Research briefing

August 2005

How global is good corporate governance?
Stephanie Maier
likely to continue. As codes converge and standards improve investors are looking beyond straightforward compliance to seek out factors that contribute to the creation of long term value. However, despite this promising trend important geographical variation in governance practices remains and as EIRIS’ analysis shows some companies and countries still have a long way to go: • Only 25% of US companies separate the roles of chairman and CEO compared with at least 50% for companies in other developed economies • Swiss boards have the highest percentage of independent directors (81%) – Germany, Austria and Japan all have less than 10% • Only 4% of companies in Japan have audit committees comprising a majority of independent directors compared to over 95% in the USA, Canada, the Netherlands, Luxembourg, the UK and Ireland • Only 22% of companies in Singapore and 25% of companies in Hong Kong have meaningful codes of ethics

Inside
What is corporate governance?........................... 2 Evolution of corporate governance – scandals and emerging code trends .................2 The role of investors ….…………6 Governance in practice – board structure and size, independence, remuneration disclosure, board diversity …………………………….7

Overview
High profile corporate governance scandals and increased shareholder activism are driving better governance practice. As governments and regulators respond to these challenges with the adoption or revision of new corporate governance codes we are seeing an emerging consensus of accepted best practice and this trend is

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1. What is corporate governance?
Corporate governance describes the framework by which companies are directed and controlled i.e. the setting of corporate objectives and the monitoring of performance against these objectives. Good corporate governance aims to provide incentives for the board and management to pursue the objectives that are in the interests of the company and its shareholders. This framework encompasses structural and behavioural components. Structural components include whether the roles of Chairman and CEO are separated and how many independent directors are on the board. Behavioural components include the level of directors’ attendance at board meetings, disclosure of directors’ remuneration and remuneration policy. Increasingly, the issues of board diversity and a company’s code of ethics are also considered when assessing the effectiveness of a company’s decision making. While not traditional elements they are viewed as indicators of independent and accountable decision-making. Corporate governance defines a set of relationships between a company’s management, its board, its shareholders and other stakeholders. It is the process by which directors and auditors manage their responsibilities towards shareholders and wider company stakeholders. For shareholders it can provide increased confidence of an equitable return on their investment. For company stakeholders it can provide an assurance that the company manages its impact on the environment and society in a responsible manner.

Corporate governance encompasses the combination of laws, regulations, listing rules and voluntary private sector practices that enable the company to attract capital, perform efficiently, generate profit and meet other legal obligations and general societal expectations.

2. The evolution of corporate governance
2.1. The scandals Recent history is littered with high profile examples of corporate governance scandals and failures. The result is loss of investor confidence in financial markets and fall in market value. Below we take a closer look at high profile examples of scandals that played key roles forming the corporate governance landscape – companies from opposite sides of the Atlantic operating in different decades. Maxwell Corporation (1991) The Maxwell ‘empire’ was largely comprised of two publicly quoted companies – Maxwell Communication Corporation and Mirror Group Newspapers. Heavy borrowing to finance the expansion of his publishing and media empires led to unsustainable levels of debt. Following the presumed suicide of Robert Maxwell, the group’s financial problems were exposed. Debts of GBP 4 billion and a GBP 441 million sized hole in its pension funds were eventually revealed1. Subsequent analysis highlighted a number of corporate governance deficiencies. Robert Maxwell held the positions of both chairman and chief executive. The lack of separation of these roles led to the concentration of power which facilitated the fraudulent activities. The effectiveness of the non2/20

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executive directors and pension trustees was also questioned although the Serious Fraud Office brought no charges against them. The Maxwell scandal has been described as the greatest fraud of the 20th Century, forcing the issue of corporate governance firmly into the public, business and political arena. Enron (2001) The name Enron is now synonymous with corporate scandal. Previously ranked in the US’ Fortune Top 10 companies based on turnover, it ended its days as one of the largest bankruptcies in US history and was instrumental in the collapse of Anderson, one of the “big five” global accounting firms. Enron, operating in the energy market, set up a series of ‘special purpose entities’ (SPEs) or off-balance sheet entities to enhance its earnings and conceal its debts from the market2. Subsequent investigation focused on the role of the auditor and, in this case, their apparent failure to ask sufficiently probing questions of the directors. It also highlighted the need for directors to act with honesty and integrity and the need for non-executive directors with sufficient experience to oversee the decisions of executive directors. In the aftermath of this scandal, the US government was quick to implement corporate governance reforms together with revisions of the New York Stock Exchange’s (NYSE) listing requirements. Most notably, companies are now required to have an audit committee wholly comprised of independent directors and to publish a code of ethics for senior financial officers.

