2

Governance and Management

ln which we recognize:

)w to rcelY

ight?

- the significance ofconstitutions for corporate entities - the distinction between governance and management - the performance and conformance aspects ofgovernance - definitions of corporate governance - the scope ofcorporate governance - drivers ofgood corporate governance Entities The Significance of Constitutions for Corporate
Every Corporate Entity Needs a Constitution
of members organizes a company' instituA corporate entity is formed whenever a group their purpose' Being artificial' corporate tion, society, association, or other entity to serve form of constitution'which maybe fbrentities have to be created. For thattheyneed some law or the law registering cooperatives' or mal uncler the law, for exampie under company name, a purpose' and a set of rules' As it carr be informal, consisting of little -o,. tha,, a the way these corporate entities are the name indicates, .orpo,it governance is about
governed.

ralia,
ecurchael rnies. rn for ented

ment, 3, and

malln

stions.

In each case the entity has an existence separate from needstokeepseparatefinancialaccounts.Itsconstitutiondefinestherightsanddrrtiesof conthe way it is to be governed' Typically' the its members, and lays down the rules about

its members, runs activities' and

its rights and duties and how its sritution will define the nature of the governing body,
members are elected or chosen'

the separation entities' Table 2.1 provides some comparisons of corporate :h:Ytnc with examples of different constitutions betrveen corporate entities and tireir members,
and governing bodies.

ropose?

over a corporate entity' However' gorr..rrlrrg body usually wields governance power other drivers of governance power in the c-ase of companies, particularlypublic companies

Ti.

rnance.
?-

investors, corporate raiders, hoiders of can include shareholder activists, institutional bids. we will discuss these later in this blocks of shares, as well as threats of hostile takeover
chapter.

rce and

26

PRINCIPLES

Table

z.t

Examples of the governance arrangements in different corporate entities

ffi
emcpruir
@,mlfiDRd

Corporate

entity

Members Shareholders

Constitution Memorandum and articles of association

Charter and

Governing body Board of directors Council Committee General Executive Council Governing body

Limited tiabitity
company ProfessionaI

Ueml"In rry"dt

organization
Local footbalt club

Quatified members of the profession

Club members Registered members Fellows of the Cottege

5rFdr* {nlm.rb- -o
nhrrmtrfulrl rCqgl[cainr q[EJ]rgrrnl mdqrcd)-h Jt frc trrffii um-Othgrt &"offiG$
tE

rnembership rules
Rutes

Trades Union Oxford College

Constitution and branch rule books

Founding statute or

fhcryfu

charter

set

Whether the constitution is formal, as required under the respective law or an informal of rules, it is a fundamental underpinning of the corporate entity and, hence, its governance. Yet, amazingly, many people, appointed as directors of limited companies or elected to councils or committees of other bodies, have never read that entity's constitution. An important part of the induction of every director should be to study and understand the memorandum and articles of their company.

rurmcbrcn
6c UBiEdl

&d6cltl o&r.ueim
frft"r in

mfu

oryoodburir

Case Stu<ly

2.1 Momcastle Museum Ltd

MomcasUe Museum Ltd was incorporated to run a heritage museum in one of En$and's ancienttowns. lt had forty members with one share each. To avoid dominaUon and to keep the membership local, the founding members included terms in the articles which restricted members to one share each and required anyone wanting to sell their share to seek the directors' approval of the new member. Unfortunately one shareholder was unaware of these conditions and sold her share to a business colleague in another town, who turned out to be unacceptable to the board of directors. The sale of the share was not accepted by the company' The problem would not have arisen had she appreclated the significance of the company's

frrmobcsyt prifuofrrthc dhrSsitba pbll*edonl

rymlarincorpon

tn Europ, ho TheEuropeanC

ahrfd;ngompt

d ncorporatinX mbdprHker
btrsats"
One-1

articles of association.
Discusslbn Questions

e4frer).Prwid Dwiryth19

ryu,v
1. Was it reasonable for a shareholder to
company's artic{es of association?
be expected to know what was in the

law b

Cmrdr,India"

f,o&fore'ernl hEderdope{
Typicalty, con

2. Are most shareholders

aware of the contents of the articles or the memorandum of companies in which they invest (consider both private and public companies)? How can a shareholder obtain a copy of a company's articles

litll hrHicEmi cdFblic

LTKrrHK
therarerer

of association?

3.

Would your answers be different if the shareholder was also a director of the

company?

irywifith
peniesarel

GOVERNANCE AND

MANAGEMENT 27

lncorporating

oint Stock Limited Liabitity Company

*
rectors

the registration of formal docuThe incorporation of a limited liability company irwolves jurisdiction in which the company is to be ments, irrli.r. with the company laws of the of the company have to incorporated. Tlpically, theiounding rnembers (shareholders) and articles of association for the proposed

f..p*. urd ,,rb*lt th. *.-orunJ'm

ecutive body

Lformal

iovernelected

ion. An and the

of the company may buy company to the company's registrar. Alternatively, the promoters in setting up companies, and simu.o-p*y'off the shl6'from-abusiness that specializes ply change the name of the company to the one theywant' name to ensure that there is The co-mpanies' registrar will check the proposed company (for example, in the UK names that no duplication and that the name is not undesirable with unacceptable activities are ,trgg"r, a connection with the royal family or involvement on the companies' register not allowed). On incorporation, the company's name is entered public documents, available for scrutiny by and the memorandum and articles become with the details of the shareanyone. Other statutory documents, such as an annual return details and changes to the capital hoid.rr, officers, and directors, changes to company financial accounts' structure have to be filed along with, in some jurisdictions' laws of one or In the united states of America companies are incorporated under the public compunies, with shares listed on a United states stock

other of the states. Many

*l
nina-

nthe ngto

I
I

'J:;:

I
I

prolany'sl

I
I

laws allow more fleximarket, are incorporat.i itr ttt" state o] Dehware, where corporate has a highly bility in condtrciing business than in many other states. Delaware also Delaware Court of Chancery' which is considered respected business court known as the most other countries, there is no by ,o-. to be sympathetic to boards of directors. unlike level in the United States' although provision for the formation of a company at the federal oversight of public comthe Securities and Exchange Commission provides federal level panies listed on United States stock markets' at the European level. In Europe, however, it is now possible to incorporate a company Europtaed (SE), enables comThe European Company, known by the Latin term'S ocietas Union to merge or to form panies incorporatedln iifferent member states of the European other words it provides firms with the option a holding company at the European level. In holding company is available of incoriorating in other member states. Formation of a SE or branches in different memto both public and private companies with registered offices (which we will explore in the next ber states. one-tier or two-tier boards are permitted in company matters' chapter). Provisions also call for the participation of employees the British Empire, British Ouring the 19th and early 20th centuriei with the spread of .o^pury law became the tasis of company law in many other countries-Australia, Malaysia, and Hong canada, India, many African countries, New Zealand' Singapore, laws have diverged as these countries Kong, for example. Of course over the years company have-Jevelopea, brrt linkages still remain through the commonwealth'

Tlpically, companies can be divided into three rnain types:

(r)

be offered for sale to the genPublic limited company, where the company's shares may amount unpaid on their shares. In the eral public. Members'iiuUifity is limited to any their name, elsewhere UK, public limited companies must add the designation'PLC'to so that those contractname, they are required to add the word'Limited' or 'Ltd' to their that the shareholders liability is limited. Not all public coming with them understand companies' on a stock exchange, but all listed companies must be public palnies are listed

