, insurance, and other widely used services sectors. The policy sets out prohibitions on offering or accepting any benefits, provides a reporting mechanism for violations, and establishes procedures for detecting and investigating potentially corrupt practices. To ensure the correct use of the company's funds, it is also important to anticipate the nature of the gifts that can be given to customers and business partners, as well as the persons responsible for the implementation of these requirements. To make the board, supervisory board, and staff aware of the importance of the threat of corruption, regular training should be considered to review the most common risk situations.

 9. Prevention of conflicts of interest

 A problem. The often-heard phrase “the world is small” also applies to cases where the board or supervisory board has to consider an issue that unexpectedly affects the personal or property interests of a decision-maker: relationship with a family member, business partner, opponent in litigation, etc. Conflicts of interest affect the work of the board and council because the decision-making process no longer ensures objectivity - trust is lost, in more severe cases it affects the company's reputation or even financial performance. To address the problem before it arises, good corporate governance practices encourage the development of criteria for identifying conflicts of interest and dealing with them if they are identified.

Solution. Development of conflict-of-interest prevention and management policy. The policy identifies situations where there is a risk of conflict of interest depending on the company's industry, develops basic principles to prevent the possibility of risks occurring, and an action plan for identifying conflicts of interest. Where a conflict has been identified, the policy should set out the responsibilities of those responsible for managing and preventing the situation, including restrictions on the flow of information and confidentiality considerations. It is important to note that depending on the company's field of activity, different conflict of interest management measures may also differ - it is affected by the number of resources to be invested, the risk of foreseeable reputational risk, and other circumstances.

 10. Decision making of shareholders

 A problem. In large companies, it is important to ensure that their owners (shareholders) are informed about the developments in the company, financial position, current issues. Active participation of shareholders in the discussion of decisions facilitates additional supervision over the work of the board and council. Due to the limitations of COVID-19, the organization of shareholders' meetings at a distance is becoming increasingly applicable. It should be noted that by last year's amendments to the Commercial Law, the Articles of Association may provide for the right of participants to participate in meetings by electronic means, vote before the meeting, or stipulate that meetings of shareholders take place only in an electronic environment.

Solution. Improvement of the rules of procedure of shareholders' meetings, supplementing the articles of association with the possibility to participate and vote in meetings using electronic means of communication. When drawing up the rules of procedure, it is necessary to determine the issues on which the shareholders will decide at the meeting and to provide for the procedure for convening an ordinary or extraordinary meeting. For the meeting to run smoothly, arrangements should be made for drawing up and sending the agenda, including the obligation to provide information in good time and the possibility of requesting additional information. The Rules of Procedure determine the procedure for voting and counting votes, voting restrictions.

 11. Dividend policy

 A problem. Often, companies do not have a well-thought-out and transparent profit-sharing model, which is especially important for investors to feel safe and to ensure regular dividend payments to owners, while not forgetting the achievement of short-term and long-term business goals.

When planning the company's long-term strategy, it is important to anticipate certain conditions, under which the profit will be distributed or invested in further development.

Solution. Development of a dividend payment policy for determining the action strategy with the company's profit, taking into account the company's short-term and long-term goals, financial and market situation, industry, as well as investment plans. The policy should determine the procedure for calculating the number of dividends to be paid, how the decision on their payment is made, as well as the method when dividends are to be paid. Policy development will also avoid mutual shareholder disputes.

 12. Transparency of information

 A problem. Corporate openness or transparency provides significant confidence in the company's operations not only to the public and business partners but also to potential investors. Transparency starts with making the necessary information available to employees and continues with the public availability of annual reports, internal policies and procedures, and the basic principles for determining the compensation of the board and council.

Information creates the image of a company in the eyes of the public and investors, so it is important to add that this image can be affected not only by published information but also by employees, board or supervisory board members in the public environment - to avoid controlled disclosure, which someone may interpret differently, damaging the company's reputation.

Disclosure should align the alert framework for the protection of employees or other persons related to the company who have disclosed potentially infringing information about the company's activities to third parties.

Solution. The development of information circulation, confidentiality, and openness policy will help to categorize information, manage and control its circulation in the company. The policy includes such issues as the procedure for receiving, classifying, and storing information, the procedure for the circulation of internal and external information, and the measures to be implemented for the protection of information and data. It is important to indicate the methods used by the company to ensure quality control, its operational vision, values, and expected liability for violations. Trust to confidentiality requirements, in turn, will strengthen the trust of customers and partners in the work of the company, as it will determine how the information obtained is processed and protected and who is entitled to access it.

