What is the history of corporate governance and why does governance matter? In this guide we examine the history of corporate governance, how it developed in various countries and why good governance matters.
The topic has several milestones worth our attention because they have shaped the business world as we know it today.
Before we go any further, let’s define: corporate governance involves all the systems influencing a company’s direction – all the processes, structures and mechanisms.
In some ways, the concept had existed since the dawn of modern corporations – around the 17th century, when European powers began to exert their dominance worldwide.
In other ways, corporate governance is new, because the modern idea only emerged in the latter part of the 20th century. It is this idea that this article will focus on, and we can reduce its history to a few key takeaways:
- It is generally accepted to have begun in the United States during the 1970s.
- Lawmakers have often increased its importance in their drive to avoid economic crashes and large-scale business scandals.
- Such growth has repeatedly been interrupted by periods of pushback, particularly from fiscal conservatives and proponents of laissez-faire economics.
- Legislation around corporate governance has coalesced into national “codes” that act as corporate governance rulebooks.
That “1970s” beginning point might seem odd. How could this vital business concept have been born so late in the game?
Part of the answer is that corporations have always undergone some form of governance, but nothing compared to modern times’ level of control and oversight. Now, governments, consumers, and corporate culture care a lot about ensuring that companies live by a strict system of laws and practices.
Looking to the future, it is doubtful that this drive for more accountability will fade.
How did corporate governance start?
The modern iteration of corporate governance started in 1970s America – when authorities began to care more about the inner workings of some of the country’s biggest companies. Most of these companies had spent the previous two decades enjoying enormous success in the markets, with little legal oversight, while their boards largely went along with management decisions.
Corporate governance was born in this environment, and the Securities and Exchange Commission (SEC) – the country’s market watchdog – led the efforts to develop it.
Although the SEC had been in operation since the 1930s, it was only forty years later that it began clamping down on what it deemed foul play in the markets and boards that were “asleep at the wheel” while it was occurring.
Reform through legislation began from that point on. In the 1980s, it endured a backlash from Reagan-aligned opposition, who didn’t want this regulatory reboot. Legal and economic scholars joined them as they thought more research was needed to develop a comprehensive package of rules to govern companies.
From the 90s, investors and shareholders finally began to care more about the companies they worked with. After the 2008 economic crash, that attention grew again. Suddenly, everyone wanted answers on how businesses behaved and how they made internal decisions.
That level of attention has continued to grow to this day.
Corporate governance outside the US
Elsewhere in the world, things have evolved a little differently, although many other countries have considered the US an early example.
Another notable example is the United Kingdom. Because while the US was the first to place importance on good corporate governance, the UK was arguably the first to get to the nitty-gritty. In other words, it sought to answer the question, “how do we make companies behave themselves?”
The UK was the first country to introduce a detailed corporate governance “code”, and it has been copied and adapted in many countries across the globe since.
In the early 90s, a string of corporate scandals prompted the government to commission a report – dubbed the Cadbury Report – which contained the framework for a new set of rules.
The code was fully launched in 1998 and was the first to include the “comply or explain” concept, which has been copied in other national codes since. “Comply or explain” requires companies to adhere to the law, and if they don’t, they must explain why in writing.
Lawmakers hoped that his policy would enforce a more rigorous standard of corporate governance in the UK and prevent high-profile scandals from happening again.
Elsewhere in Europe, attention began to fall on corporate governance in the early 2000s – but it failed to stop the high-profile losses of the late-2000s recession. Increasingly, as the EU becomes more centralised in regulating markets, the rules for corporates within the bloc are becoming stricter.
What did early corporate governance look like?
Early corporate governance culture had a lot of hope but little follow-through.
By the 1970s in America, officials had realised that reform was needed to steer corporations away from cheating the marketplace, but by and large, they hoped that this problem would sort itself out. The only input that authorities would have in the meantime was encouragement.
Throughout this period, businesspeople (and lawmakers) jealously defended the right of corporations to pursue a more laissez-faire business model. They wanted to make their own business decisions independently of government oversight.
The early days did produce some critical milestones in America, however. The Protection of Shareholders Rights Act 1980 introduced, for the first time, a minimum standard for large public companies – making rules for independent boards, thorough audits, and safeguarding shareholders’ rights.
The first corporate governance codes
- 1998 – The United Kingdom. Introduced after years of review and building on the work of the Cadbury Report. This code served as a template for others and pioneered essential principles like “comply or explain”.
- 2000 – India. One of the earlier adopters of a corporate governance code came following the work of the “Birla Committee” – set up to improve standards in corporate governance that existed at the time. The Indian code was influenced heavily by its British counterpart.
- 2002 – The United States. Introduced party in response to the high-profile bankruptcies of telecoms company WorldCom and energy and commodities firm Enron.
- 2002 – Australia. The Australian government has updated it several times, mostly due to financial scandals.