28

PRINCIPLES

(z)

is limited to the amount Private company limited by shares' where members'liability of incorporation. unpaid o.' ,hu,., they hold. This is by far the most common form or'Ltd'to their name' Again private limited companies are required to add'Limited' is limited Private company limited by guarantee, where guarantor members'liability assets if it is wound up' to the amount they have agre.d to co.rtribute to the company's u nominal amount. This form of incorporation is often used

Box
A

2.1

Examg

typical set of

b)

Share Capital

This is often only jurisdictions the word by charities and other not-for-profit entities and in many name' 'Limited'need not appear in the company

(CICs) in the UK' to facilitate The recently developed Community lnterest Companies public and private sectors, may be private companies participative venturestetween the ii*it.J ty shares, companies limited by guarantee' or public limited companies' groups of companies we will study subsiiiary and associated companies, and complex (the result of one company owning another) in chapter 4'

Details of the sh voting rights or b lf the shares are shares may be t resolution of the

General Mee0ne

The requiremen governing speci

meetings. Prcc{ appointment of

present or by a Directors
The numberofd of the remunera

The Memorandum and Articles of Association

a company's name' A company's memorandum is usually a short document that states
address of its registered office' outlines the purposes for which it has been created, gives the of shares with which it is being formed, and states that lists the nominal amount and classes In most jurisdictions' the liability of its members is limited to the equity capital subscribed' included' A registered offrce is needed details of the initial subscribing members are also with the company needs to know because the company is not a person and anyone dealing its purposes' In the early lvhere to fincl it. rhe objects cla.tre in a memorandum defines

tion of directors
meetings, or bei

ector. The lengU

daysthiswas'ineffect,aconstraintinrposedbythecommunityforallowingthecompany inliability. Action taken by a company outside its objects would be

tiring every yeat quorum, electiq

to trade with limited so that the company is valid. Subsequently this clause has often been drawn very widely, of activities now included free to carry on a wide range of activities. Because ofthe breadth clause' some comPanylaws no longer require an objects io .ff..t, the rules by which the company is governed' The articles of associatio=n

Officers of the ( The board's po

pany secretary,

CompaniesActsinmanyjurisdictionscontainadraftmemorandumforguidance. is limited and the In most jurisdictions the nombe, of members of a private company as demanding as those for requirements for filing documents with the registrar are not p,rth. .o-punies, those rvhich may offer shares to the public' we saw in private companies may not offer their shares to the public' As
By contrast,

"r",

Dividend Policy
The powers

oft

payment of divi proposals put t

the corporation all companies were the last chapter, in the original lgth century concept of public. subsequently companies were public, being incorporate-<l to obtain funds from the seeking funds to obi"in th. benefit of limited liability for a business, without

Requirements I

The requirema

incorporated public companies' from the public. Today private company registrations far outnumber meet the listing requirements of To obtain a listing orra stock exchange u io-purry *ust pass thg scrutiny of the securthat exchange. In sol-e jurisdictions the company also has to preparation of a prospectus' ities regulatory authority. Typically, a listing requires the the typical contents of aprospectus to raise shares' This of Box2.2provides u., "t"*pl" an introduction on the ofis a prospectus issued by the British Energy Group PLC seeking ficial list ofthe London Stock Exchange'

and to provide sheet to the rru

panies Acts.
Provisions for

The procedure
enforced liquid

GOVERNANCE AND

MANAGEMENT 29

Box
A

the following: contain detailed rules on typical set of articles might

2'1

of Articles of Association Example of the Contents

share

**:ffi::

such as class of shares with special rights g s u c h r ghts :Tx'";;n; *. " n s or v a r vi n : The way that calls may be mede' on issue' are not *"U O"'O Yut lf the shares The type of meeting and 'O snareholder io another' shares may be capital' "unu'u"'*Ji'o*'onu to alter the cotnpany's r"o"'*o resorution ot tne menrnJrl

capital

'

[1:ff [l:i;l;]

'I :'^^r"r;^d

iffi :f

anrr

tl:

l;:ifl#,.fl'Jf:-r;nt#ffllur
oi"t"*

members rhe rures *.uting of the sharehorder The notice required for t"ui'l-g^t oi ***nutt' quorum' the governing special o' *ut*o'n'nu'y including the necessary C*n"'"i meetings' meetings. Proceedings show of hands of those by a

"i anO voting on appointment of the chairmJn' or by a poll based shareholdings'

Directors

'"'o'"'ont

lt
s,

qualiflcation for directors, any shareholding The disqualificaThe number of directors, uno J,ti"' of directors'

the determination

direitors. The powers of the remuneration of uq!

lu oeuut tttt Dy o"**' '5 of directors, for "e tion or di recro,r, ro, exampl

d
i\^r

'ly
ny

*:*;

"*l'i*

::i::-;;";r r-egstrar from lil; ff"'[i :: j::11;*::?,H acting as a dirrrn xa m p

I

at directors' meetings' tiring every year' The O"*J'ng' jetegation of powers to committees of the board' quorum, election ot tt'tui*un'

ru;;ll:i::l5 ::": fJ'T:

:"",:l[

Jf

;" lffi ';''"including notice of meetings'

e
w

i'lh

on

e th i rd re.

nris
ted

:[ffi:iT:;TJi:%t"int
pany secretarv, unO

a managing

a com' chier executive orricer'

otnliof{'""" 'uch as a chieffinance

l''^:',:"'or

officer'

ed.

the

il:tr"#i::"it;:ffi;::n
payrrrent of dividends.

for

and the agree poficies on{eserves senerar Tuutl:l1to the generat meeting will follow irr,""*, on such matters tiie

ptopotuft

put"

before it by the board'

win
,gefe

were unds
tes.

and Audit Requirernenfs for Accounts the company praper fitrancial records for clirectors to keep The requirement for the

and tr: provitlu'ugu'u'""ttountf periodically' The appotn sneet to the rnembers

panies Acts.

iyru1

:i:,Hl

l3:f

:i:rl;,:;!.ff;ilT;ilt,ff

rts
i.

of

ecur-

i.This he of-

the Company on Frovlsions for Windin$ up nrembers' agreement or up the company with the The procedures for winding enforced liquidation'

32

PRINCIPLES

Other Forms of lncorPoration

We have looked at the

l;se Stud[ 2.2

*16-

incorporation of limited liability companies (private company limited shares)' by shares, private .o*pu.ry limited by guarantee, and public company limited by companiesare registered. Butthere underthe Companies Acts ofthe jurisdiction inr+'hichthe in table 2. 1. are other ways that corporate entities can be formally created, as we saw building Some sectors, for e*ample savings and loan associations in the United States, cooperasocieties in the UK and Commonwealth countries, farmers and other suppliers tives in Canada, consumer cooperatives in the UK' are incorporated under legislation
designed to facilitate and regulate that specific sector" Incorporation of specific corporate entities by the state is also common in many coun-

.t-gr;;3- =g

ffi 1 l-:r:e-3: d r 3f,?-n:''s ni":

md-(:s:3i : -,4 gl-:5: :r 3 ''l- '

tr 2T]

