The business world has become increasingly complex as the 21st century ushered in a new era of globalization and interconnectedness. Corporations are going global, merging and buying other companies, and getting more attention from regulators.
Now, people expect businesses to do more than just make money; they also need to act ethically and be socially responsible. Their shareholders, employees, customers, and the communities where they do business hold them more accountable.
So, following legal compliance has become an important part of running a business. Let’s explore why.
Legal Compliance and Corporate Governance
What is Legal Compliance?
Legal compliance means that a business follows the rules, laws, and industry standards that affect how it does business.
Legal compliance in the business world means making sure that the company’s actions and procedures are in line with all applicable laws and regulations, both domestic and international laws. This includes federal, state, and local laws as well as rules that are specific to the industry.
Institutions dealing with legal compliance may include government agencies, industry associations, and independent regulatory bodies. For instance, a drug company must follow the rules set by the Food and Drug Administration (FDA) in the US and any other rules that apply in the countries where it does business.
What is corporate Governance?
Corporate governance is the set of rules, practices, and procedures that a business uses to be led and managed.
The goal of corporate governance is to make sure that the business is run in an ethical, transparent, and accountable way. It also seeks to safeguard the interests of every participant—including consumers, staff, owners, and the society.
Corporate governance is a system with several facets including board supervision, financial reporting and openness, risk management, and ethical guidelines.
The Three Key Areas of Corporate Governance
- Board Oversight
The board of directors is responsible for overseeing the company’s operations and ensuring that it is managed in accordance with legal requirements and ethical standards. They also decide the company’s long-term goals and make choices about risk management, financial reporting, and corporate social responsibility.
- Transparency and Disclosure
Transparency and disclosure refer to the company’s commitment to providing accurate and timely information to all stakeholders. Financial reports and details about the business’s rules, methods, and performance are all part of this. Transparency and disclosure are essential for building trust with stakeholders and maintaining a positive reputation.
- Accountability
Accountability is a fundamental principle of corporate governance. It refers to the responsibility that individuals and entities have for their actions and decisions. This entails accountability for the company’s ethical conduct, compliance with laws and regulations, and performance in a corporate environment. Businesses that place a high priority on accountability are more likely to develop an integrity-based culture.
Is There a Difference Between Legal Compliance and Corporate Governance?
Origin and Purpose
While legal compliance and corporate governance may seem similar, they have different origins and purposes.
Legal compliance is primarily driven by external factors like government regulations, industry standards, and societal expectations. Its primary objective is to guarantee that organizations adhere to the constraints established by legislation and regulations.
Corporate governance on the other hand is more internally driven. It is shaped by a company’s values, culture, and ethics. Its purpose is to promote responsible and ethical management of the company.
Overlap and Interdependency
While legal compliance and corporate governance have distinct origins and purposes, they are closely intertwined. One could contend that corporate governance includes legal compliance as a subset.
A strong system of corporate governance promotes legal compliance by setting ethical standards and ensuring accountability. Upholding sound corporate governance requires compliance with laws and regulations.
The Letter and Spirit of the Law
Legal compliance often focuses on meeting the letter of the law or simply following rules and regulations. Still, a company’s dedication to corporate governance should transcend simple legal compliance.
The spirit of the law is the fundamental ideas and values guiding rules, which businesses should also aim to respect.
For instance, a company might be legally compliant by paying the minimum wage criteria. It should also think about how to treat its employees in a fair and honest way as part of good corporate governance, .
Linking Legal Compliance to Corporate Governance
Internal controls and risk management are key areas where legal compliance and corporate governance intersect.
Internal controls are the procedures, policies, and systems a business implements to protect its assets and guarantee accurate financial reporting. These controls help companies comply with laws and regulations.
risk management involves identifying and mitigating potential risks to the company. This covers legal risks including non-regulating compliance.
A strong system of corporate governance encourages ethical behavior and responsibility inside the business, so supporting internal controls and risk management.
7 Reasons Why Legal Compliance is Critical to Corporate Governance
More than just aligning with legal requirements, legal compliance is a critical aspect of good corporate governance.
Consequences of Non-Compliance with Legal Regulations
A famous saying goes, “ignorance of the law is no excuse.”
