{"id":45779,"date":"2023-08-20T12:33:46","date_gmt":"2023-08-20T12:33:46","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=45779"},"modified":"2026-03-18T11:33:06","modified_gmt":"2026-03-18T11:33:06","slug":"corporate-governance-and-mechanisms-to-manage-shareholder-relationships","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/corporate-governance-and-mechanisms-to-manage-shareholder-relationships\/","title":{"rendered":"Corporate Governance and Mechanisms to Manage Shareholder Relationships"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/corporate-governance-and-mechanisms-to-manage-shareholder-relationships\/#qapage-question-1\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/corporate-governance-and-mechanisms-to-manage-shareholder-relationships\/#question-1\",\n    \"name\": \"Which mechanism is most likely used by shareholders to promote good corporate governance?\",\n    \"text\": \"Which of the following is most likely a shareholder mechanism used to promote good corporate governance?\\nA. Bond indenture.\\nB. Employment contracts.\\nC. Shareholder derivative lawsuit.\",\n    \"answerCount\": 1,\n    \"author\": {\n      \"@type\": \"Organization\",\n      \"name\": \"AnalystPrep\"\n    },\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/corporate-governance-and-mechanisms-to-manage-shareholder-relationships\/#answer-1\",\n      \"text\": \"C. Shareholder derivative lawsuit. A shareholder derivative lawsuit allows shareholders to bring legal action against a company\u2019s directors, management, or controlling shareholders to address misconduct and promote good corporate governance.\",\n      \"author\": {\n        \"@type\": \"Organization\",\n        \"name\": \"AnalystPrep\"\n      }\n    }\n  }\n}\n<\/script>\n\n\n\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/ItdqLrUGIXQ\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>An appropriate corporate governance structure considers the rights, responsibilities, and powers of each stakeholder in a corporation, whilst meeting the corporation\u2019s objectives.<\/p>\n<h2>Corporate Reporting and Transparency<\/h2>\n<p>The principles of governance are fundamentally based on corporate reporting and transparency.<\/p>\n<p>A company\u2019s external shareholders can gain financial and non-financial information through annual reports and other company disclosures.<\/p>\n<p>Investors can obtain a wide range of financial and non-financial data of a publicly traded company through various sources such as annual reports, proxy statements, corporate disclosures, and investor relations resources. This information encompasses details about the company&#8217;s operations, strategic goals, audited financial reports, governance framework, ownership configuration, compensation strategies, transactions with related parties, and associated risks.<\/p>\n<p>Unlike public companies, private companies disclose information only to the extent required by regulations or voluntarily. They, however, disclose their information confidentially to their investors.<\/p>\n<p>Specifically, investors utilize corporate reports and information for the following purposes:<\/p>\n<ul>\n<li>To evaluate the performance of a company as well as that of its directors and managers.<\/li>\n<li>To make decisions regarding valuation and investments.<\/li>\n<li>To cast votes on crucial corporate issues or changes.<\/li>\n<li>To verify adherence to legal obligations stipulated in debt agreements through an intermediary called a trustee (who is hired to report and manage bondholders\u2019 payment administration.<\/li>\n<li>To verify adherence to legal obligations stipulated in debt agreements through an intermediary called a trustee (who is hired to report and manage bondholders\u2019 payment administration.<\/li>\n<\/ul>\n<h2>Shareholder Mechanisms<\/h2>\n<p>Shareholders are motivated to protect their legal and contractual rights through various procedures, some of which are discussed below.<\/p>\n<h3>Shareholder Meetings<\/h3>\n<p>General meetings allow shareholders to participate in company-related discussions and vote on significant corporate matters.<br \/>\nCompanies usually hold an annual general meeting (AGM) within a certain period after the end of their financial year. The primary purpose of an AGM is to present shareholders with a company&#8217;s annual audited financial statements, provide an overview of a company&#8217;s performance over the year, and address any shareholder concerns.<\/p>\n<p>A company or its shareholders can also convene extraordinary general meetings (EGMs) within the year. This should happen whenever significant resolutions requiring shareholder approval are proposed.<\/p>\n<p><strong>Proxy voting<\/strong> allows shareholders who cannot attend a general meeting to authorize someone else to vote on their behalf. It is the most common form of investor participation in meetings. Minority shareholders tend to use proxy voting in an attempt to increase their influence in companies.