=r'-arr if|i]*l::e - 33( il*r-6n-<. 'i

r'{!!:e-rle---::

tries. The legislature provides the new organization with its own facilitating legislation, its which defines and creates the entity and determines its governance processes' including how the directors are mission and accountability, the form of its governing body and appointed, which is often by the government or state agencies. For example' the Federal National N,Iortgage Association (Fannie Mae) was created by the uS government to for provide government backing for financial products and services that make it possible buy homes of their own. Such entities are sometimes lor,v and middle-income families to referred to as quangos, which is an acronym for quasi-autonomous uon-governmental the organization, because, although they have a life and mission seParate from the state, state maintains an arm's length interest in them' To add a degree of confusion, quango is also used, particularlv in the United Kingdom . andAustralia, as an acronym for a quasi-autonomous national governmenial organization to describe organizations to which governments have devolved power' but in which they UK retain a clirect influence. Examples include the Adult Learning Inspectorate of the the Vehicle Certification Agency of the Department Department of Education and Skills, of Tiansport, the Agricultural Wages Board of the Department of the Environment, Food and Rural Affairs, and the Job Centres of the Department of Work and Pensions' the Charities are often set up as not-for-profit, incorporated bodies and registered under in charities law in the relevant jurisdiction. Most of the principles and practices discussed go\rernthis book apply to the governance of such entities, although those serving on their and subject to additional requirements of trust law. ing bodies may also be trustees professional bodies provide some interesting cases of alternative approaches to incorporation and governance. In some countries professional bodies are incorporated under their own statute by state authorities. In the UK and some other Commonwealth coun-

:::l-:r?'re' S '* siL.:3- -e:: ; lsrussion Qre

t _.- :j.L. +:+,'.ff -J

r['- Jire Ce -- -; -:-rE.S

>-r_

:e :'"':
ts -t> ----^.--

= -i

!tr

r'rL,:,.-.

tries many professional bodies are created under a Royal Charter' Such chartered

professional bodies have sor.ereignty over their own affairs, including the examinatiou and admission to membership, the maintaining of standards and the disciplining of members. The engineering profession in both the United States and Britain has developed with

constitutionally separate professional bodies to represent the interests of the various

branches-electrical, civil, an,l mechanical and so on. Subsequently, in Britain, the Engineering Council rvas created b,v Royal Charter to oversee an effective federation of the ,"purut. bodies. Unlike ttie engineers, the UK accountancy profession has not managed to agree a federation and has a number of separate professional bodies' Criticisms following the collapse of Enron and its auditors, Andersens, led to the creation of the

GOVERNANCEAND MANAGEMENT

33

Case Study
red
3s), tere

2'2

Gross The American Red

ling
era-

don )undon, rg its

S AIE

in bv a Board Crosswas established The American Red ltsiranoate with governance of the been media criticism as a chartered org"n,ru,.,oilintJi "staorisrteo i* r"cent years tn" new deof Governors with fifty was appropriat" t: the way it conquestion-s'***"' "n committee initiated a Red Cross anO tn" s"nutt ''n"ntu gou"tnance' Subsequently' mands that it had to of tlre orgaii'u*n'' expressed concerns sressional inquiry into '"""'ui"'p"Os Senate fllance Committee the size of its Board of February 2006, the

setup byCongress 1881' and subsequently

*;;;;.

d;;; ;"t *u'

i-n

';' #ilil;*e

;';;i;;oos'

aboutthe mission ""0 #;nilationui"urtu'"otti"unJ whether they were sufficiently J oou'o set up a covernors, ilt" pa'ticipaiiln gou"'n"nt".T tJu'tthe Board of Governors

*uiitott'

t"*t""

independentto

jrowing demands of its mission' comprehensiv"ut'""'i"niof-itsgoverna"""*"0'"io'dentifyconcretereformsand meetthe

streamline the or*un,ru,,o"nlrlou'ria
Discussion Ouestions
f ormembersof

"*"'"i'"i'io"i

deral nt to
ile

corporate entities set 1. The constitutions of

with charitable.
_up

obj"::lo"t often
I

call

for

times
rental te, the rgdom ization

q re boardmemberstob:":::i-",1l1t]i::;,::T:Til:'[T?iX""'];'t ;;iJn'"'" " ero u ps wo u d vo u re u :: :J'ff; :1 regulators' l"J,T"#: the state' employees' benefactors' o{ io be representeOZ tConsiOer include representatives inouro,n"'*"io ,",

;"ffi ilffi
"in"rs.i

societar interests, the beneficiaries?

""0

2.

be board of such organizations and top executives Should the chief executive

members?

theY

he UK

rtment
t, Food
rder the
ussed
g.

profession PublicCompanyAccountingoversightBoard.(PCAoB)intheUnitedStates,aswewill uil *.*igt i of .n. accounting are provincial later. In *n. Uf<"rl",lalra, explore of'Institutes of charlo$atrn by a number

are maln-

in

go\rern-

o incor:d under

th coun:hartered rdon and nembers.

rped

tained "' *tth b"litt; many of which " institutes of The governant"';;;:J:itl we canada' can be intriguing' As tered Accountants of utai"' (ott" tiilta""""tilt) can come into play' go;;;;;g have relatively l"'gt of to'pJutt governance are created of the n"itin"i"'nttt' shall see, many of J-urf corporate entities uu" arts socrshould "tt-u"' Finallv, we clubs' drama sroups' #;;;";erested p""it'' ipo'ts entities need simpty by agreemen' *t"t'if'ttttt' all such

;;;;;nt

chartered;:;;;'

c";;;;;;g'cot"'til

;;;';;;"t'ait'the*

#;;

eties, religiou' o'*un"ut'on'' und' governing u, *tlt u"nun-uging'

ull p'ouidt

*"'iott'1

cot"o":lJ;;;;;itt*

of constitution' which

with

e various

il::fiiilU*:l:l::'",',rullr.Tliql",l:,il:'*:l'::':,:::1""'i'nrheprin. irtt* i;'iffi::;?:;:ll-,ltJ of corporate governance il;t;;; repetltlon' ciples and practices
I

rn of
,

Engineerthe managed

the need adapting to on we shall focus

Criticisms

ttt*lti""t*' To avoid unnecessary other corporate can be on;;;;;'"""t" or to,''iu"itt' 1t"s;triris:Y:" of governing companies entities ,r..d .orporJ;tffiffi;""a.fr.*.,t.ds sectors' non-company
u"a other adapted to the not-fol-p"ont

ion of the

34

PRINcIPLES

Oiscussion Ques

Case StudY

2.3 Network

Rail

\las it a soul-

nationalized and run by the state enterprise The railways in Britain had long been railway Conservative Government Otl"Ii::,*" British Railways' ln 1994, tf'" tn"n

run train serr control the el

some station

System.Companiesweregrantedtherightstoruntrainservicesovervariotf,routes. Meanwhile,RailtrackplCwasincorporatedtocontroltheentirerailwayinfrastructure public company listed on

2.

stations) as a (tracks, signals, bridges, tunnels' and some .. - -.. ^^-I the London Stock market tn was criticized for its poor performance over the following few years Railtrack projects' the spiralling costs of new maintaining and developing,the rail infrastructure' route' and particularly on its poor safety including extensions to the Euro Tunnel

Was the Gov Railtrack PL( Evaluate the

3.

\etwork

Rail

industrY. the expected in

record.Fatalcrashesoccurred.Railtrack'suseofcontractorsonmaintenancework Withallegedlossofcontrolandreducedsafetywerealleged;Sowastheoriginalstrat. used by all the train

the rail network' which was egy of having a single company run
operators.