Parmalat (2003) So soon after the Enron scandal many assumed that no similar financial collapse could take place in Europe. However Parmalat, one of Italy’s largest publicly quoted companies, was declared insolvent in December 2003. The scandal was similar to Enron in that the auditors apparently failed to pick up on fraud3. Forged documents showed cash holdings at a subsidiary, Bonalat, which simply did not exist. This scandal again highlighted the role of the auditor and need for an effective whistle-blowing system. An investigation found that while a number of employees suspected wrong-doing, no-one came forward. The company’s board and ownership structure also raised questions over corporate governance best practice. While publicly quoted, the company was still 51% owned by the Parma based family of its founder Calisto Tanzi. Further, Tanzi held the role of both Chairman and CEO and the board was far from independent, comprising a number of family members. 2.2. The development of codes around the world Against the backdrop of corporate scandals and fraudulent accounting practices, governments and regulators have sought to introduce stronger legislation and regulation to guard against similar collapses in the future and restore investor confidence in financial markets. In some countries legislation and codes addressing corporate governance have been in existence for decades, in others governments are just embarking on the development of such codes. Below are some of the key legislative developments that form the corporate governance landscape in their
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respective countries and have influenced governance codes around the world. 2.2.1. Cadbury Report - UK

audit committee. The Combined Code is now appended to the London Stock Exchange’s (LSE) listing requirements requiring a compliance statement (or explanation of non-compliance). 2.2.2. Sarbanes-Oxley Act – USA

The UK is relatively experienced regarding the corporate governance debate. Following various scandals in the UK, most notably the collapse of the Maxwell publishing group, the Cadbury Committee report (1992) recommended a Code of Best Practice4. Recommendations covered a range of governance practices including the structure and composition of the main board and board committees and highlighted the importance of nonexecutive directors. Importantly, it established the ‘comply or explain’ principle whereby companies should comply with the Code or give reasons for any areas of non-compliance. The Cadbury Report was taken forward by the Greenbury (1995)5 and Hampel (1998)6 Committees tasked with examining directors’ remuneration and implementation of Code recommendations respectively. The Combined Code, drawing together the recommendations of each of these reports, was published in 19987. The Combined Code operates on the ‘comply or explain’ principle. The revised Combined Code, published in 20038, incorporated recommendations from two further reports – the Higgs9 and Smith10 Reviews. The Higgs Review examined the role and effectiveness of nonexecutive directors. Key recommendations addressed the independence of non-executive directors and their contribution to the board. In particular, it recommended encouraging the disclosure of the number of meetings attended and improved training for directors. The Smith Review examined the role of the
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Again, following high profile scandals – this time Enron and WorldCom – the US Congress working with the New York Stock Exchange (NYSE) agreed reforms to address potential conflicts of interest and the close working relationship between companies and their auditors. The result was The Accounting Industry Reform Act 2002, widely known as the Sarbanes-Oxley Act (2002). The purpose of the act is to enforce the independence of external auditors, reinforcing the duties of chief executive officers (CEOs) and chief financial officers (CFOs) by imposing strict penalties for misrepresenting the financial position of their companies in quarterly and annual reports. Penalties of personal fines up to USD 1 million or imprisonment of up to 10 years, or both, are available for mis-declaration. Sarbanes-Oxley has had a profound effect on corporate governance strategies within the US and further afield. The NYSE listing requirements proscribe additional requirements including that listed companies must have a majority of independent directors and must adopt and disclose a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers.

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2.3. Emerging consensus of corporate governance standards The global nature of financial markets links companies and investors around the world. The impact of major corporate scandals and subsequent regulatory and legislative responses from governments and regulators has been felt in all major economies. It should therefore come as no surprise that the principles of good corporate governance are converging, while variations in national company law and practice remain. Below we summarise the governance principles developed by the OECD to assist both OECD and nonOECD governments in their efforts to evaluate and improve the legal, institutional and regulatory framework for corporate governance in their countries and look at common principles in the corporate governance codes of 24 developed economies. 2.3.1. OECD Principles of Corporate Governance The Organisation for Economic Cooperation & Developments (OECD) first published its Principles for Corporate Governance in 199911. These are widely used as a benchmark for policy makers, investors, corporations and other stakeholders. The principles are nonbinding but represent common corporate governance standards and good practice, intended to reflect and inform the corporate governance debate internationally. The principles were revised in April 2004 and cover the following issues: I - Ensuring the basis for an effective corporate governance framework II - The rights of shareholders and key ownership functions III - The equitable treatment of shareholders