<\/p>\n<h3>Shareholder Activism<\/h3>\n<p><span style=\"color: initial;\">Shareholder activism techniques (which include proxy fights to pressure management, proposing shareholder resolutions, and publicizing issues of dispute) may be employed to force a firm to act in a desired way. Shareholder activism\u2019s primary goal is to increase shareholder value relatively quickly.\u00a0<\/span><\/p>\n<h3>Shareholder Litigation<\/h3>\n<p>Shareholders can also employ lawsuits. One common type is shareholder derivative lawsuits. <strong>Shareholder derivative lawsuits<\/strong> are legal actions brought by one or more shareholders against the board of directors, management, or controlling shareholders. The plaintiff shareholder in these actions is deemed to be acting on behalf of the company in lieu of its directors and officers who have failed to act appropriately in the interest of the firm and its shareholders.<\/p>\n<h3>Corporate Takeovers<\/h3>\n<p>Corporate takeovers are scenarios in which shareholders of a company hire and fire management to achieve better resource utilization. They can be pursued through a <strong>proxy contest\/fight<\/strong> where shareholders are persuaded to vote for a group seeking a controlling position on a company&#8217;s board. Alternatively, a <strong>tender offer<\/strong> strategy can be employed. In this case, shareholders sell their interests directly to the group seeking company control. Lastly, a <strong>hostile takeover<\/strong> can be resorted to. This refers to an attempt one company makes to acquire another company without the consent of the other company&#8217;s management.<\/p>\n<p>A company can adopt anti-take-over mechanisms that increase takeover costs, thereby reducing the likelihood of a takeover. These mechanisms include staggered board elections and poison pills, Staggered board elections prevent shareholders from replacing the whole board at any given time. Poison pills, also called shareholders rights plan, make it possible for shareholders to purchase additional shares at a discount if another shareholder buys a certain percentage of a company\u2019s shares.<\/p>\n<h2>Creditor Mechanisms<\/h2>\n<p>Creditors use many mechanisms to protect their interests in a company. These include:<\/p>\n<ul>\n<li><strong>Bond indenture<\/strong>: This legal document outlines the components of a bond, a company&#8217;s responsibilities, and bondholders&#8217; rights.<\/li>\n<li><strong>Creditor committees<\/strong>: Once a corporation declares bankruptcy, creditor committees are constituted to represent bondholders throughout the bankruptcy process. Their primary role is to safeguard bondholder interests in any restructuring or liquidation. In cases where a company fails to meet its obligations as stipulated in the bond indenture, bondholders may form an Adhoc committee tasked to present the company with potential options to restructure their bonds.<\/li>\n<\/ul>\n<h2>Board of Directors and Management Mechanisms<\/h2>\n<p>Company shareholders elect a board of directors to provide oversight. The board appoints the top management, is held accountable by shareholders, and is responsible for the overall governance of the company.<\/p>\n<h3>Board Committees<\/h3>\n<p>The boards assign specific tasks to committees usually compossed of some of the board members. The core committees include an audit committee, a nominating or governance committee, and a compensation or remuneration committee.<\/p>\n<p>The committees are in charge of considering, monitoring, and acting on issues related to their competence. A committee regularly reports to the board and makes recommendations of things that fall under their mandates. The three core committees are discussed below.<\/p>\n<ul>\n<li><strong>Audit committee<\/strong>: The appointment of external auditors, as well as the implementation of high-quality accounting principles, are all overseen by the audit committee. In addition, this committee ensures the accuracy of the financial statements. According to best practices, an audit committee should comprise of independent board members, with at least one having accounting or financial management expertise.<\/li>\n<li><strong>Remuneration or compensation committee<\/strong>: This committee focuses on issues related to compensation. Such issues include defining director and executive remuneration policies, managing the administration, and assessing performance policies. Further, this committee establishes human resources policies regarding employee compensation.<\/li>\n<li><strong>Nomination\/Governance committee<\/strong>: It oversees director and manager nominations and elections, identifies candidates for senior leadership positions, and maintains the makeup and independence of a board of directors. It is also concerned with the process of nominating and electing board members.