BBCG3103 Corporate Governance PDF

OUM Business School
BBCG3103
Corporate Governance
Copyright © Open University Malaysia (OUM)

BBCG3103
CORPORATE
GOVERNANCE
Dr Noor Afza Amran
Dr Basariah Salim
Dr Norhani Aripin
Dr Hasnah Kamardin

Project Directors: Prof Dato’ Dr Mansor Fadzil
Prof Dr Wardah Mohamad
Open University Malaysia
Module Writers: Dr Noor Afza Amran

Dr Basariah Salim
Dr Norhani Aripin
Dr Hasnah Kamardin
Universiti Utara Malaysia
Moderator: Assoc Prof Dr Zuhairah Ariff Abd Ghadas

International Islamic University Malaysia
Developed by: Centre for Instructional Design and Technology

Open University Malaysia
First Edition, August 2013

Second Edition, August 2015 (rs)
Copyright © Open University Malaysia (OUM), August 2015, BBCG3103

All rights reserved. No part of this work may be reproduced in any form or by any means without
the written permission of the President, Open University Malaysia (OUM).

Table of Contents
Course Guide ixăxiii
Topic 1 Theoretical Aspects of Corporate Governance 1

1.1 Corporate Governance ă Definition and Importance 2
1.1.1 What is Corporate Governance? 2
1.1.2 Why is Corporate Governance Important? 4
1.2 Theories Associated with the Development
of Corporate Governance 8
1.2.1 Agency Theory 9
1.2.2 Transaction Cost Economics 10
1.2.3 Stakeholder Theory 11
1.2.4 Stewardship Theory 11
1.2.5 Legalistic Perspective 11
1.2.6 Resource Dependency Theory 11
1.2.7 Resource-based View of the Firm 12
1.2.8 Managerial Hegemony 12
1.3 Separation of Ownership and Control 13
Summary 16
Key Terms 17
References 17
Topic 2 Development of Corporate Governance Codes 19

2.1 Corporate Governance in the UK 20
2.1.1 Financial Reporting Council 20
2.1.2 Chronological Development of the Corporate
Governance Code 21
2.1.3 The UK Corporate Governance Code (2010) 21
2.2 OECD Principles of Corporate Governance 24
2.2.1 Background of Organisation for Economic
Cooperation and Development (OECD) 24
2.2.2 OECD Principle of Corporate Governance 25
2.3 Commonwealth Association for Corporate Governance 26
2.3.1 Background of the Commonwealth 26
2.3.2 Commonwealth Association for Corporate Governance
(CACG) Guidelines: Principles for Corporate
Governance in the Commonwealth 27
2.4 Basel Committee 29
2.4.1 Background of Basel Committee on Banking
Supervision 29

iv X TABLE OF CONTENTS
2.4.2 Principles for Enhancing Corporate Governance 29

2.5 Sarbanes-Oxley Act of 2002 32
2.5.1 Background of Sarbanes-Oxley Act of 2002 32
2.5.2 Major Elements in the Sarbanes-Oxley Act of 2002 32
Summary 36
Key Terms 37
References 37
Topic 3 Shareholders and Stakeholders 38

3.1 Who are Shareholders and Stakeholders? 38
3.1.1 Shareholders 39
3.1.2 Types of Shareholders 39
3.1.3 Stakeholders 41
3.1.4 Types of Stakeholders 42
3.1.5 Arguments on Stakeholders 43
3.2 ShareholdersÊ Rights and Interests 44
3.2.1 ShareholdersÊ Approval 45
3.2.2 Shareholders and General Meetings 46
3.2.3 ShareholdersÊ Rights 46
3.2.4 Rights and Responsibilities of Shareholders in
Relation to General Meetings 47
3.2.5 ShareholdersÊ Rights to Vote at General Meetings 48
3.2.6 ShareholdersÊ Rights to Inspect Register of
DirectorsÊ Shareholdings at AGM 50
3.2.7 ShareholdersÊ Rights: Meetings and Resolutions 50
3.2.8 Protection of Minority Shareholders 51
3.2.9 Who is Responsible for Protecting and
Managing ShareholdersÊ Interests? 51
3.3 Roles of Stakeholders 52
Summary 54
Key Terms 54
References 55
Topic 4 Family-owned Firms 57