IV - The role of stakeholders in corporate governance V - Disclosure and transparency VI - The responsibilities of the board Rather than advocating a particular board structure or proscribing behaviour the principles identify common elements that underlie good corporate governance. For example, principle I states that the corporate governance framework should promote effective and transparent markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities. 2.3.2. Common governance code elements Corporate governance codes address a wide range of structural and behaviour elements including board accountability, shareholder rights (e.g. the one-share-one-vote-one-dividend principle), financial disclosure and internal controls, executive remuneration and board structure and functioning. National codes vary in quality significantly; in many countries, especially where codes have only recently been adopted, there remains a discrepancy between code recommendations and corporate governance standards in practice. Nonetheless, signs of convergence are unmistakable. For instance, the separation of chairman and chief executive is no longer unknown in the USA. The EU is promoting the role of independent directors and the disclosure of directors' pay. France has updated its governance code12, which advocates more independent audit committees and stipulates that a third of directors should be independent. The German Cromme Commission in May
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2003 urged greater transparency of director salaries. More recent codes, and those codes recently revised, include the ‘comply or explain’ principle, whereby companies are required to comply with code provisions or provide and explanation for non-compliance. 19 of the 24 developed economies covered by EIRIS incorporated this provision. For the purpose of this analysis, EIRIS has focused on four key indicators of board structure and compared the key code recommendations in relation to the following indicators: • Separation of powers at board level • Independent scrutiny of management • Independence of audit committee • Transparency of remuneration A full comparison of national codes according to these for elements can be found in the annex. 2.3.3. Future developments

3. The role of investors
3.1. Shareholder activism Large institutional investors, predominantly pension funds and insurance companies, have historically played a significant role in engaging with companies to raise concerns over corporate governance. This is driven by both the scale of their investments and their longer-term interest. Given their longer term perspective, pension funds in particular are considering the impact their investments are having on the world their members will retire into. Shareholder activism is particularly strong in the UK and US. In the UK, the Association of British Insurers (ABI) and National Association of Pension Funds (NAPF) have developed their own best practice guidelines for corporate governance. Together with advocacy organisations, such as the Pensions Investment Research Consultants (PIRC) and Institutional Shareholder Services (ISS), these organisations monitor corporate governance activities and provide voting advice. Collective abstentions or votes against management at Annual General Meetings (AGMs) send strong messages to company boards. In the US, the California Public Employees' Retirement System (CalPERS)13 has considerable influence in altering company corporate governance practices. In the UK, shareholders have seen their influence sky-rocket. In May 2003, shareholders successfully voted down plans that would have allowed JeanPaul Garnier, chief executive of GlaxoSmithKline, to pocket a ‘platinum parachute’ payment of GBP 22million if he left the company14. This represented a watershed as companies realised that they could loose votes – since then shareholders have been increasingly

Social, environmental and ethical (SEE) risk management, company wide codes of ethics and board level responsibility for stakeholders are increasingly considered when looking at a company’s governance framework. Legislation such as the Operating Financial Review (OFR) in the UK will undoubtedly prompt better disclosure on these issues from companies. The OFR requires directors to provide shareholders with a balanced and comprehensive analysis of their business, including future prospects. If relevant, the OFR must include information about the environment, employees and social and community issues. If directors choose not to disclose such information they must make a positive statement to this effect.

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vocal, especially on the issue of executive remuneration. 3.2. Motivations It is often asserted that corporate governance impacts on the bottom line. Good corporate governance practices may grant a competitive advantage allowing companies to achieve: • lower borrowing costs • lower litigation costs • reduced chance of being targeted for shareholder action and negative proxy votes • increased chance of recruiting and retaining high quality directors • increased market trust in reported earnings • a higher stock price This view is clearly now shared by a number of investors. Evidence from a 2002 Global Investor Opinion Survey conducted by McKinsey & Co. found that a majority (over 75%) of investors were prepared to pay a premium for companies exhibiting high governance standards. Premiums average 12-14% for companies in North America and Western Europe, 20-25% in Asia and Latin America, and over 30% in Eastern Europe and Africa. High governance standards were defined, for the purposes of the McKinsey study, as: a majority of outside directors; outside directors being truly independent with no ties to management; directors with significant shareholdings; a material proportion of directors’ pay being stock-related; formal director evaluation in place; and responsiveness to investor requests for information on governance issues. Top reform priorities were: strengthening corporate transparency; more independent boards; and greater boardroom effectiveness through such steps as better director selection.

Active dialogue frequently occurs between companies and their shareholders as companies are challenged on their disclosures of noncompliance with corporate governance codes. A balance is sought between securing good governance through compliance with corporate governance codes without creating overly proscriptive requirements that may damage companies and result in unnecessary additional costs.