The development of a trade secret protection policy allows the company to ensure that the circulation of information containing trade secrets is carefully controlled. The policy will define the information that will be considered a trade secret in the company, set out safeguards, responsibilities, and rights of employees, the board, and the council when working with data containing trade secrets or terminating employment, and provide for liability for illegitimate disclosure.

Development of an alert policy for the protection of whistleblowers and secure reporting. The policy should specify the circumstances in which the person may report, to whom the report of the whistleblower is addressed, what legal protection measures are to be taken, as well as the liability if the data of the whistleblower is disclosed to third parties.

 13. Corporate social responsibility

 A problem. Although profitability continues to be the comprehensive goal of businesses, new trends have emerged in the current understanding of the company's role in implementing socially responsible policies. The concept of corporate social responsibility requires a company to contribute to the protection of the environment or the public interest in its field of activity, for example by choosing more environmentally friendly technologies, supporting diversity in the team, implementing various inclusive initiatives, or supporting specific groups in society. A socially responsible company is valued not only by employees and customers but also by partners and potential investors. In the digital age, the public image of a company must be created with particular care, so the implementation of the basic principles of social responsibility is a valuable tool for achieving long-term goals.

Solution. Development of Diversity Policy and Sustainability Policy - ensuring the increase of the company's value and promoting the achievement of strategic goals, the observance of the basic principles of corporate social responsibility in the company should be considered. When developing these policies, they determine how the work in the company (remote / office / mixed) is organized, what requirements are observed in the communication between the management and the employees, how the employee selection process takes place, observing the prohibition of different treatment. It is important to identify those responsible who will promote diversity and tolerant attitudes in the workplace. The Sustainability Policy will identify those socially important areas that are affected by the company's day-to-day work, such as defining environmentally responsible behaviour (saving electricity, water, or paper), setting preconditions for participating in charitable activities, or providing support to vulnerable groups.

 14. Compliance with data protection requirements

 A problem. Personal data, known as the currency of the future, has reached an unprecedented level of protection at the European Union: no category of personal data may be processed unless there is a legal basis for processing it. Strict regulations and requirements are often a cause for concern, as data must be passed on to a partner outside the EU, attacks on technical devices occur, or mistakes are made. The data protection authorities of the Member States have been harsh in their decisions, imposing fines of up to several million euros for non-compliance with data protection requirements.

Solution. Development of personal data processing policy, preparation of employee privacy statement - to protect data provided by customers, employees and business partners, each company must develop and periodically update the existing data processing policy to determine data collection, transfer, and other activities, while avoiding possible breaches.

 15. ​The business partner research process

 A problem. Researching potential business partners is one of the most important steps on the way to a successful transaction. Verification of information is a common procedure in other areas as well - both when opening a bank account and applying for a job - so the research of a potential partner will also provide a comprehensive insight into financial indicators, structure, quality of services or goods and other aspects. For companies operating in the financial sector, research on business partners is an even more important process, as incorrect research can have adverse consequences: reputational risk or even the risk of loss.

Solution. Development of business partner research policy - to prevent potential reputational and security threats, when initiating and continuing relationships with business partners, information analysis and compliance of identified risks with the company's long-term strategy must be performed. The policy will specify the information resources from which information on counterparties can be obtained, the impact of the identified risks on the conclusion of transactions, and the action to be taken if the information obtained does not allow the assessment of potential risks.

Conclusions

Summarizing the problems set out in the guide for the implementation of corporate governance principles and the proposed solutions, corporate governance is a diverse set of activities that provide opportunities for development and increase the value of the company according to the company's industry, size of management institutions, and other factors.

Achievement of strategic goals takes place through the effective management of various processes: from decision-making and implementation monitoring to comply with the basic principles of social responsibility and risk management. To ensure that the principles of corporate governance are not just abstract ones, internal policies and procedures are useful, which determine the procedures for the performance of various activities, the responsibilities of employees, board and council members, and ensure the effective implementation of internal processes.


[1] G20/OECD Principles of Corporate Governance. Available here:  https://www.tm.gov.lv/lv/media/2425/download 

[2] Corporate Governance Code. Available here: https://www.tm.gov.lv/lv/media/4138/download 

Source: Forbes Latvia.