Fo|lowingtheSecondofthesecrashestheRailtrackboardofdirectorswassaidto havebeennearpanic.Maintenanceandsafetyroutineswereexamined'emergency and speed restrictions were imposed tests showed major faults on many lines'
aroundthesystemcausingmajorproblemstothetrainoperatorsandthepassengers. level of indebtedness' which left it no longer By 2001, Railtrack nal reacneO a from the taxpayer. controversially it used financially viable without repeated subsidy

The Distinct 5

-';e >art in the :::cr.lghout the l(

:r::--i:lt than the

thiSgovernmentfundingtopayadividendtoitsshareholders.ButbynowtheGovernState for Transport'

ment had changed. tn o"ctooei

zool the New Labour Secretary

of

-sn qoYernancl lhe notion of : i :gure 2. i.

4-

StephenByers,calledforRailtracktobeputintoadministrationonthegroundsofits
insolvencY' bankrupting the company to partially critics accused the government of deliberately control' bringingthe infrastructure back under state re-nationalize the railwf system, the shareholders, arguing that the comto The Government offerei no compensation

;hief execud

m,i. ;o on doltt
;l:"dTtlt'ards

\\ith

ss;ller iunction
mer to be defin

panywasinsolventandthatinsuchacaseadministrationwascoveredintheoriginal
privatization legislation' incorporated as a private company infrastructure: Network Rail, which was

fi;:.lgement, bt
3,ut rr*rere is t;,r.:1 erf

Theninoctober2Oo2,theGovernmentcreatedanewcompanytorunBritain'srailby limited

x;';-*" rsho repol

guarantee.GovernancewasexpectedtomeetthestandardsrequiredofaPl-C.The companyhadoverahundredguarantor.members'(notshareholders),whorepreof Transport' and the public' The company sented the rail industry, the Department ,not for dividend company' , that it operated as a commercial explained that it was a businessdirectlyaccountabletoitsmembers,whoreceivedtheannualreportand and auditors'

the mal

::*;'."-nsibilifi-

at

l::t

in.'rrk of the

;;:e:i-rnPosed c ,:: a unitan-

the appointment ofdirectors accounts, attended the AGM and approved The members could remove top executives' to governance were seen ln 2O0g when some ofthe weaknesses ofthis approach

.tlii':;.-nis

the e:

:::ernLrer ot

Significantoverrunsonmaintenanceworklefthundredsofthousandsoftravellers Some of the governing members complained stranded over the New Year holidays' to anyone' 'There is a democratic that management was not really accountable deficit,wroteLordBerxeleyamemberrepresentingtherailfreightindustry,callingfor ,governors, who wourd have wider powers to supervise a new board with fewer
management.

GOVERNANCE AND

MANAGEMENT 35

Discussion Questions

1.

government t: franchise Was it a sound strategy for the tutes' whilst incorporating Railtrack PLC to run train services oueTuarious tunnels, and infrastructure (tracks, signars, bridges, contror the entire listed on the London stock market? some stations) as a p'blit to*puny

different companies to

rai;t

2.

of no compensation to the shareholders Was the Government right to offer

RailtrackPLC,arguingthatthecompanywasinsolvent?
I

3.Evaluatethenew'notfordividend'privatecompanylimitedbyguaranteecalled NetworkRail,withguarantormembersnotshareholders'representingtherailbe problems might

and the public' What industry, the Department of Transport' expected in its governance?

I (
LL

o
ry

and Management The Distinction Between Governance

professional management was the As we saw in the first chapter'

d
S.

f]ior'focus

tll:lTt

er )d

throughoutthe20thcentury.Toduyth.*aycompaniesaregovernedhasbecomemorermbeytt people iail to make the distinction portant than the *uy *"f u" *u"ugtd' 'o*t
tween governance and management'

nrt,
rts

Thenotionofmanagementasahierarchyiscommonplace-asintheclassicalpyramid

rlly

"t l-.i1:r';i.curive has overarl responsibility, with other managers reporting to him is delegated hierarchy. Authority and responsibility and so on down the management

or her

ol.
rm-

nal

rail

lbv
the lreany

downwardswithmatchingaccountabilityexpectedupwardsin.return.Theclassicaltheory management responsibilto be depicted and [ne and staff enables functionul d.purtirents picture of the realities of thai this is an inadequate ities to be de{ined. w. ,r.ra..rrund management,butweg.,,.,"ltyacceptthatmanagementoperatesthroughhierarchies.We organization' know who reports to whom in the not organization charts' The board is
has Neittrer is it a hierarchy' Every director part of the managem..r, ,rro.ror.. responsibilityandsimilardutiesandpowersunderthelaw.Thereisno.boss'ofaboard. Theworkoftheboard,thegoverningbodyoftheentity,isdepictedinfigure2.2asacircle,
superimposed on the appear on But where is the board? Boards seldom equal

cial
and ors.

management'
tt ut is
u board

In

a unitary uoura,

.r ---^-.-+:.,^ and nnn-ev or outside with both executive ^-l non-executive'

directors,theexecutivedirectorsholdamanagerialroleinadditiontotheirresponsibilities

hen
llers ined

asamemberoftheboardofdirectors.sho*'trinfigure2.2,theysitinboththeboard

ratic rg for
rvise
Figure

z.r

Classical depiction of management

t6

PRTNcTPLES

The Perforn
@ outside,

@ The board
@ / \

non-executive

directors
@

Board Respon
We can now explo

j
j

n
ffi

executive

directors

ottrer managers not on the board t-__________-----.----

Figurez.z

The board and management

which is why dir elements-stratq

circle and the management triangle. As executives they are employees of the company and covered by employment law..Directors, as such, are not employees and are subject to company law. The other directors, shown @ in the figure, are the non-executive or outside directors-members of the board circle but not part of the management hierarchy. Other managers,lv-ho are not on the board, are shown W.

and accountabilit consider the futrr take a view lookin the company in it
social context

inv

A further important distinction can be drawn between outside, non-executive directors who are independent of the entiry and outside non-executive directors who, although they are not executives of the company, have some link with it. Independent
non-executive directors have no relationship with the company that could affect the exercise of independent judgement. Those who are not independent have some link with the company, such as close family ties to the chairman, being a representative of a dominant shareholder, having previously served as an executive of that company, having links with major trading partners of the company and so on. Such connections raise questions about these directors'independence. There may be good reasons for having them on the board, but we shall refer to them as connected non-executive directors. These issues will be explored further in chapter 3. In the United States the common practice is to refer to non-executive directors as outside directors. For consistency we will use the acronyms INED (independent non-executive director) and CNED (connected non-executive director). Some authorities refer to a CNED as an affiliated non-executive director. We now have a model which enables us to distinguish governance from management. (See figure 2.3.) In other words-management runs the business; the board ensures that it is being well run and run in the right direction.

inftgure2.4. In formulating and outside the fir lated into policie

control. The boan ment, looking inr Accountability inr

ance to the shareh

Boards vary in
delegates work to

monitoring and cr Of course, a si

processes;

but at externally in spaa An extension ol ing that boards w chief executive or the extent ofthet boards play a maj