4. Governance in practice
EIRIS’ research into over 1600 companies on the FTSE All World Developed Index representing leading large and medium companies in 24 developed economies provides a global picture of corporate governance practice in Western Europe, North America and Asia Pacific15. 4.1. Board structure A fundamental corporate governance difference among countries, frequently embedded in company law, relates to board structure and the use of a unitary versus a two-tier board. In the majority of countries (three quarters) the unitary structure based on the AngloSaxon corporate model is predominant. Elsewhere, notably in Germany and Austria, the two-tier structure predominates. Variations of these structures include a unitary board with a separate board of auditors (Italy) or unitary board which appoints a separate managing director (Finland). Despite these formal structural differences, there are significant similarities in actual board practice. Generally, both the unitary board of directors and the supervisory board in a two-tier structure are elected by shareholders. Also, under both types of systems, there is usually a supervisory

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function and a managerial function, although this distinction may be more formalised in the two-tier structure. In some countries, employees may appoint board members in companies of a certain size. For example, in Germany companies with more than 500 employees have employee representatives comprising one third of the supervisory board. In a quarter of countries analysed there are provisions for direct employee involvement at board level. 4.2. Board size In a number of countries minimum board size is determined by national law or listing requirements. The ‘appropriate’ board size may be dependent upon company size and sector. Corporate governance codes have tended to shy away from the complex and potentially restrictive task of recommending a specific size, instead employing more general guidance. For example, “An effective board should not be so large as to become unwieldy. It should be of sufficient size that the balance of skills and experience is appropriate for the requirement of the business and that changes in the board’s composition can be managed without undue disruption.” Higgs Review (2003) Analysis of EIRIS data reveals that New Zealand has the smallest average board size of 7.2 directors. Austrian and German boards are largest with an average of 18.1 and 22.1 directors respectively. The smallest board range (four) is also found in New Zealand with boards of between five and nine directors. The largest range is found in Japan (47) where board size varies dramatically between three and 50 directors. Interestingly, a recent study investigating corporate boards in OECD
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countries found a negative impact of board size on company value (Alonso et al, 2001)16.
Average board size (directors) 7.2 8.1 9.7 9.9 10.0 10.1 10.7 11.4 11.6 12.0 12.3 12.6 12.9 13.0 13.0 13.5 14.9 15.0 15.0 15.2 16.5 17.0 18.1 22.8 11.9 Min size 5 5 5 8 4 7 5 6 5 5 6 9 8 3 6 5 8 10 7 10 9 13 6 8 3 Max size 9 14 28 14 15 22 23 25 19 22 15 16 25 50 22 24 27 21 23 21 31 21 26 32 50

Country New Zealand Australia Switzerland Norway Singapore Finland USA UK Hong Kong Denmark Sweden Greece Netherlands Japan Canada France Belgium Ireland Italy Spain Portugal Luxembourg Austria Germany Total

Range 4 9 23 6 11 15 18 19 14 17 9 7 17 47 16 19 19 11 16 11 22 8 20 24 47

EIRIS data: Autumn 2004

4.3. Separation of chairman & CEO A key principle in the majority of corporate governance codes is the clear division of the responsibility for running the board and the executive responsibility for running the company’s business. The idea is that no one individual should have unfettered powers of decision. The role of the chairman in leading the board, ensuring its effectiveness through dissemination of accurate, timely and clear information and communication with shareholders, is highlighted in a number of codes. In some countries, such as Sweden, the legislation requires an executive managing director separate from the non-

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executive board. Elsewhere, the twotier board structure ensures the separation of roles.
Country Austria Denmark Ireland Luxembourg Norway Sweden Germany Australia UK New Zealand Netherlands Italy Finland Belgium Canada Singapore Switzerland Hong Kong Portugal Greece Spain France Japan USA Average Separation of Chair & CEO 100.0 100.0 100.0 100.0 100.0 100.0 97.7 97.3 96.2 95.5 95.0 88.1 87.5 84.6 79.7 78.0 77.8 65.7 62.5 58.3 58.3 52.5 50.8 24.9 56.3 Predominant board structure Two-tier Two-tier Unitary Unitary Two-tier Unitary (appoints managing director) Two-tier Unitary Unitary Unitary Two-tier Unitary(board of auditors required) Unitary (appoints managing director) Two-tier board on the decline Unitary Unitary Unitary Two-tier Unitary Unitary (board of auditors required) Unitary Unitary Unitary (both permitted under French law) Unitary(board of auditors required) Unitary
EIRIS data: Autumn 2004