4.1 Ownership Structures Around the World 57
4.2 Ownership Structure in Malaysia 60
4.3 Family Ownership 64
4.4 Characteristics of Family Firms 70
4.5 Family-owned Firms and Governance 71
Summary 73
Key Terms 74
References 74

TABLE OF CONTENTS W v
Topic 5 The Role of Institutional Investors in Corporate Governance 80

5.1 Growth of Institutional Share Ownership 81
5.1.1 Definition of Institutional Investors 81
5.1.2 Current Trend of Institutional Investors 81
5.2 Influence of Institutional Investors 83
5.2.1 International Corporate Governance Network
(ICGN) Statement of Principles on
Institutional Shareholder Responsibilities 83
5.2.2 The Role of Institutional Investors in Malaysia 85
5.3 Tools of Corporate Governance 85
5.4 Corporate Governance and Corporate Performance 86
Summary 88
Key Terms 89
References 89
Topic 6 Socially Responsible Investment (SRI) 91

6.1 SRI and Corporate Governance 92
6.2 Strategies for SRI 94
6.3 Corporate Social Responsibility (CSR) 98
6.3.1 CSR Reporting 99
6.3.2 CSR in Malaysia 100
6.3.3 Benefits of CSR to Companies 105
6.4 The Impact of SRI on Shareholder Value 112
Summary 112
Key Terms 113
References 113
Topic 7 Directors and Board Structure 115

7.1 Board of Directors 115
7.2 Role, Duties and Responsibilities of the Board 117
7.2.1 Principal Responsibilities of the Board 117
7.2.2 Director's Duties 117
7.2.3 Constituting an Effective Board 118
7.3 Board Subcommittees 119
7.4 Audit Committee 120
7.5 Remuneration Committee 125
7.6 Nomination Committee 128
7.7 Risk Committee 129
7.8 Non-executive Directors 130
7.9 Independence of Non-executive Directors 130
7.10 Director Evaluation 133

vi X TABLE OF CONTENTS
Summary 134
Key Terms 135
References 135
Topic 8 DirectorsÊ Performance and Remuneration 136

8.1 Key Elements of Director Remuneration 137
8.2 The Role of Remuneration Committee 139
8.3 Remuneration of Non-executive Director 140
8.4 Disclosure of Director Remuneration 141
8.5 International Guidance on Executive Remuneration 143
Summary 147
Key Terms 148
References 148
Topic 9 Corporate Governance in Malaysia 150

9.1 Corporate Governance Background in Malaysia 151
9.2 Corporate Governance Structure in Malaysia 153
9.3 Governing Bodies and Regulations in Malaysia 156
9.3.1 Securities Commission (SC) 156
9.3.2 Bursa Malaysia 157
9.3.3 Malaysian Institute of Corporate Governance
(MICG) 158
9.3.4 Minority Shareholder Watchdog Group (MSWG) 161
9.4 Corporate Governance Issues and Challenges in
Malaysia 163
Summary 165
Key Terms 165
References 165
Topic 10 Implementing Corporate Governance 168

10.1 A Basic Model for Implementing Corporate Governance 168
10.2 Activating Basic Model of Corporate Governance 172
10.2.1 Shareholders 172
10.2.2 Board of Directors 173
10.2.3 Regulatory Bodies 173
10.2.4 Other Stakeholders 173
10.3 Integrating the Corporate Governance Model 174
Summary 174
Key Terms 175
References 175
References 176

