DAY ONE

Introduction to Corporate Governance

Day One overview:

Corporate Governance A brief Historical perspective Defining Corporate Governance Corporate Governance Factors & Concerns

Corporate Governance in the Context of Investment & Growth

Corporate Governance (CG) from a Historical Perspective

Private and Publicly owned business corporations can be considered as one of the most successful institutions invented in the history of Capitalism. During its more than four hundreds years history it has been one of the main driving forces of economic development and it has had a major impact on the economy and society. The fact that the corporation has huge wealth creating potential and at the same time has the capacity to create important negative impacts whether real or potential to society and the economy, has always intrigued the academic and business world, as well as governments, into directing their attention towards the nature and workings of corporate governance. In the last decade, though, the appearance of widespread and very damaging problems of corporations, have reached an alarming scale making more and more evident that the quality of corporate governance has a major impact on the corporations profitability, as well as, on its international competitiveness, and it has shown that it might affect the countrys financial strength negatively.

Corporate Governance from a Historical Perspective

The stock market crash 1929-1933

The Securities Act of 1933

The Securities Exchange Act of 1934

Mandatory Public Disclosure of Accounting Information

Creation of the SEC

Mandatory Auditing

GAAP

APB

FASB

Reviews & Enforcement

AICPA

Financial Accounting Rules Established by Private Sector

Standards for Auditing Established by 4 Professional Accountants

Corporate Governance from a Historical Perspective (contd)

The term corporate governance was practically forgotten following the 1930s market crash in USA. It was not even defined prior the traumatic collapses of profound multinationals in late 1990s Contemporary corporate governance as we know it today started in 1992 with the Cadbury report in the UK Cadbury was the result of several high profile company collapses It is concerned primarily with protecting weak and widely dispersed shareholders against self-interested Directors and Managers

Corporate Governance from a Historical Perspective (contd)

In the USA in the first half of the 1990s, the issue of corporate governance received considerable press attention due to the wave of CEO dismissals (e.g.: IBM, Kodak, Honeywell) by their boards.

In the early 2000s, the massive bankruptcies (and criminal malfeasance) of Enron and WorldCom, as well as lesser corporate scandals such as Adelphia Communications, AOL, Arthur Andersen, Global Crossing, Tyco, led to increased political interest in corporate governance.

Current status on Corporate Governance - Codes

Most Countries now have implemented Corporate Governance is by way of legislation or best practice Code, such Euro zone, India, Japan, Ghana etc. These Codes are voluntary and are enforced by shareholders Most of them operate on a comply or explain approach The Media also play a part in highlighting good or bad practices

Corporate Governance Codes Country Perspective

Corporate Governance is by way of legislation or best practice Code US adopted legislation in 2002 - Sarbanes Oxley Act Most other developed and emerging market countries have adopted best practice Codes e.g. Combined Code in the UK, Cromme Code in Germany and the King II Code in South Africa

Corporate Governance Codes Country Perspective (contd)

Countries in Africa have tended to adopt a hybrid approach whereby they have followed the comply and explain approach but have enshrined some of the principles in law to assist in enforceability
The reason is the weakness of the shareholder base and of the media

Corporate Governance Codes Country Perspective (contd)

Quoting from James D. Wolfenson A battle for Corporate Honesty THE ECONOMIST; THE WORLD IN 1999 PAGE 38

The governance of the corporation is now therefore as important in the world economy as the governance of countries.

