Speaker 1: Chapter 1 Corporate Governance Concepts The Basics of Corporate Governance Let's take a look at some important questions regarding corporate governance. We will start with, what is corporate governance? There are many definitions aimed at encapsulating the spirit of corporate governance. Corporate governance is simply described as the process by which organizations are directed and controlled in terms of authority, accountability, stewardship, leadership, direction, and control. Corporate governance is more comprehensively described as the framework by which a company's board of directors and senior management establishes and pursues objectives while providing effective separation of ownership and control. It includes the establishment and maintenance of independent validation mechanisms within the organization that ensure the reliability of the system of controls used by the board of directors to monitor compliance with adopted strategies and risk tolerances. Why is corporate governance important? The implementation and maintenance of strong corporate governance policies ensure that proper oversight is in place to hold the organization accountable to the standards, laws, and regulations that it should be abiding by. Effective corporate governance helps an organization to achieve its objectives and desired outcomes and fulfill its obligations through sound strategic and business planning, risk management, financial management and reporting, human resource planning and control, and compliance and accountability systems. Effective governance also helps provide a framework for establishing responsibility to all of the participants connected to the organization spanning clients, employees, and providers of capital. An effective corporate governance framework is essential to a banking organization's overall safety and soundness. How is corporate governance assessed? Assessing corporate governance can be classified into four general topic areas structure effectiveness, board supervision adequacy, management effectiveness, and adequacy of control functions. A three-tiered rating system of strong, adequate, or weak is commonly used to summarize the results of an assessment. A review of structure effectiveness targets the organizational structure through a top-down review of legal entities, individuals, and policies. More specifically, it focuses on how clearly roles, responsibilities, and lines of authority, as well as communication channels, are reflected in the legal structure of the institution. In addition, it considers the quality of the ethics policy and the code of employee conduct established by the board to guide the actions of management and employees on behalf of the institution. A review of the adequacy of board supervision focuses on elements that demonstrate the ability of board members to understand and oversee the activities of the organization. Board charters are reviewed to understand the legal requirements that are established for the board by the shareholders. The assessment of board committees focuses on how committees are structured, the quality of minutes, and most importantly, the quality, frequency, and timeliness of information flow to the full board. Given the importance, additional attention is placed on the activities of the audit and governance committees. The evaluation of board supervision adequacy also considers board members and their qualifications, the reasonableness of compensation practices, the quality and accuracy of board minutes and reporting, and the adequacy and frequency of training and self-assessments. And finally, a thorough review will focus on board member attendance. Evaluation of management effectiveness centers on management committee charters and activities and line of business metrics. In particular, the review of this area focuses on the qualifications of committee members, the scope of committee activities, and the flow of information to the board. Line of business management, through self-assessments and other reporting systems, can provide useful information to the board of directors regarding risk profile and valuable insight for setting strategy. So, for institutions managed by line of business, which are typically the more complex institutions, the quality of self-assessments was evaluated. As control functions provide an independent assessment of the quality of internal controls and risk levels, their effectiveness and relationship with the board is an important component of corporate governance. In this context, evaluation of the adequacy of control functions focuses on the efficacy of the internal audit, external audit, credit review, and compliance. A three-tiered rating system of strong, adequate, or weak is commonly used to summarize the results of an assessment. A strong rating reflects that for all or a significant majority of the characteristics reviewed for each element, the institution performed at the highest standards possible and no characteristics were rated weak. An adequate rating reflects an institution generally meeting expectations for each element but could have anywhere from one to a few instances where individual characteristics did not meet expectations. These shortfalls could be easily addressed in the normal course of business and would not be significant enough to adversely affect any supervisory ratings. A weak rating reflects the institution had one or more characteristics where there were serious shortfalls in meeting minimum expectations. These shortfalls would require significant efforts to correct and could negatively affect an institution's supervisory rating. Now that we have answered some basic questions about corporate governance, let's take a look at the role that banks play in world economies.