- 2003 – Canada. Canada’s law was passed to complement the American version and was heavily influenced by it.
- 2015 – Japan. Established by the Tokyo Stock Exchange.
The EU has no corporate governance code defined in legislation, instead relying on directives for this kind of guidance. Directives, essentially, are a level down from laws. They set out requirements, but the responsibility for introducing legislation to enforce them lies with member states.
Some European examples of this include:
- 2002 – Germany, after the nation’s second-largest construction company Phillip Holzmann filed for bankruptcy in a major corporate scandal.
- 2010 – Spain.
- 2014 – Ireland, upon the passing of the Companies Act.
Why is corporate governance necessary now?
Corporate governance has grown thanks to expanded codes, more rigorous legislation, and a general shift in marketplace culture.
Far from the early days of the 1970s, now there are stakes, and they are here to stay. This means that if a firm fails to, or in some cases chooses not to, act in the name of good corporate governance, its decision could have catastrophic effects.
It’s a simple chain reaction: bad corporate governance creates an environment of poor ethical decisions, which will land the firm in hot water. Once a company starts going down this road, it’s a question of “when”, not “if” trouble will occur.
Is corporate governance more important now than ever?
Yes – plain and simple. There are several reasons for this:
- The amount and severity of corporate scandals, bankruptcies, and financial penalties against corporations are not decreasing. Government pressure to do well is mounting, and public scrutiny is right alongside.
- Legislation mandating corporate governance is being expanded and is increasingly cross-border in focus.
- COVID-19, the Russian invasion of Ukraine, and the global supply crisis have all created a tremendously uncertain environment where investors are screaming for clarity and safety.
- The rise in importance of Environmental, Social and Corporate governance (ESG) – which essentially requires companies to care about goals besides profit – demonstrates that the world values corporate integrity, and wants to maintain that priority in future.
Corporate governance is a standard on which businesses will be judged. Those judging are also those who can provide funding and business, so it’s a simple choice: please them and survive, or don’t and face bankruptcy.
What can happen if things go wrong?
Much of the legislation and codes above were rolled out in response to big scandals – in other words, the worst examples are what fuel the strictest laws. This alone should be enough for companies to realise the importance of good corporate governance.
Not following governance codes, getting lax, boards falling asleep at the wheel – not only could these land a company in trouble with lawmakers, but it can also seriously harm their business prospects.
Examples of when things went wrong:
2002 – WorldCom. Already mentioned, many accept this scandal as the main reason the US launched its corporate governance code a short time later.
Essentially, this long-distance telecommunications company (the second largest in America in the early 2000s) was forced to “re-state” its corporate earnings for the five previous quarters in a row, leaving a hole of approximately $3.8 billion.
This massive gap was intentional – perpetrated by senior management, using complex accounting techniques to hide losses so that they could meet their Wall Street targets. Internal accountants, in conjunction with external auditors at KPMG, eventually discovered what they had been doing.
By the time the board grasped the gravity of the situation, it was too late. The company was already struggling with poor credit ratings and piling debt. It ultimately announced it would lay off 17,000 employees and file for bankruptcy.
WorldCom survived, albeit under a new name of MCI, and was subsequently acquired by Verizon in 2006.
2014 – Tesco. It is one of the biggest supermarket chains in the UK and Ireland, but in 2014, the organisation tumbled into chaos over misleading accounts, which the board failed to supervise appropriately.
That year, it was discovered that the company had “artificially” inflated its recorded profits by £263 million to make itself more attractive to investors.
After the discovery, four senior executives were suspended from the company, accounting firm Deloitte and audit company PwC also came under scrutiny for their roles, and the Tesco board had to wipe £2 billion away from the company’s value.
2019 – WeWork. WeWork is a lesson in how not to manage one of the most pivotal moments in a startup’s lifespan. The company – a provider of co-working spaces – aimed to go public in 2019, but was forced to cancel this plan a short time later.
Ahead of going public, the company was valued at around $47 billion, on the back of several investment rounds and years of business. Around this time, WeWork filed a public prospectus, showing potential buyers the company’s financial state.
This document is supposed to provide reassurance and entice investors, but WeWork’s 2019 document did the opposite – spooking buyers by revealing a string of financial losses. It cast severe doubts over the $47 billion price tag.
Critics condemned the company, primarily for its poor corporate governance record and how it impacted WeWork’s ability to make even tiny profits.
Ultimately, the company had to cancel its plans to go public, while co-founder and CEO Adam Neumann resigned.
Corporate governance may have come late in the game compared to the companies themselves, but decades of history have shown that its importance will only grow.
The concept has won the attention of investors, consumers and politicians alike – largely thanks to a string of financial scandals: the shining examples of what can happen if corporate governance doesn’t exist.
These stakeholders are eager to prevent these types of scandals in future, and they are now going further than ever to ensure this is a reality.