Defining Corporate Governance

A generic term which describes the ways in which rights and responsibilities are shared between the various corporate participants It represents the relationships created among the various stakeholders of a business corporation to effectively direct its activities in meeting their objectives

Used in corporations to establish order between the firms owners and its top-level managers
Is a commitment to values and to ethical business conduct

Conceptualizing Corporate Governance in the context of institutions offering Islamic financial services (IIFS)
A defined set of relationships between a companys management, its Board of Directors, its shareholders and other stakeholders which provides the structure through which:

the objectives of the company are set; and the means of attaining those objectives and monitoring performance are determined. a set of organisational arrangements whereby the actions of the management of IIFS are aligned, as far as possible, with the interests of its stakeholders; provision of proper incentives for the organs of governance such as the Board of Directors and management to pursue objectives that are in the interests of the stakeholders and facilitate effective monitoring, thereby encouraging IIFS to use resources more efficiently; and compliance with Islamic Shar`ah rules and principles.
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In the context of IIFS, good CG should encompass:

Conceptualizing Corporate Governance (contd)

OECD Definition
System by which corporations are directed and controlled. Spells out the rules / procedures for making decisions on corporate affairs. Provide the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance Specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders

World Bank Definition

Corporate governance is about promoting corporate fairness, transparency and accountability
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What is Corporate Governance?

According to Hill & Jones (2001) Corporate governance is: the mechanisms that are used to govern managers and ensure that the actions are consistent with the interests of key stakeholder groups
CORPORATE GOVERNACE THEREFORE RELATES TO THE INTERNAL MEANS BY WHICH CORPORATIONS ARE OPERATED AND CONTROLLED, TAKING INTO ACCOUNT THE INTERESTS AND GOALS OF ALL THE STAKEHOLDERS

Modern corporations are disciplined by internal and external factors

Internal
Shareholders

External
Private
Stakeholders

Regulatory
Standards (for example, accounting and auditing) Laws and regulations Financial Sector Debt Equity

Board of Directors
Appoints and monitors

Reputational agents1

Reports to

Management
Operates

Markets Competitive factor and product markets Core functions Foreign direct investment Corporate control 1Reputational agents refer to private sector agents, self-regulating bodies, the media, and civic society that reduce information asymmetry, improve the monitoring of firms, and shed light on opportunistic behaviour
2005 YRK Reddy(Source: Corporate Governance Framework, Nadereh Chamlou, Magdi Iskande, World Bank)

Accounts Lawyers Credit Rating Investment Bankers Financial media Investment advisors Research Corporate Governance Analysis

Shareholders, Auditors and External Corporate Governance

Business Corporation Senior Mgnt

Shareholders Influence the hiring and firing of Board members

Board of Directors Provide strategic guidance Hire and evaluate senior management and auditor
Independent Auditor Independent Auditor

Board of Directors Audit Committee

Shareholders

Monitor and certify internal control & financial reporting systems of the company
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Corporate Governance Participants Roles

Shareholders those that own the company
Directors Guardians of the Companys assets for the Shareholders Managers and employees who use the Companys assets

Stakeholders - those who have direct or indirect interests in the Company such as debt holders, trade creditors, suppliers, customers and communities affected by the corporation's activities.

Corporate Governance Concerns

Primarily concerned with public listed companies i.e. those listed on a Stock Exchange
Particularly attempts to align the interests of the company, the shareholders , the board, employees as well as the community in which the company operates Focused on preventing corporate collapses such as Enron, Polly Peck and the Maxwell companies

Other Entities
Corporate Governance applies to all types of organizations not just companies in the private sector but also in the not for profit and public sectors
Examples are schools, hospitals, pension funds, state-owned enterprises

Corporate Governance and performance

Corporate Governance should be seen as a tool to support increased performance of companies rather than being just a regulatory mechanism Good governance leads to good performance It creates an open and transparent system It improves communication and breaks down systematic barriers to flow of information Good governance allows decision making based on data. It reduces risk Good governance helps in creating a brand and creates comfort for all stakeholders and society

Does performance depend on Corporate governance

Short term performance does not necessarily depend on governance Market asymmetries are responsible for this. However, this increases risk. This also creates barrier to long term growth Recall what happened to Enron?