Meta learned this the hard way when Ireland’s Data Protection Commission fined the company €1.2 billion in May 2023 for breaking the General Data Protection Regulation (GDPR). For violating the GDPR in the summer of 2021, Amazon in Luxembourg was also hit with a hefty €746 million fine.
These high-profile cases demonstrate the serious consequences of non-compliance with legal regulations. When companies fail to meet legal requirements, they not only face financial penalties but also risk damage to their reputation and loss of trust from stakeholders.
You may think that your company is too small to face such consequences. Even small businesses are subject to legal compliance with increased data privacy laws and regulations.
Protecting Company Reputation and Image
The success of a business is closely linked to its reputation and image. A single instance of non-compliance with legal regulations can have far-reaching consequences on a company’s brand perception.
Customers might stop trusting the business, which would mean less sales and money. Shareholders may also be hesitant to invest in a company with a bad reputation, which could cause them to lose money.
In the Volkswagen diesel emissions scandal, the company was caught cheating on emissions tests. This case shows how bad it is for a company’s reputation to not follow the rules. The company’s stock value dropped sharply, and it was hit with a lot of lawsuits and fines from the government, which hurt its reputation and consumers’ trust in it.
A company’s image and reputation are also closely linked to how it is run. Companies that follow the law strictly usually have better reputations and are seen as more trustworthy by those who matter.
Mitigating Legal and Financial Risks
The consequences of non-compliance are not limited to financial penalties and damage to reputation. Non-compliance can also expose companies to legal and financial risks.
You may think that your company is fully compliant with all laws and regulations, but there is always a risk of human error or oversight. Businesses expose themselves to possible legal risks when they don’t have appropriate compliance procedures in place.
For instance, if your business doesn’t follow data privacy laws, it could get sued by customers or be fined by the government. These fees can add up quickly and have a big effect on the business’s ability to stay in business.
Increasing Shareholder Trust and Confidence
A company’s shareholders and investors rely on the management group to make wise choices that will result in sustained success. Failure to comply with legal requirements can damage a company’s reputation among shareholders.
Investors might begin to doubt the company’s moral character and managerial skills. The company may experience financial setbacks as a result of decreased investments brought on by this lack of trust.
However, businesses that put a high priority on following the law and have strong governance procedures in place can inspire confidence in their shareholders. These businesses are viewed as less risky and more dependable, which attracts investors and may raise the value of their stock.
Ethical and Moral Responsibilities
When discussing corporate governance, ethical and moral responsibilities cannot be overlooked. Companies have a responsibility to not only comply with laws but also act ethically and morally in their business practices.
Legal compliance is a fundamental aspect of ethical behavior within a company. By following legal regulations, companies can ensure that they are acting with integrity and in the best interests of all stakeholders.
Ignoring legal compliance for the sake of short-term gains or cost-cutting measures may result in severe consequences for the company’s ethical standing. Companies must prioritize both legal compliance and ethical behavior to maintain a sustainable and responsible business.
Promoting a Culture of Transparency and Accountability
Customers and stakeholders are more likely to trust and support companies that are transparent and accountable in their operations. Legal compliance goes hand in hand with transparency and accountability.
By adhering to legal regulations, companies demonstrate their commitment to following the law and being open about their operations. You are also more likely to have proper systems in place to ensure that all actions and decisions are accountable.
It’s like having an insurance policy against potential legal and financial risks. By promoting such a culture within an organization, companies can foster trust and build long-term relationships with their stakeholders.
Long-Term Sustainability and Success
A company’s legal compliance practices and overall corporate governance have a direct impact on its long-term sustainability. The more you prioritize compliance, the more you mitigate risks and maintain a positive reputation.
Sustainability is not just about environmental practices; it’s also about how a company operates in terms of legal compliance. Companies that prioritize compliance are more likely to have long-term success and be seen as responsible corporate citizens.
Conclusion
Legal compliance as a part of corporate governance is now more critical than ever before. No company is exempt from the consequences of non-compliance, and a single instance can have severe and lasting impacts on a company’s reputation, finances, and sustainability.
By prioritizing legal compliance, companies can protect their reputation and image, mitigate risks, gain trust and confidence from stakeholders, fulfill ethical responsibilities, and promote transparency and accountability.
Ultimately, this can lead to long-term success and sustainability for the company. So, companies must make legal compliance a top priority in their corporate governance practices.