25% of companies in the US and just over 50% of companies in Japan. 4.4. The role of independent directors All directors should take decisions objectively and in the best interests of the company. Independent oversight of board decision-making is integral to the effective functioning of a company, maintaining accountability and transparency. Recent developments in corporate governance have focused on the proportion of independent directors on the board. Designation of independence is, to a large extent, subjective, and depends on individual integrity and judgement. However, there are certain relationships that are widely perceived to influence an individual’s capacity for independent decision-making. For example, EIRIS will accept a company’s explicit designation of independence unless we become aware of evidence that the director: • has served for 10 years or more • has close family relationships with executive directors of the company • is an employee representative • is an executive of subsidiary company of the parent company • represents a major shareholder in the company • has a major supplier, customer, consultancy or advisory relationship or contract with the company • has been employed in an executive capacity within the previous three years Switzerland, Canada and the USA have high percentages of independent directors on the board. In the wake of high-profile scandals such as Enron, WorldCom and Xerox, the US was quick to implement reform including the Sarbanes-Oxley legislation and new

The highest proportion of companies with separate chair and chief executives within a unitary board structure are in Ireland and Luxembourg, although this figure is a little distorted by the relatively small number of large and medium cap companies from these countries listed on the index used for the purpose of this research. In Australia, the UK and New Zealand over 95% of companies separate the roles. This compares with just fewer than

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NYSE listing requirements. A key focus was independence on the board. At the other end of the scale independence on German and Austrian boards is significantly below average. In these countries, national laws require the supervisory board to consist of shareholders' and workers' representatives (including trade unions) which therefore cannot be considered independent. This law has contributed to smaller numbers of independent directors on the board.
Country Switzerland Canada USA Finland Ireland Netherlands Australia UK New Zealand Norway Italy Singapore Sweden France Belgium Denmark Luxembourg Spain Hong Kong Portugal Greece Japan Austria Germany Mean percentage independence per board 81.3 73.6 68.5 66.8 61.6 57.8 55.3 51.7 51.5 49.2 48.2 46.9 43.7 43.3 42.3 38.2 30.6 28.9 28.1 23.1 19.7 5.8 4.5 1.5
EIRIS data: Autumn 2004

effectiveness of the audit process as a whole. Most large cap companies have a separate audit committee, though the proportion of independent directors that is required for an effective audit committee varies between countries. In Australia and New Zealand majority independence is specified in the codes, whereas in the US, the NYSE listing requirements prescribe that all audit committee members fulfil the independence requirements. The independence of the audit committee varies considerably from just 4% of companies with a majority independent audit committee in Japan to approximately half of companies in Norway (50%) and Sweden (56%), and over 95% in the UK, Netherlands, Canada, USA, Ireland and Luxembourg.
Country Ireland Luxembourg UK Canada USA Netherlands Italy Switzerland Singapore Finland France Denmark Australia New Zealand Germany Hong Kong Belgium Sweden Norway Portugal Greece Spain Austria Japan Average Majority independent audit committee 100 100 97.7 97.1 95.7 95 92.9 88.9 86 75 72.9 71.4 68.8 68.2 68.2 66.7 61.5 56 50 50 41.7 33.3 14.3 4.1 64.5
EIRIS data: Autumn 2004

4.5. Audit committee independence The role of the audit committee has come under close scrutiny, especially in the aftermath of recent accounting scandals. The main responsibilities of the audit committee are to monitor and review the integrity of the company’s financial statements, its internal financial controls, the external auditor’s independence and objectivity and the

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4.6. Remuneration disclosure “Levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully, but a company should avoid paying more than is necessary for the purpose. A significant proportion of executive directors’ remuneration should e structured so as to link rewards to corporate and individual performance” Higgs Review (2003) In recent years investors have become more active in challenging remuneration packages. 2002 was a significant year for UK shareholders who successfully persuaded major companies such as Vodafone and GlaxoSmithKline to withdraw or amend share scheme proposals. Directors’ pay continues to concern shareholders, though a lack of transparency in remuneration can make it difficult for shareholders to hold companies accountable. EIRIS has analysed remuneration disclosure, where disclosure is defined as disclosure of the CEO’s salary, or the salaries of all directors individually or as a whole. The quality of disclosure, e.g. full details of salary, bonuses and share options is not taken into account here. Most countries have a relatively high level of disclosure at this definition. In many cases this is because it is required by national legislation or stock exchange listing requirements. Countries without such requirements perform noticeably worse. Greece and Japan are clearly the laggards with 58% and 44% disclosure respectively.