COURSE GUIDE

COURSE GUIDE W ix
COURSE GUIDE DESCRIPTION

You must read this Course Guide carefully from the beginning to the end. It tells
you briefly what the course is about and how you can work your way through
the course material. It also suggests the amount of time you are likely to spend in
order to complete the course successfully. Please keep on referring to the Course
Guide as you go through the course material as it will help you to clarify
important study components or points that you might miss or overlook.
INTRODUCTION
BBCG3103 Corporate Governance is one of the courses offered by the OUM
Business School at Open University Malaysia (OUM). This course is worth 3
credit hours and should be covered over 8 to 15 weeks.
COURSE AUDIENCE
This course is offered to all learners taking the Bachelor of Business Administration
with Honours and Bachelor of Management with Honours programmes. This module
aims to impart the efficient use of resources and accountability for stewardship of
these resources. This system is essential to ensure proper accountability, probity and
openness in the conduct of an organisationÊs business for the long-term benefit of its
shareholders and stakeholders.
As an open and distance learner, you should be acquainted with learning

independently and being able to optimise the learning modes and environment
available to you. Before you begin this course, please ensure that you have the
right course material, and understand the course requirements as well as how the
course is conducted.
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a three-credit hour course, you are expected to spend
120 study hours. Table 1 gives an estimation of how the 120 study hours could be
accumulated.

x X COURSE GUIDE
Table 1: Estimation of Time Accumulation of Study Hours
Study
Study Activities
Hours
Briefly go through the course content and participate in initial discussion 3
Study the module 60
Attend 3 to 5 tutorial sessions 10
Online participation 12
Revision 15
Assignment(s), Test(s) and Examination(s) 20
TOTAL STUDY HOURS ACCUMULATED 120
COURSE OUTCOMES
By the end of this course, you should be able to:
1. Explain the formal processes of governance;
2. Evaluate the principal concepts underpinning corporate governance;
3. Describe the importance of the behavioural, organisational, political and
social aspects of governance;
4. Evaluate the practical impact of existing and proposed schemes of
corporate governance; and
5. Discuss the interdependencies between internal and external institutions of
corporate governance (with reference to the financial aspects of corporate
governance).
COURSE SYNOPSIS
This course is divided into 10 topics. The synopsis for each topic can be listed as
follows:
Topic 1 begins with the definition of corporate governance, why it is important to

have corporate governance, related theories and separation between ownership
and control.
Topic 2 discusses the development of corporate governance codes in the United

Kingdom, OECD Principles, the Commonwealth Association for Corporate
Governance, the Basel Committee as well as the Sarbanes-Oxley Act 2002.

COURSE GUIDE W xi
Topic 3 defines who the shareholders and stakeholders are and provides
guidance on shareholdersÊ and stakeholdersÊ interests and their roles.
Topic 4 discusses ownership structures around the world, family-owned firms

and governance as well as smaller quoted companies.
Topic 5 explains the role and influence of institutional investors in corporate

governance. This topic also highlights the growth of institutional share
ownership as well as the relationship between corporate governance and
corporate performance.
Topic 6 describes socially responsible investment in relation to corporate

governance, strategies, corporate social responsibility and the impact on the
shareholder value.
Topic 7 discusses the directors and board structure which include their roles,
duties, responsibilities and the involvement of subcommittees.
Topic 8 discusses director performance and remuneration with stress on key

elements in director remuneration, the roles, disclosure and guidance on
executive remuneration.
Topic 9 highlights the background, structure, governing bodies and regulations

as well as current issues and challenges related to corporate governance in
Malaysia.
Topic 10 deals with the implementation of the corporate governance model.
TEXT ARRANGEMENT GUIDE

Before you go through this module, it is important that you note the text
arrangement. Understanding the text arrangement will help you to organise your
study of this course in a more objective and effective way. Generally, the text
arrangement for each topic is as follows:
Learning Outcomes: This section refers to what you should achieve after you
have completely covered a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your understanding of the topic.
Self-Check: This component of the module is inserted at strategic locations

throughout the module. It may be inserted after one sub-section or a few sub-
sections. It usually comes in the form of a question. When you come across this

xii X COURSE GUIDE
component, try to reflect on what you have already learnt thus far. By attempting
to answer the question, you should be able to gauge how well you have
understood the sub-section(s). Most of the time, the answer to the questions can
be found directly from the module itself.
Activity: Like Self-Check, the Activity component is also placed at various