Governance-the work ofthe board of directors or other governing body

lllanagement-the work ofthe executive

management team

Figure

2.3 Governance distinguished from

management

lHilmer, Frederick

GOVERNANCE AND

MANAGEMENT 37

of Governance The performance and conformance Aspects

Board ResPonsibi tities
Wecannowexplorewhattheboarddoes.overall,theboardstaskistodjrectthecompany'

whichiswhydirectorsaresocalled.Thisactivitycanbeseentoinvolvefourbasic management'
elements-sttut.gy
directors have to and others. rrironui"g their duties, and accountability to shareholclers and recent results' also as well as its present fosition consider the future of the company parts as well as externally at .o-puny and its compon.rrt take a view loot irg i.r*urd urrt . t:"':1t and ttre broader economic' political' and the company in its competitive market rn.r. uasic board perspectives and processes are shown social context i" *hi.h ;;;;rui.r.

fo,-"*ion

and poliry making' supervision.ofexecutive

r and

comrtside

Jther
e dirrvho,

managemenr, rooking ahead in time strategy the board works with top then need to be transits strategic environment' Strategies and outside th. firrrr, ,.ti"g it in

fff::]ii"ring

latedintopoliciestoguidetopmanagementactionandprovideplansforsubsequent of executive manage-

ndent
he exk

with

and supervise the activities control. The board ur*'rr..a, to monitJr performance' managerial situation and at recent ment, looking inwards at the current performanJreflecting corporate activities and Accountability ir.,ot r., to*or.i"g "",*"tas accountability' to stakeholders with legitimate claims ance to the sharehold.r, urra olher

domg links
estions

Boardsvaryintheextenttowhichtheboardasawholeengagesinthesefunctionsor
delegatesworktotheCEoandthemanagementteam,whilstensuringthatthenecessary
place'

on the
res

will

*oriito.irrg and control processes are in Ofcourse,asimple2xzmatrixnecessarilypresentsasimplifiedviewofboard internally and forwards and backwards in time and processes; Uot ut t.u'iUy looking
externally in space it is all embracing! cell recognizboard processes introduces a.central An extension .f ,rr" u"rJq""irarit of and through their mainagement, working with ing that boards work with urrd a.t through this Process. Boards can choose chief executive -";;;t;;iir.iror.t r"igor. z.ia.picts for example' ", the management. In some cases, the extent of their d.l;;"ti"; oifon.tiorrJto in others this is formulation of the .l*purry't strategy, boards play a major part in the
Outward

refer to

ronyms

tive diIement.

ingwell

looking
AccountabititY

StrategY

formulation

lnward

Supervising executive activities

Past and

PoticY

making
Future

tooking
present focused

focused

Figure

z'4

processes The basic board perspectives and

rHilmer,FrederickG.(1993)SttictlyBoardroomsydney:InformationAustralia'

38

PRINCIPLES

Outward

8ox 2.3
definest
so

looking
Approve and workwlth and through th CEO

epr@ran

asto
Nott

it

lnward

!'lrfl\tbrf
Past and

Iooking

Both tht
unation
oro.z is fhe B\-

for

Figure

activities 2.5 Framework for anatysing board

mirrors th

l00l

Outvvard

,;:'[.fronrte g

tooking
lnward

Conformance
Past and Present

Performance

.IL

Esituti
AIso

arpsande
Future

looking

in

',Fr?$rata

Figure

z'6

aspects of a board's work The conformance and performance

w.

gnd

!''|D&fnJgCTt

lre
delegatedtotoPmanagementwiththeboardreceiving,questioning,andfinallyapproving
man-ag.ment's strategic proposals' roles in dilemma for the unitary board. The Figure 2.5 can also rrigt ri+, " potential performance and poliry making-are the right hand columnasiat.gy formulation leftto corporate direction' Those on the roles, concerned with the board's-iontribution .rr.rriiully concerned with ensuring conexecutive supervision and accountability-are
,snzcg'

har

ffiorctrqP

faft

d'rtmehofu

Tbe

rr

rdors
fre$ar
r[rrp
Fr&-titl

i"t-**. flg*e 2.6 shows this important distinction'

fo

board-1hair.m1' once As Lord Caldecote, a very experienced

later' the roles are separated with

problem

:-o::ented'a

withtheunitaryboardisthatdirectorsaremarkingtheirownexaminationpapers'.Ina the executive board respontwo-tier board, u, *. 'h"ll "e supervisoryboard responsible for conformance' tt" sible for performance

prnisio
umdrse

""i

ffiartr

Defi

nitions of Corporate Governance

bebveen

Ihe

obrixt
Therehavebeenmanyattemptstodefinecorporategovernance'manyofthemmore governance and managedistinction penetrating than the, p;;;-;.t-simple mentdrawne arl\er:,managementrunsthebusiness;theboardensuresthatitisbeingwellrun and in the right directioi'

.illmrd
frmrns

Mncl
tmt

Inchapterl,wewereofferedthebroadviewsthat:.corporategoyernanceisabouttheway
corporateentitiesaregoverned,and,corporategoyernanceisabouttheexerciseofpowerover by clarke (2004), is the perspective entitie!.This ;ie; which is reinforced
corporate adopted in this book.

d duc o
ffic

{tmtlo
ge,

GOVERNANCE AN D MANAG EMENT

39

J
Box

2.3

Corporate Governance: An lnternational Review

journal founded in 1992' corporate Governance: An lnternational Review, an academic power over corporate entities defines corporate governance broadly as 'the exercise of various stakeholders" so as to increase the value provided to the organization's year this journal is published by Blackwell Publishing, oxford and Now in its 18th Dominion University, Norfolk, VA, USA' NewYork and is now edited by DrWilliam Judge, old

(1999) offered:'-corporate izationfor Economic co-operation and Development controlled'.This definition, of course' anceis the processby which rimpanie, are directedand

Both the cadbury Rep

oft (1992) and a subsequent report from the oECD-the organ-

govern-

mirrorstheperformanceandconfo,mu''..dichotomywementionedearlier. By 2001, the OECD had broadened their definition:

institutions, including laws' regulations and pubcorporate governance refers to the private and public market economy' between corporate manlic institutions, which together govern the felationship, in a those who invest resources in corporations on the other' agers and entrepreneurs, on the one hand, and

Monks and Nel Minow offered: Also in 2001 two influential American practitioners Bob , participants in determiningthe direccorporate goyernance is the relationship amongvarious

tionandperformanceofcorporations'fh'primaryparticipantsaretheshareholders'the
nng
:s

in

management and the board of directors'' role is to ensure wJave already noted the opinion of Hilmer (1993) thati the board's key above average performstrivingfor that corporate management is continuously and ffictively role with respect to of risk, [which] is not to deny the board's additional ance, taking account
shar eh older

tnce

rftcon>lem

perspectives taken by the The variations between the definitions illuminate the different concerning the activities of authors. Those who see corporate governance as principally (Monks and Minow) have taken a relatively the shareholders, the board, u,'d **ug.ment in which corporate governance is sharp focus. other contributors recognize the context auditors, and market institutions involved in the

P r o t ection'.

