The entities to which the term “corporate governance” properly applies
Posted by Drew Shagrin,
Professor of Business Law at ESCP Business School
In the classroom last week, in a discussion of corporate governance, it became clear that something was confusing: the entities to which the term “corporate governance” properly applies. I shared the following thoughts with the students after the class session.
The several definitions of corporate governance that we discussed Friday collectively invoke systems, structures, mechanisms, people, relationships, practices, procedures, and rules, all in service of establishing and limiting power in an entity recognized to have legal personhood (that is, with the capacity to own property, enter into contracts, sue, and be sued). This announcement seeks to clarify lingering confusion about the entities to which the term “corporate governance” properly applies.
Governance exists for sovereign states, too. However, very few people would use the term “corporate governance” to describe the governance of states. We can reasonably exclude states from the list of entities whose governance is called “corporate governance.”
Sometimes, states cooperate with each other in a formal, enduring organization established to facilitate such cooperation. These intergovernmental organizations, sometimes called international organizations, are usually endowed with legal personality (again, with the capacity to own property, enter into contracts, sue, and be sued). Visible examples include the UN, the WHO, and the OECD, but hundreds of international organizations exist. Because these organizations bring states together in a non-state organization, the governance of these organizations is in part like the governance of a state and in part like the governance of a purely private entity. Correspondingly, the term “corporate governance” can reasonably be used to apply to much of the governance of such organizations. However, most of the time, people using the term “corporate governance” don’t have the UN, the WHO, the OECD, or similar organizations in mind. Most of the time, people use the term for purely private organizations.
But which purely private organizations in particular? Most frequently, users of the term “corporate governance” have in mind a particular kind of private organization, a profit-motivated business corporation. Some of these firms are publicly traded (or “listed”) on a stock exchange, while others are privately held. The listed firms are typically subject to a broader set of securities-related laws than privately traded firms, subjecting them to special corporate governance challenges that private firms don’t face. For that reason, publicly traded firms attract the most attention in discussions of corporate governance, but the term “corporate governance” is equally applied to privately held business corporations.
Whether privately held or publicly traded, some business corporations have staff and facilities in more than one country (“multinational business enterprises”). Their corporate governance challenges are made even more complex by the differences in corporate governance from one country to another. In contrast, purely domestic companies have the luxury of being affected by the corporate governance elements of just one country.
More generally, whenever we discuss corporate governance, we ought to be mindful of the country or countries about which we’re talking. Given the country-by-country differences in corporate governance, it’s not always appropriate to make general assumptions or assertions about corporate governance. It’s sometimes necessary to qualify an assumption or an assertion by referring to a specific country or set of countries.
The term “corporate governance” can be used not only for private profit-motivated business corporations, but also for other profit-motivated business entities endowed with legal personality and named, in their country, something other than “corporation.” For instance, in the United States and certain other countries, laws authorize the private creation of an entity called a “limited liability company” (or “LLC”) with characteristics, rights, and responsibilities that are different from those of a corporation. Despite the points of distinction between a US corporation and a US LLC, including their tax treatment (usually double taxation for a corporation and pass-through taxation for an LLC) and their governance flexibility (usually less flexible for a corporation and more flexible for an LLC), the points of distinction don’t alter the fact that a US LLC is sufficiently similar to a US corporation to justify using the term “corporate governance” for US LLC’s as well as for US corporations. One can’t assume that the term “corporate governance” applies only to entities that are literally called corporations in the countries where they’re formed. Correspondingly, it’s sometimes useful to qualify an assumption or an assertion by referring to a specific entity (like a US corporation or a US LLC).
The term “corporate governance” can be used not only for private profit-motivated entities, but also for nonprofit ones, too. In some countries, such as the US, the term “nonprofit corporation” is explicitly used to describe an association of persons coming together for a common not-for-profit purpose, but only if the association has been endowed with legal personality (again, with the capacity to own property, enter into contracts, sue, and be sued). Other countries use a different term to describe such an entity (such as the French term “association under the law of 1901”). Whether or not the term “nonprofit corporation” is used to describe such an entity, the fact that the US uses the term “nonprofit corporation” suggests that these entities are in at least some respects corporations. Indeed, apart from the existence or absence of shareholders, nonprofit corporations and profit-motivated business corporations are quite similar, and the term “corporate governance” is therefore broad enough to include the governance of nonprofit corporations. As a result, one can’t assume that the term “corporate governance” when used for private entities applies only to profit-motivated business entities. It’s sometimes useful to qualify an assumption or an assertion by referring to a specific sector (like profit-motivated or nonprofit). That said, the vast majority of uses of the term “corporate governance” refer to profit-motivated business entities.
Not all nonprofit associations have legal personality. Sometimes people associate for a common not-for-profit purpose but they don’t take the formal steps necessary to incorporate their association (to endow it with legal personality). In the US, their association would be called an “unincorporated association.” From this label we can infer that its opposite, “incorporated association,” is another US term for a nonprofit corporation, for an association of people who come together for a common purpose through a separate entity with legal personality. An unincorporated association may well have governance features, but just as we don’t use the term “corporate governance” to describe the governance of a state, it wouldn’t ever be appropriate to use the term “corporate governance” to describe the governance of an unincorporated association. If and when an unincorporated association is transformed into a corporate entity, into a legally recognized person separate from the association’s members, then at that point the term “corporate governance” would begin to apply.
Given the multiplicity of types of entity with legal personality across the world, an exhaustive review of all the entities to which the term “corporate governance” might appropriately apply would be, well, exhausting. It suffices to observe that the term “corporate governance” can appropriately apply to many disparate entities with legal personality.
And it follows from this observation that we—all of us–would be wise to specify the kinds of entity we have in mind whenever we discuss “corporate governance” as a subject. Sometimes we’ll use the term broadly, and sometimes we’ll have a narrower focus. Specifying the kind of entity we have in mind will reduce the risk of confusion. And when we’re listening to others talk about corporate governance, we can reduce the risk of confusion by asking about the specific kinds of entity that the speaker has in mind.