Country Finland France Germany Ireland Luxembourg Netherlands Norway Portugal Sweden Switzerland UK USA Australia Italy New Zealand Belgium Singapore Spain Hong Kong Austria Denmark Canada Greece Japan Average

Remuneration disclosure 100 100 100 100 100 100 100 100 100 100 100 100 99.1 97.6 95.5 92.3 92 91.7 86.9 85.7 71.4 68.1 58.3 44.1 84
EIRIS data: Autumn 2004

4.7. Board diversity There is growing consensus that increased diversity contributes to a more effective board as diverse perspectives are taken into account in board decision-making. One of the non-code recommendations made by Derek Higgs in the ‘Review of the role and effectiveness of non-executive directors’ suggested that boards should draw more actively from areas where women tend to be more strongly represented when making appointments. A report in June 2003 by Laura Tyson17, dean of the London Business School, called for an annual census of boardroom diversity and emphasised that diversity in backgrounds, skills and experiences of non-executive directors enhances board effectiveness by bringing a wider range of perspectives

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to bear on issues of company performance, strategy and risk. EIRIS research shows that: • Only 7% of the directors of leading companies in the major developed economies are women (7.1%) • Over 46% of the companies have no women on the board (46.6%) • Only 23% of the companies have more than one woman on the board (23.1%) • North American companies are among global leaders in terms of the percentage of women on their boards, although women still represent less than 13% of directors on US boards and less than 11% of Canadian boards • Australian and New Zealand companies also have above average representation (9.4% and 10.4% respectively) • Japanese companies are at the other extreme, with only 0.4% of their board members being women. This is easily the lowest of any major developed economy • Nordic companies are, on average, global leaders, with Norway the leading performer globally (21.1%) Nordic countries appear as global leaders with women representing on average 26% of board directors in Norway and 20% in Sweden. Scandinavian countries generally perform better on other indicators of overall gender equality (such as the UNDP’s Gender Development Index). In addition, senior politicians in both Sweden and Norway have threatened to legislate quotas for companies if the number of women on boards does not increase, introducing targets of 25% and 40% respectively.

Country Norway Sweden Finland USA Canada New Zealand Denmark Australia Germany UK Greece France Switzerland Singapore Netherlands Austria Belgium Hong Kong Spain Luxembourg Ireland Italy Portugal Japan

Women on the board: average percentage representation

26.2 19.9 14.3 12.7 11.1 9.9 9.3 9.3 8.0 7.5 7.4 6.4 6.0 6.0 5.9 5.8 5.3 4.5 4.1 3.8 3.8 2.6 0.7 0.6
EIRIS data: Autumn 2004

4.8. Code of ethics In recent years a number of major intergovernmental, NGO and privatesector initiatives have focussed on the need to combat bribery and corruption, and on the underlying need to improve standards of corporate governance, ethics, transparency and integrity. The NYSE has included a requirement of listed companies to adopt and disclose a code of business conduct and ethics for directors, officers and employees as part of their listing requirements. The implementation of systems to support codes of ethics is increasingly included when looking for good governance practices. The analysis below highlights the significant variation the rates of adoption of codes of ethics and supporting management systems. The table shows the percentage of companies assessed as ‘basic’ or above.

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Code of ethics - to be assessed as ‘basic’ EIRIS requires the presence of a code with at least one of the following specific elements: • Obeying laws and regulations • Prohibits giving and receiving bribes • Restricts giving and receiving gifts • Prohibits facilitation payments • Prohibits donations to political parties • Conflicts of interest • Other – this includes ‘ethical competition’, anti-competitive practices, use of company resources, external activities of employees, cultural sensitivity, innovative or sector-specific elements. Management system– to be assessed as ‘basic’ EIRIS requires at least one of the following specific elements: • Employee training* • Compliance monitoring • ‘Whistleblowing’ procedures • Reporting –includes details of breaches and enforcements • A regular review of code
* Requires an additional element

• Neither of the two major companies in Luxembourg have policies • Hong Kong and Singapore adoption rates trail significantly behind with less than 25%
Country Finland Netherlands UK Norway Italy Sweden Denmark Australia Canada Portugal France Switzerland Belgium Germany USA Austria Ireland Japan Greece New Zealand Spain Hong Kong Singapore Luxembourg Average Code of ethics 100 95 93.2 87.5 83.3 80 78.6 75.9 75.4 75 72.9 66.7 61.5 61.4 60.4 57.1 57.1 57 50 45.5 41.7 25.3 22 0 62.1 Ethics systems 62.5 85 86.4 75 64.3 64 57.1 58 75.4 62.5 62.7 66.7 61.5 56.8 59.3 71.4 57.1 60.2 33.3 40.9 45.8 18.2 8 0 58.5

A number of countries, such as the United States and Spain, have recently introduced listings requirements for companies which include ethical codes for directors. Where a company has a policy in such circumstances, and where this is not clearly applicable to all employees then this has been classified as ‘Limited’ and does not meet the ‘Basic’ requirements. The analysis shows for codes of ethics: • Overall half (62.1%) of companies have a meaningful code of ethics or equivalent policy • Companies in Finland and the Netherlands have the highest proportion of companies with basic policies • UK companies follow closely behind with 93.2% having ethics codes