Ina
Pon-

pru.tir.d and include the regulators, provision of capital (OECD Z-OOr). wittt the widest focus

who recognize that an every element that can all and understanding of corporate governance needs to involve o,,., totpot"tions (Clarke 2004andthis book)' affect the."...ir. of power
are those

The Scope of CorPorate Governance

more
nage:lI

run

eway

over

ective

processes of the governing body are Obviously, the structure, the membership, and the and other sources of central to corporate governance. But relations with shareholders and (in listed companies) the finance, the link wittr the independent external auditors, institutions, are fundamental' So are influence of the stock market and the financial the regulatory mechanisms of the effects of the company law, the legal institutions, and with contractual stakeholdersthe country .o,,..,,'.d. The company's relationships also become vital in understanding employees' suppliers, customers, for example-have responsibility and the interests of other' the governan.. of.orporutions. corporate social

40

PRTNCIPLES

Sharehotders (mem bers)

- institutional investors

Later we shall cons four massive, internar Andersen, after the committees of the mz

'private investors
SocietaI influences and other stakeholders

corporate governancr The contractual st relationshiP with the

corporate governancr

governance Practice i of the comPanY' all d

Government and other corporate regulators

suppliers oforiginal tailers to the final cu

contractual stakeholders
Externat auditors

capital), including br For public, listed , significant to corPor

company's shares are mental to the effectir
also playing an

Figure 2.7 The scope ofcorporate governance

imPo

non-contractual stakeholders and society at large are also ences in corporate governance, as we will see in the second part of this book. The schematic of figure 23 afiempts to provide an overview of the scope of corporate
governance.

now wielding significant influ-

Case StudY 2'5

ASX has two bas

Central to the study of corporate governance are, of course, the members of the entity (shareholder

in a limited company), the governing body (the board of directors in

1.

To oPerate Au

and fixed inte

company), and the management of the enterprise. We shall be focusing on the structures, relationships, and realities of these groups throughout this book' Auditors play a crucial role in corporate Sovernance' though they are not often presented as central to its study. In the original 19th century concept ofthe corporation the shareholders appointed some of their own members to act as auditors, to check on the reports presented to them by their directors. Subsequently they were replaced by professional auditors, as the accounting profession developed in the later years of that century'

comPrehensir prices. Under that are fair. (

2.

To suPervise

enforcing con sets standar(

Case Study

2.4

Great Western Railway Company

Report of the Audit Committee The auditors and Mr Deloitte attended the committee and explained the various matters concerned with the finances and other departments of the railway, which explanations were highly satisfactorY. The committee considered the auditors had performed their arduous duties with great care and intelligence and therefore confidently recommend that they be continued in office.
(Paddi ngton Station, Benjam i n Lancaster, 22 F ebr uar y L87 2\

ln 2006, to or cial functions. a supervisorY fun its own board. A monitors comPl ties for significa The ASX Cort ples of Good Cc

Discussion Que

1. 2.

Evaluate the

subsidiarY c
How does

Discussion Question

tt

1.

How does the audit committee in the old GWR differ from its modern counterpart?

which You

at

GOVERNANCE AND

MANAGEMENT 41

Laterweshallconsidertheimplicationsofauditinthemodern,globalworld,withjust demise of the fifth' Arthur of accountants, following the four massive, international firms standing importance of audit cgnmittees' after the nnron debacle' The Andersen, committeesofthemainboard,whicharenowrequiredbyallthecodfsofgoodpracticein be studied in depth' corporate governance' will also who have a contractual ull tlrore firmslncl individuals of The contract.rut *ut rrota.rs ar. increasingly recognized as part
relationship with the
good corporate when comparing the codes of ut *t corporate gov..,tu"tt i"itit"J' 'hu[ "e include the employees world. The contractual stakehtlders governance practice around the added-value chain' from urra individuals in the company's of the company, all tho; fir*, wholesalers' rett'rough supply firms' distributors' of origltut gooit ;tJ share suppliers ""'itt''the nnance (other than the equity as to the final t""";;;' ;' ;e[ "r for loans and other debt capital' tailers "'pprittt other financiuLir,rtiirrtio.r, vitally capital), incluairrg uu.,k, ;;a i, urrJtneir listing rules are' clearly' i For public, rirr.a market' on which the The.ruf'tt'"'gout"' the s]1ck

."*"",

and who.se

inter;s;are

."-iuJ*-it *.r. **t

significant to
company's

corporat;;;;;;ance

of listed comfJnies. mental to the effective governance t ' -ing of corporate governance codes' tole in the creatiot u"d pt also playing an i*po'tJ"t (ASX) The Australian Stock Exchange

shu,t'u'"ti'tt?*' uttai"pu"itt-'tuttt" "q"ittmentslaiddownforlistingarefundaworld are Stock markets around the

luate

Case Study
ASX has

2'5

tity

1.

To operate

na
res,

exchange for equities' derivatives' Australia's primary national stock lt also provides including settlement facilities' and fixed interest securities'

two basic functions:

?re-

the the
rfes-

Act ASX prices. Under tne nustratran Corporations transparent' that are fair, orderly, and and monitoring participants' conduct 2. To supervise the market, incruding

comprehensiveinformationontheAustralianstockmarket'includingshare is required to operate markets

enforcingcompliancewiththerules'Toprotecttheintegrityofthemarket'ASX setsstandardsforthebehaviouroflistedcompaniesthroughitsListingRules' ln2006,toovercomeconcernsaboutconflictbetweenitsregulatoryandcommer.its AsX placed greater transparency and accountability cial functions, and to provide Supervision' with subsidiary calied ASX Markets supervisory function in a separate on the ASX' processes applications for listing its own board. ASX Market Supervision monitorscompliancewiththeListingRules,andreviewsproposalsfromlistedenti. re-organizations' and new issues' ties for significant restructures'
and Best Practice Recommendations' ples of Good Corporat" eou"'nunte (For more information see www'asx'com'au)
|

ry.

l
:\ .t rn,2\

TheASXCorporateGouernanc"Councilhasdevelopedasetofguidelines,Princi.

Dl'scussion Questions

1. 2.

into a separate putting its supervisory function Evaluate the ASX poricy of policy? Supervision' ls this a sound
subsidiary carreO niivrarkets stock exchange with compare with those of another How does this ASX policy which You are familiar?

42

PRTNCTPLES

ruc fr,c,j --or

th(

Box2.4 The Listing Rules of the Australian Stock Exchange

To protect

u tinc;r.inpar

the integrity of the market, ASX sets standards for the behaviour of listed companies through its Listing Rules. These Listing Rules cover the following matters:

. . . . . . . . . . . . . . . . . .

lSrrefnmer rry.slation nrpmered in t

.qmnr"iies.

Admission of companies to the ASX official List Market quotation Continuous disclosure of relevant information Periodic disclosure of specific information Additional reporting for mining and exploration Securities tradlng Changes in capital and new issues of shares Transfers and registration of share transactions Restricted securities Transactions with persons in a'position of influence

T:e registr

'iurncj*rn of tl q'ilnjilr:: in effec

firms I

;il,r!:tranies is

Oase Stut

i- :he
'e!