Does performance depend on Corporate governance (Contd)

Medium to long term performance requires governance Most companies which have grown in the last 25 years have outstanding performance and have good governance structure A good governance structure treats all stakeholders fairly Governance alone cannot ensure performance

Investing in Corporate Governance

Companies need to invest in good governance Corporate governance has a direct bearing on business performance and thereby ROI and wealth creation

On average, businesses with superior governance practices generate 20 percent greater profits than other companies A study based on 256 companies conducted at the MIT Sloan School of Management
FUTHERMORE !!!

The Irresistible Case for CG

Korea-US Research: 160% premium ABN/AMRO: Best CG Rated companies had P/E ratios 20% higher Russian study: 70,000% increase in firm value of 21 companies Deutsche Bank: S&P 500: 19% out-performance. Harvard / Wharton: abnormal returns of 8.5% Cheaper debt: Romania`s BCR Operations too: better ROE; EVA

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Corporate Governance impact on the Investment Process and the creation of Wealth
Equity and other forms of investment are likely to flow to those jurisdictions and companies that are known and perceived to have adopted good corporate governance practices.
Good corporate practices attract both local and foreign investments This will have a positive impact on the economic development of the country or progress of the particular company
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Corporate Governance impact on the Investment Process and the creation of Wealth (Contd)
If a country does not have a reputation for strong corporate governance practices, capital will flow else where. If a country opts for lax accounting and reporting standards, capital will flow else where. All enterprises in that country will regardless of how steadfast a particular companys practices may be suffer the consequences.
If investors are not confident with the level of disclosure, capital will flow else where.
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Corporate Governance impact on the Investment Process and the creation of Wealth (Contd)
WEALTH CREATION Improved Corporate Governance and Corporate Performance is a necessary condition for national development. This in turn;
RESULTS IN WEALTH CREATION DUE TO increased flow of investments leading to increased productivity growth, employment and consequently, poverty reduction
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Corporate Governance impact on the Investment Process and the creation of Wealth (Contd)
In General; Corporate Governance if well practiced should lead to:
Create efficient companies Promote competitiveness Increased performance and profitability of companies Increased share prices in listed companies Leading to increased sales/exports higher GDP growth Send a powerful signal to encourage domestic and international investor confidence (gives confidence to
investors)
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Corporate Governance impact on the Investment Process and the creation of Wealth (Contd)
In particular regarding the welfare of individuals, Corporate Governance if well practiced should lead to: Create jobs, generate income and income tax Produce a wide variety of goods and services Provide mechanisms for savings and investments Environmentally and socially responsible corporate organizations

Essentials for Developing Good Corporate Governance Structures

Well-developed and well regulated securities markets Laws that recognize shareholders rights and require the equitable treatment of minority and foreign shareholders. Enforcement mechanism for protecting such shareholders rights Anti-corruption laws to prevent bribery and protection against fraud on investors.

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Essentials for Developing Good Corporate Governance Structures (contd)

Sophisticated courts and regulators An experienced accounting and auditing profession. Significant corporate disclosure requirements.

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Final Thoughts: The Role of Corporate Culture and the Gatekeepers

Regulation is a blunt and only partly effective tool in the governance field... That is not to say that regulation doesnt have a vital role to play Many of the provisions of the SarbanesOxley Act such as officer certifications, bans on loans to officers, mandated audits of internal controls and others have substantially improved the regulatory structure in areas where too many boards historically failed to act*However, government+ regulation is less and less efficient when issues become more subjective and less clear-cut In contrast, boards of directors, outside auditors and outside counsel are the gatekeepers of behavior standards who are able to prevent damage before it occurs if they are alert, and above all if they are willing to act when necessary.

Restoring Trust, Report on WorldCom, Richard C. Breeden, August 2003

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Summary
Corporate governance is determined first and foremost by company law, but there are also a number of reports and best practice codes that complement the recommendations and guidelines contained in the strictly legal framework.
Corporate governance is one of the main means of reducing agency costs arising out of the potentially conflicting relationship between shareholders and management.

Studies on corporate governance and value tend to demonstrate that good corporate governance will create value.

Corporate Governance
End of Day One

Shokran
Thank You
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