<\/li>\n<\/ul>\n<h3>Additional Committees<\/h3>\n<p>Other committees include risk committees, investment committees, and other industry-specific committees.<\/p>\n<ul>\n<li><strong>Risk committee<\/strong>: It helps the board identify a firm&#8217;s risk profile and appetite and ensures an organization has a suitable enterprise risk management system and coordinates corporate operations with risk appetite.<\/li>\n<li><strong>Investment committee<\/strong>: It examines and assesses the viability of the vital investment options suggested by the management.<\/li>\n<\/ul>\n<h2>Employee Mechanisms<\/h2>\n<p>By managing employee relationships, employers can ensure that their staff members act in the business&#8217;s best interests, meet their obligations to the organization, and have the requisite motivation to serve in their roles efficiently.<\/p>\n<h3>Labor Laws<\/h3>\n<p>The rights of employees are primarily secured through labor laws. Labor laws define the standards for employees&#8217; rights and responsibilities. The laws cover working hours, pension plans, hiring and firing practices, and vacation and leave entitlements. Unions seek to influence certain matters that affect employees&#8217; well-being in their jobs.<\/p>\n<h3>Employment Contracts<\/h3>\n<p>Employment contracts specify an employee\u2019s rights and responsibilities. However, they do not cover every situation between employees and employers.<\/p>\n<p>Effective human resource policies seek to attract and recruit high-quality employees. To improve employee retention, such policies provide remuneration, training or development, and career growth prospects. Employee Stock Ownership Plans (ESOPs) are also used to retain and motivate employees.<\/p>\n<p>Companies sometimes use Codes of Ethics and business conduct to establish their values and standards of ethical and legal behavior that employees are expected to follow.<\/p>\n<h2>Customer and Supplier Mechanisms<\/h2>\n<p>Customers and suppliers of a firm enter into contracts that define the goods and services that underlie the relationship, the costs and terms of payment, the rights and obligations of each party, and any guarantees. Contracts also outline the steps to be followed and available options in the event of a contract breach.<\/p>\n<h2>Government Mechanisms<\/h2>\n<h3>Laws and Regulations<\/h3>\n<p>Governments and regulators create regulations that businesses must abide by. In addition, governments keep track of how well the regulations are being followed. A stricter regulatory framework is applied to industries whose services and goods are more likely to put the public at risk (for instance financial services, healthcare, and agriculture industries).<\/p>\n<h3>Corporate Governance Codes<\/h3>\n<p>Numerous regulatory bodies have implemented corporate governance codes comprised of guiding principles for publicly listed firms. These codes mandate companies to either reveal their compliance with the suggested corporate governance practices or provide reasons for non-compliance, a method known as the \u201ccomply or explain\u201d approach.<\/p>\n<p>For instance, in Japan, companies without external directors must justify why the appointment of such directors is not suitable.<\/p>\n<blockquote>\n<h2>Question<\/h2>\n<p>Which of the following is <em>most likely<\/em> a shareholder mechanism used to promote good corporate governance?<\/p>\n<ol type=\"A\">\n<li>Bond indenture.<\/li>\n<li>Employment contracts.<\/li>\n<li>Shareholder derivative lawsuit.<\/li>\n<\/ol>\n<p><strong>The correct answer is C<\/strong>.<\/p>\n<p>A shareholder derivative lawsuit is a shareholder mechanism used to promote good corporate governance. These are legal actions brought by one or more shareholders against the board of directors, management, or controlling shareholders.<\/p>\n<p><strong>A is incorrect<\/strong>. Bond indentures are credit mechanisms a company&#8217;s creditors use to protect their interests in a company. It is a legal document that outlines the components of a bond, a company&#8217;s responsibilities, and bondholders&#8217; rights.<\/p>\n<p><strong>B is incorrect<\/strong>. Employment contracts are employee mechanisms used by employees to promote good corporate governance. They specify an employee&#8217;s rights and responsibilities in a company.<\/p><\/blockquote>","protected":false},"excerpt":{"rendered":"<p>An appropriate corporate governance structure considers the rights, responsibilities, and powers of each stakeholder in a corporation, whilst meeting the corporation\u2019s objectives. Corporate Reporting and Transparency The principles of governance are fundamentally based on corporate reporting and transparency. 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