EIRIS data: Autumn 2004

However, these figures drop when looking at the proportion of companies with systems in place to support their codes of ethics. While in the UK, the Netherlands, Canada and Norway over 75% of companies have a ‘basic’ management system; in a quarter of countries less than 50% of the companies have a ‘basic’ management system. The importance of systems to support a company policy is becoming increasingly apparent. While a good code of ethics and indeed systems to support it cannot protect against wrong-doing, provisions such as easily accessible ‘whistleblowing’ procedures will increase the chance that wrongdoing is identified.
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4.9. Overview of governance performance EIRIS has combined six key corporate governance indicators to provide an overall picture of governance performance in the leading large and medium companies across Europe, North America and Asia Pacific. EIRIS corporate governance ranking
UK Netherlands Finland Ireland Italy Switzerland Canada Norway Australia Sweden USA France New Zealand Belgium Denmark Portugal Singapore Luxembourg Austria Germany Spain Hong Kong Greece Japan 0% 50% 100%

Countries are ranked according to the proportion of companies meeting each of the four core indicators and the two additional indicators assessed at ‘basic’ or above. All six elements are equally weighted. This reveals that the UK, the Netherlands and Finland appear as the countries with the ‘best’ governance practices. Greece and Japan perform significantly worse. The UK and the Netherlands have the highest percentage companies meeting all six indicators. In the case of the UK this is perhaps unsurprising, as a robust corporate governance code has been in place for over 10 years. The Combined Code has been, and continues to be, used as a template for a number of national governance codes as consensus on corporate governance best practice emerges. In addition, shareholders in the UK are some of the most active globally, increasingly challenging companies and questioning their compliance and governance practices. In the Netherlands, the prevailing board structure and new governance code have contributed to good governance practices there. At the other end of the scale less than 50% of companies in Hong Kong, Greece and Japan meet the indicators. This appears to be the result of having only recently adopted a national governance code or having a less proscriptive code in place. However, it is anticipated that investors, in their quest for long term value, will continue to push for higher governance standards worldwide.

The assessment takes into account the four core indicators of board practice: • Separation of Chairman and CEO • Over a third of the board independent • Majority of the audit committee independent • Director remuneration disclosed And two further governance indicators: • Quality of the code of ethics • Quality of systems for implementing the code of ethics

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Notes
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‘The man who wasn’t there’, Financial Times, January 1996 ‘A guide to corporate scandals’, The Economist, July 2002 ‘Parma splat’, The Economist, January 2004 Cadbury, Sir Adrian (1992) Report of the Committee on the Financial Aspects of Corporate Governance Greenbury, Sir Richard (1995) Directors’ Remuneration Hampel, Sir Ronnie (1998) Committee on Corporate Governance: Final Report Combined Code (1998) Combined Code – Principles of Corporate Governance Combined Code (2003) The Combined Code on Corporate Governance Higgs, D (2003) Review of the Role and Effectiveness of Non-Executive Directors Smith, Sir Robert (2003) Audit Committees Combined Code Guidance OECD (1999) OECD Principles of Corporate Governance and OECD (2004) OECD Principles of Corporate Governance See http://www.oecd.org Bouton, D (2002) Pour un meilleur gouvernement des entreprises cotées: Rapport du groupe de travail présidé par Daniel Bouton, président de la Société Générale, MEDEF and AFEPAGREF See http://www.calpers.ca.gov/ for further information Financial Times – Sundeep Tucker (26 January 2005) Company specific data is available to clients of EIRIS through the Ethical Portfolio Manager (EPM) software. Alonso et al, (2001) Corporate boards in some OECD countries: size, composition, committee structure and effectiveness Tyson, L (2003) The Tyson Report on the Recruitment and Development of Non-Executive Directors. London Business School.

Definitions
Board - the ultimate decision-making body of a parent Company. Two board structures predominate. For two-tier boards, EIRIS combines both supervisory and management committees, treating them as one. We include alternate directors. In the USA, advisory directors may sit on the board. These directors are paid an annual retainer but have no voting rights. Advisory directors are not included as members of the board. Women on the board - EIRIS includes all board members, both executive and nonexecutive. Including both full-time and part-time board members generally boosts the percentages. Women directors are more likely to be part-time, non-executive directors, than full-time, executive directors. In general if full-time directors only are counted the percentages of women would be even lower.