L]nil

Significanttransactions
On-going requirements

stered -K have t -equired d

doc ComPar

-rese

Additional requirements for trusts Meetings required Documents required

Fees

\EiRL (ext(

=rancial d
ComPar Drrect is

sdresset
*om over
company'

The halting of trading, suspension and removal of companies

Application of the listing rules

(The ASX Listing Rules, Appendices, and Guidance Notes are available in electronic

bought on

format)
(For more information see www.asx.com.au)

Discussio

a
Ir{arket intermediaries play an increasingly important role in modern corporate governance. In the original model of the corporation, shares were held by individual shareholders

Check does t

who interacted directly with their company, Today, although individual investors do have a significant share in some markets, institutional investors play a very significant part in most. The institutional investors may include an affay of financial institutions such as pension funds, investment funds, life assurance funds, unit trusts, hedge funds, and other investment houses. There can be a raft of intermediary institutions between the company and the ultimate investor in its shares. Investment bankers may act as underwriters in launching shares in an IPO, an initial public offering of shares. Brokers, merchant bankers, and other institutions can hold shares on behalf of others. A further complication can arise if the financial institution holding shares lends them as security for another transaction. This situation can make it difficult for companies to know who their voting shareholders

Corporat, ranr- iuris.li i"-tir-in-, dett lol$er to en

In the Un

hl-estors. m

SEC overss

=curities

br

etrtec-tit-enes

aaion agair

GOVERNANCE AND

MANAGEMENT 43

areandforthoseshareholderstoexercisetheirproxyvotesandtakepartinthegovernance

the legislation that facilititir, ,.gr.rlut.r, Acts are obvious creation and updating of companies registered in their jurisdi.rJ".

$;"::ffi:ll;

to corporate gove^rnance bv enacting obviousry provide the underpinning the activities of corporate entities
urrd ionrtrujrrs

ri.

t-ffilftt;o*ation

is also a access to corporate documents of companies and the filing and government, J'2 department' The relationship betlveen function of the relevant government in its jurisdiction' and entity to be l.eut.d and operate which in effect allows the corporate of corporate governance' companies is an important element

Case Study

Registration Service 2.6 Companies House: The UK Company

all companies House is the central registry for ln the United Kingdom, Companies guarantee' All companies in the puOf ic' and limited by registered in the UK-prrvate' file the through companies House, and must UK have to be formal, whenever changes occur' 'n"oroorua"d accounts' annually or required documents and financial for public scrutiny' t-f'-eru Oocr*ents are then available
t-anguage) is a standard XBRL (eXtensinte Ausiness nelporting

CompaniesHouseWebFilingServiceallowscompaniestofllerequiredformsonline. system which describes

financialdataandfacilitatesthecreation,distribution,anduseofbusinessreports.
companies registered addresses on over two million

CompaniesHouseprovidesafreesearchableindexofcompanynamesand in the uK. Companies House

Directisanon-linesearchtool,foraccessinganddownloadingcompanyinformation fromover250million.onnoun,documentsincludin$companyaccounts.Copiesofa reports can be annual return and some company company's latest accounts and
bought on-line' (For more i nformation see www'companieshouse'
gov'
u

k)

Discussion Question

1.
ern,ders

UK' How on a sample of companies in the Check out the information available countries? compare with that available in other does this

have
Lrt

in
as

pany jurisdictions now

CorporateregulatorsplayaneverincreasingroleincorPorategovernance.Manycomwhich monitors stock market

rh

rther
'pany :rs in
rkers,
r

has the with corporate governance codes' and activity, determines and requires compliance power to ensure comPliance'

h#

a separate

regulatory authority,

and effrcient investors, maintain fair, orderly,

IntheUnitedStatestheUSSecuritiesandExchangeCom.milion(SEC)existstoprotect The markeis, and facilitate capital fbrmation'

arise

stion.
olders

SECoverseesthekeyparticipantsinthesecuritiesworld,includingsecuritiesexchanges, securitiesbrokersanda.d.,,,i,'.,.,tme,,t"dui,ors,andmutualfunds.CrucialtotheSEC,s being able to take legal areas is it, ..rfo...-.nt authority' effectiveness in each information' "i;;J fraud, and the provision of false action against insider trJi-rii, u.coontirg

44

PRTNCIPLES

case study 2.7 The History of the US Securities and Exchange commission
The SEC was created following the great crash of 1929. Previously there was little support for federal involvement. During the 1920s over twenty million shareholders set out to make their fortunes on the stock market' Of around US$50 million in new securities issued, half became worthless. Countless fortunes were lost' Many banks failed. Depression followed and confidence in the markets collapsed.

CeeStudY2.S

-re

Securities an statutory bodY otr -Llures markets il securities and fi.tl

congress passed the 1933 Securities Act to restore investor confidence' The Securities and Exchange Commission was set up to enforce the new laws designed
to promote security in the market by requiring public companies to tell the truth about their business, their securities, and the risks involved, and requiring security dealers to treat investors fairly and honestly. The mission of the US Securities and Exchange Commission is to protect investors# maintain fair, orderly, and efficient markets, and facilitate capital formation' Unlike the banking world, where deposits are guaranteed by the federal government, stocks, govern the securbonds, and other securities can lose value. The laws and rules that
ities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge forthemselves whether to buy, sell, or hold a particular security' The SEC oversees the key participants in the securities world, including securities exchanges, Securities brokers and dealers, investment advisors, and mutual funds' Crucial to the SEC's effectiveness in each of these areas is its enforcement authority. Each year the SEC brings hundreds of civil enforcement actions against individuals and companies for violation of the securities laws. Typical infractions include insider trading, accounting fraud, and providing false or misleading information about secur-

Cevelopment of U The statutorY d

.
.

To maintain ant

and orderlinest

To Promote unt

securities and

. To provide Prote . To minimize cri

duce sYstemic cial SecretarY priate steps in

As the statutor mission Places gt our accountabilit\

corqorate governi /ic bodies.' All imf isional staffatter

which meets reg

'

ational matters i itions of the Com

ities and the companies that issue them. To help support investor education, the sEC provides a mass of information, including the EDGAR database of disclosure documents that public companies are required to file with the Commission.
Though it is the primary overseer and regulator of the US securities markets, the SEC works closely with many other institutions, including Congress, other federal departments and agencies, the self-regulatory organizations (e.g. the stock exchanges)' state securities regulators, and various private sector organizations. ln particular, the Chairman of the SEC, togetherwith the Chairman of the Federal Reserve, the Secretary of the Treasury, and the Chairman of the Commodities Futures Trading Commission, serves as a member of the President's Working Group on Financial Markets' (For more information see www'sec.gov) Discussion Questions

Discussion Ques

1. The SFC won

Disclosure A Accountants

2.

Evaluate the of the board'

Previously the P tastrophes. But in

the investigative

1.

Explore the sEc website. what is your impression of the EDGAR database? key issues the SEC is pursuing at the moment?

to be considered b Finally, the grot ate governance ne on their activities by the laws of th,

2. What are the

GOVERNANCE AND

MANAGEMENT 45

CaseStudy2'STheRoleoftheHongKongSecuritiesandFuturesCommission
The Sec u riti es a nd Futu res Com

:ff;ilffi ;;ilffi;"ivir

on (SFC) s :" .'to: T.l::, :i l"i securities and the service, responsibre ror regurating
m
i

ssi

"t:1il: ::i

futuresmarketsinHongKong,responsibleforadministeringthelawsgoverningthe encouraging the in Hong Kong' and facilitating and securities and futures markets
develoPment of these markets' The statutory duties ofthe SFC are:

. .

