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The Governance Loop: Protecting Stakeholder Interests

David McNamee, CIA, CISA, CFE, CGFM, FIIA(M))

In restructuring, re-focusing and reengineering modern organizations, it is sometimes useful to have a map of the important strategic relationships before reconstruction begins. An important strategic planning step for the organization going through transformation is to understand the concept of corporate governance.

Corporate governance is one of those terms that most managers use but few can define precisely. Corporate governance is about how the organization achieves its purpose. It involves the meaning of organizations and how organizations fulfill their purpose. It has elements of leadership, stewardship, ethics, security, vision, direction, influence, and values. Corporate governance is about protecting stakeholder interests in the organization.

Organizations are groups of diverse elements (people, assets, ideas) that are held together by a shared purpose. The organization exists to achieve its purpose: to deliver something of value to its customers or constituents. Customers have needs to be met, and organizations are a means of organizing the diverse elements required to meet those needs efficiently and effectively.

There are certain differences between for-profit organizations and not-for-profit and government organizations, but these differences are smaller than the similarities that they share as organizations of diverse elements with a common purpose. All forms of organizations exist to serve a purpose of creating value to meet the expressed or perceived needs of their customers. For-profit organizations have an additional complexity in the concept of ownership interests. Ownership is a common trait of all organizations, but it is more forceful in for-profit ones.

One of the ways managers can come to grips with corporate governance concepts is through a model such as the Governance Loop. The Governance Loop is a model of the factors and forces involved in corporate governance. It begins with the basic Wealth Loop. Customers have needs, and the organization attempts to fulfill those needs by developing plans and allocating resources to provide goods and services to meet those needs.

Leaders (Senior Management and the Board) provide Plans that organize and allocate resources for the Organization (Staff) to use to provide Benefits in the form of goods and services to Customers, who in turn provide Funds to keep the loop going. This is the simple version of the Wealth Loop with only three stakeholders (Leaders, Organization and Customers). This form ignores external influences or ownership, so it is useful only as a starting point for discussing the many relationships that make up "corporate governance."

The Wealth Loop at this stage does not provide Leaders with information upon which to formulate future plans, except in the form of current receipts from sales of product. To increase management effectiveness (a form of corporate governance), internal feedback loops are built to measure overall value by measuring both the efficiency with which plans are converted to goods and services (costs) as well as the effectiveness (how well the benefits meet needs) perceived by customers. The feedback loops in the Simplified Governance Loop are monitored by Auditors.

In response to Customer needs, Leaders provide Plans that organize and allocate resources, the Organization creates Benefits in the form of goods and services, and the Customer provides Funds in exchange for the Benefits. Except at this stage, feedback loops are installed to help management control the process for greater efficiency and effectiveness. Plans can be adjusted to changes in Customer needs or changing cost patterns (or both). The value of the enhanced corporate governance structure is that it provides the entity with guidance. This entity (Figure 2) is more likely to thrive and survive than taht represented by the simple Wealth Loop in Figure 1.

The entity does not exist in a vacuum, and corporate governance involves more than the entity's wealth-creating loop. Outside interests also have an effect on corporate governance.

Owners (including holders of both equity and debt claims) provide the resources through shares and loans to finance the entity. In return, they receive wealth in the form of dividends, interest, and increased share price. Corporate governance must include this relationship in order to protect the interests of the owners and the vital flow of finance to the entity.

Suppliers/Unions (including suppliers of labor and contract employees) provide the purchased goods and services. Their interest in the entity is one of supplier to customer. Corporate governance must recognize the interest in ensuring a smooth supply of purchased goods and services at the appropriate prices. The entity must also take into consideration what information should be shared to make the relationship more worthy to both. Corporate governance establishes the relationship between the two so that neither is unfairly disadvantaged

Regulatory/Government interests provide laws and regulations governing the owners, the suppliers, and the entity. These restrictions and inducements are significant influences to all. Corporate governance must include the legal compliance issues mandated by regulatory, taxing, and other government authorities.

Community Interest is influenced by citizens as consumers of goods and services, but the greater community interest also provides a profound influence on the operations of the entity in the community. Corporate governance includes ways to take into account the prevailing community mores.

Any of these other "loops" could be explored with some insights gained:

The Owner's Loop: The appropriate relationship (or possible relationship) of the Owners to the rest of the entity. What is the extent of influence possible in widely held public entities, and do various classes of owners, such as mutual funds vs. individual investors or holders of debt vs. holders of equity, have a different relationship with the entity? Are these differences justified?

The Regulatory/Government Loop: The appropriate relationship and how that should be manifested between Government and the Owners (or entity through the Owners) as influencers of Government. Likewise, the appropriate relationship between Government and those that may peddle influence on behalf of suppliers or trades unions could be explored. Do some entities have a disproportionate share of influence in making or enforcing regulations or influencing the course of government?

The Community Interest Loop: How the entity interacts with the community and how the community influences the entity's operations. How does the entity value the community interest and factor that value into management planning? Does the entity have a disproportionate influence on local government bodies?

These are some of the interesting questions that can be explored using a model of corporate governance as a framework. Corporate governance is a set of relationships and stakeholders. The essence of corporate governance is to protect these stakeholder interests in such a way as to achieve some balance that satisfies all interests.

In transforming the organization, a map of important strategic relationships is a key to success. Using a model such as the Governance Loop ensures that all significant interests will be considered in the strategic plan.