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5. Annex
5.1. Comparison of corporate governance codes Summary of predominant corporate governance code and key code recommendations in relation to four core areas identified by EIRIS. Details of additional and predecessor codes can be found at http://www.ecgi.org/codes/all_codes.php
Remuneration disclosure Board independence Audit committee independence

Australia

ASX Corporate Governance Council – Principles of Good Corporate Governance & Best Practice Recommendations March 2003 Austrian Code of Corporate Governance November 2002 Corporate Governance Committee –Belgian Corporate Governance Code December 2004 Joint Committee on Corporate Governance & TSE Disclosure Requirements & Amended Guidelines March 2002 Nørby Report & Recommendation December 2001 Helsinki Stock Exchange – Corporate Governance Recommendations for Listed Companies December 2003

Majority of board to be independent

Majority ind. & all nonexecutive

Comply or explain

Austria

Two-tier board

Max. 2 former Mgmt. board/ senior mgmt appointed to supervisory board

Committee chair not to be former mgmt board

Mgmt. board only

Comply or explain

Belgium

Majority nonexecutive

All ind. nonexecutive

Comply or explain

Canada

Named ind. board leader if roles combined

Majority of board to be independent

All ind nonexecutive directors

Not specified

Comply or explain

Denmark

Two-tier board

Majority of board to be independent

Not specified

Total for director & manager

Voluntary

Finland

Separate managing director

Independence to be evaluated

All ind nonexecutive directors

Comply or explain

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Compliance provision

Country

Separation Chair/ CEO

Code

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France

The Corporate Governance of Listed Corporations: Principles for corporate governance (consolidated 1995, 1999 & 2002 AFEP & MEDEF reports) October 2003 Cromme Commission Code & Amendments February 2002/ May 2003 Mertzanis Report – Principles of Corporate Governance in Greece October 1999 Hong Kong Stock Exchange Listing Requirements – Principles of Good Governance, Code Provisions & Recommended Best Practices November 2004 IAIM (Irish Association of Investment Managers) Guidelines March 1999 Corporate Governance Code (Praeda Code) July 2002 Revised Corporate Governance Principles – Japan Corporate Governance Forum October 2001 No Code The Dutch Corporate Governance Code (Tabakslatt) December 2003 Corporate governance in New Zealand: Principles & Guidelines February 2004

Statute provides for option of separate or combined roles

Between one third and half of board to be independent

Two-thirds ind nonexecutive directors

Comply or explain

Germany

Two-tier board

Max. 2 former mgmt board/ senior mgmt appointed to supervisory board Majority nonexecutive

Committee chair not to be former mgmt board

Mgmt board only

Comply or explain

Greece

All nonexecutive

On aggregate

Comply or explain

Hong Kong

At least one third ind.

All nonexecutive & majority ind directors

On aggregate within bands

Comply or explain

Ireland

Endorses UK Combined Code

Endorses UK Combined Code

Endorses UK Combined Code Majority ind Internal Control Committee

Endorses UK Code

Comply or explain

Italy

Not specified

An ‘appropriate number’ should be independent

Voluntary comply or explain

Japan

Majority nonexecutive

Majority ind

Not specified

Voluntary

Luxembourg

No Code

No Code Wholly ind supervisory board (except one) One third independent

No Code

No Code

No Code

Netherlands

Two-tier board

Max one member not ind CEO & senior mgmt

Comply or explain

New Zealand

Majority ind

Comply or explain

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Norway

Norwegian Code of Practice for Corporate Governance December 2004

Two-tier board

At least half s/holderelected directors independent of exec mgmt & bus contacts % at least 2 ind of main s/holder At least one independent director

Not specified

Comply or explain

Portugal

Singapore

Spain

Securities Market Commission recommendations & revisions November 2001/ November 2003 Code of Corporate Governance March 2001 (Proposed revisions published for consultation December 2004) Aldama Report January 2003

Not specified

Not specified

Not specified

Comply or explain

One third independent

All nonexecutive & majority ind directors Ind chairman All ind of company & senior mgmt & at least one to be ind of majority s/holder Nonexecutive, preferably ind

Within bands

Comply or explain

Not specified

Significant number

Comply or explain

Sweden

Swedish Code of Corporate Governance December 2004

Separate managing director

Majority independent

For chair & other board members

Comply or explain

Switzerland

Corporate Governance: Swiss Code of Best Practice July 2002

Provides for option of separate or combined roles

Not specified

Not specified

Comply or explain

UK

Combined Code June 2003

At least half the board (excl. chair) independent for larger companies Not specified Majority independent

All ind nonexecutive directors

Sep. remun. report
Covered by US disclosure rules

Comply or explain

USA

NYSE Corporate Governance Rules November 2003

All ind nonexecutive directors

Comply

Abbreviations: Ind – independent; Mgmt – management; NS – not specified; s/holder – shareholder; sep – separate; remun – remuneration

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