To maintain and promote the To promote

fairness, efficiency, competitiveness, and futures industry E and orderliness of the securities operation and functioning of the the understanding by the public of

transparency'

securities and futures industry .Toprovideprotectionformembersofthepublicinvestinginorholdingfinancialproducts *:"]::111T-trv;to re. crime and misconduct in the securities
To minimize

3n! ducesystemicrisksinthesecuritiesandfuturesindustryandtoassisttheFinan. Hong Kong by taking approfinancial stability of cial secretary in rnuintuinir,g the and futures industry' priate steps in relation to the securities

ASthestatutoryregulatorofthesecuritiesandfuturesmarketsinHongKong,theCommissionplacesgreatimportanceoncorporategovernance..Wealwaysstrivetoenhance ouraccountabilwtothepublicandthetransparencyofourwork.Weadoptandimplement applicable to pubrate wiinthe best stand ards corporate governance practices comrnensu licbodies.,Allimportantpoliciesanddecisionsarediscussedandapprovedbytheboard'

whichmeetsregularly"u",ymontnandholdsadditionalmeetingsasnecessary.Divisionalstaffatt"nOnou'Omuetingstoexplainpolicyproposals'reportonimportantopert

r
l-

ationalmattersandregulatoryissues.Membersarealsobriefedonthefinancialpos. statements'

provided with monthlyfinancial itions of the CommissiJn and (For more information see www'sfc'hk) Discussion Questions

t-

1. The SFC won the platinum award

c
tle
ir-

the 2OO7 Best Corporate Governance pubric Hong Kong Institute of certified Disclosure Awards, run ov tne judgement?
in

2.

Do you agree With their Accountants. (www'hkicpa.org.hk) senior executives be members board structure of the SFC' Should Evaluate the of the board?

le

tastrophes. But in

recent;;";;. media has shone a spotlightgovernance process a'd have ;tui;t i" tt" to'porate the investigati". -taiu "JJii;;; to be considered by practitioners' stakeholders in corporor ro.i.tul influences and other Finally, the g."*i"g i;;;;;lrr.. tended to be left alone to carry In earlier days companies ate governance needs ;il;rir. provided that they abided
of profit *itttooiir',t.rference, on their activities in the fursuit many people l" which they opt*tta' No longer' Today by the laws of the jurisiittio"'

Previouslythepressshowedlittleinterestinbusinessaffairsunlesstherewefemalorcaon corporate activities' and

46

PRINCtPLES

expect companies to adopt a socially responsible attitude to their activities, for example br-

:1

.,:

not doing objectionable things, such as polluting the environment, exploiting workers, or

killing animals.
Corporate social responsibility (CSR) reflects what some commentators see as companies' obligations to everyone who might be affected by the company's activities (the stakeholders). Not only contractual stakeholders, such as employees, suppliers, and customers, but local neighbourhoods who could be affected by a plant closure, cities and states
affected by the loss of jobs and tax revenues by a company's strategy to move activities elsewhere, even larger international society for company's employment policies, environrlGfl-

ll

tal impacts, or marketing polices around the world. We shall explore these issues later.

Drivers of Good Corporate Governance

In this chapter we have seen that the board is the major driving force of governance in
a

company. Primarily, the board determines whether a company's governance is sound. But there are other drivers ofgood governance in a company. In the original model of the company, shareholders were individuals and met together

periodically to receive the report and accounts of their directors, to elect or re-elect them, and to approve significant changes, such as an alteration in the share capital, as required by company law or the company's articles. But today the potential for individual shareholder activism in a company with large numbers of diverse shareholders is low. The one share, one vote principle of, so-called, shareholder democracy no longer leads to shareholder power. In America shareholders can only run a campaign to nominate or remove directors at their own expense, whereas the company pays for the board's campaign. Under the proxy voting rules only'for'votes count, votes cast against a candidate are ignored. Moreover, incumbent boards frequently refuse to put shareholder resolutions on the proxy ballot and, even if a resolution succeeds, the board may choose to treat the resolution as advisory and ignore it. In Britain shareholders do have the right to have resolutions put on the ballot and, if successful, they are
usuaily binding on the directors. For major companies, particularly those listed in the liquid markets of the United States or the United Kingdom, a significant proportion of their shareholders will now be institu-

tional investors-banks, insurance companies, pension funds, hedge funds, sovereign

funds (all of which we will discuss later). Many of these institutions hold between one and five percent of the equity and in America now account for around two-thirds of the investment in major companies. Some of these institutional investors have become drivers of corporate governance change, ivielding governance power particularly if they act in concert through an independent association. Dissatisfaction with boards has increased in recent years with concerns over poor corporate performance, allegedly excessive directors' rewards, loss of
investor confidence following down turn in markets, and company collapses. A few hedge fund managers have become active shareholders. Interestingly, they can sometimes afford the advice of leading lawyers and investment bankers, who previously might have felt a loyalty to their corporate clients but now recognize the fee potential of activist adventurers.

GOVERNANCE AND

MANAGEMENT 47

rise of shareholder Some commentators have depicted the situation as an irresistible

powerandaninevitablestrugglebetweenshareholdersandtopmanagement.otherstake theoppo,it.position,arguirrgthattheseparationbetweenshareholdersandtopmanagefreedom' they argue' to take ment is at the heart of tt. gorr.rnu.t.. ,yrt.-. Boards need from interventionist institutions' business decisions 1., good faith without interference focusing on the short term, failotherwise boards might respond to investor pressure by institutional investors are ing to make crucial long term investments. Moreover, they add, ultimate individual owners and companies' in effect intermediaries in the chain between

in recognizing and responding to Such institutions have governance problems of their own
the different aims of their investors' and obviously can exert Corporate raiders are a special case of institutional investor large holding in a company considerable governance power. By acquiring a sufficiently example, investor Kirk Kerkorian these investors can directly influence its activities. For on the board of General Motors in 2006. on the other hand'
was able to place his.romine. of Timewarner' carl Icahn arrd ro*e hedge funds failed to gain control of the board

bid from the friendly warner company

of 1989, the supreme-corrrt of Delaware ruled that directors bid from Paramount and accept a lower company could turn down a us$220m. hostile creating Timewarner, despite the effect on share-

In

the Time publishing

holders.Sincethen,boardsofthemanymajorUScompaniesincorporatedinDelaware
shareholders. Then they adopted became entrenched, and felt safe from pressure from their (thus making it impossible to replace anti-takeover poison pills, staggered board elections board membership' at one time), and lgnored shareholders'pressure to change
a

is

t-

n d
t;e

board a hostile takeover bid The market fo, .o.porut'. control, that is the ever-present threatof for board performance and from a predator company, is supposed to provide an incentive liquid markets (such as the US and the is anoth.r potential driver of govefnance power. In to be constantly uK), the potential of the muriet fo, control is significant and boards.need we will see in a subsequent vigilant on corporate performance and their share price. As governance systems and .h"upt., this is ; significant feature that distinguishes corporate are relatively illiquid and practices in these countries from those where the stock markets and fapan)' In such markets reliance is placed more on debt capital (such as Germany of finance become a driving driven by debt rather than equity, the banks and other sources force for good governance. incentives in ln pu.Jrrg *. should also note that giving directors and top management governance' the form of stock options also provides a driver for better founders and their famiIn some countries controlling block-holders of shares, often power by being able to influence decilies, also provide a significant driver of governance shareholder vote' However' the sions in the boardroom over and above the power of the spain is beginning to reduce deepening of the stock markets in countries such as Italy and
some of the significance of such block-holders'

1-

of
ge

gor...u*. that a hold]ng

rd

v'

company' and that the joint its group, that family meribers ha* over the board of a family over their jointly-held joint veriture partners have, through the joint venture agreement, of such entities in a future venture company. we will .*plor. the nature and governance chapter.

the effective driver of Finally, in ieviewing drivers of governance we should note and associated companies in .o*p"rry has ovel the subsidiary