locations or junctures throughout the module. This component may require you
to solve questions, explore short case studies, or conduct an observation or
research. It may even require you to evaluate a given scenario. When you come
across an Activity, you should try to reflect on what you have gathered from the
module and apply it to real situations. You should, at the same time, engage
yourself in higher order thinking where you might be required to analyse,
synthesise and evaluate instead of only having to recall and define.
Summary: You can find this component at the end of each topic. This component
helps you to recap the whole topic. By going through summary, you should be
able to gauge your knowledge retention level. Should you find points in the
summary that you do not fully understand; it would be a good idea for you to
revisit the details in the module.
Key Terms: This component can be found at the end of each topic. You should go
through this component so as to remind yourself of important terms or jargon
used throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.
References: The References section is where a list of relevant and useful

textbooks, journals, articles, electronic contents or sources can be found. This list
can appear in a few locations such as in the Course Guide (at the References
section), at the end of every topic or at the back of the module. You are
encouraged to read or refer to the suggested sources to obtain the additional
information needed and to enhance you overall understanding of the course.
PRIOR KNOWLEDGE
No prior knowledge required.
ASSESSMENT METHOD
Please refer to myINSPIRE.

COURSE GUIDE W xiii
REFERENCES
Christine, A. M. (2013). Corporate governance (4th ed.). Oxford, UK: Oxford
University Press.
TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

LIBRARY
The TSDAS Digital Library has a wide range of print and online resources for the
use of its learners. This comprehensive digital library, which is accessible
through the OUM portal, provides access to more than 30 online databases
comprising e-journals, e-theses, e-books and more. Examples of databases
available are EBSCOhost, ProQuest, SpringerLink, Books24 7, InfoSci Books,
Emerald Management Plus and Ebrary Electronic Books. As an OUM learner,
you are encouraged to make full use of the resources available through this
library.

xiv X COURSE GUIDE

Topic X Theoretical
1 Aspects of
Corporate
Governance
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Define corporate governance;
2. Explain why corporate governance is important;
3. Differentiate between various theories associated with the
development of corporate governance; and
4. Discuss the role of corporate governance in a company with
separation of ownership and control.
X INTRODUCTION
The modern corporation which is commonly characterised by the separation of
ownership and control requires effective corporate governance to safeguard
company assets. Corporate governance has been a major concern which was
initially driven to protect shareholdersÊ interests from expropriation by the
management. This is because the owner (shareholder) does not manage the
company. Instead, the agent (manager) manages the company. Consequently,
there is a need to protect minority interests from controlling shareholders
whereby the controlling shareholders (owners) are also involved in the
management such as practices in family business firms.

2 X TOPIC 1 THEORETICAL ASPECTS OF CORPORATE GOVERNANCE
We have seen high-profile corporate collapses such as those of Barings Bank,

Enron, WorldCom, Royal Ahold, Parmalat and HIH which are all related to the
lack of effective corporate governance. During the financial crisis in East Asian
countries between 1997 and 1998, poor corporate governance partially
contributed to the crisis. After the crisis, governments around the world focused
their efforts on instilling good corporate governance with the development of
corporate governance codes and other directive regulations to ensure that public
companies move towards best practices of transparency and disclosure, control
and accountability as well as effective board structure.
ACTIVITY 1.1
Do you know the factors that led to the collapse of Barings Bank,
Enron, WorldCom, Royal Ahold, Parmalat and HIH. Discuss with
your coursemates.
1.1 CORPORATE GOVERNANCE – DEFINITION

AND IMPORTANCE
In this subtopic, we will discuss further the concept of corporate governance and
the importance of effective corporate governance in a company.
1.1.1 What is Corporate Governance?

In the early stages of corporate governance development, the focus was on the
relationship between the principal (shareholders or owners) and the agent
(management) which was essentially about managing the potential conflict that
might arise between the shareholders (outside investors) and managers (corporate
insiders) due to the separation of ownership and control of a firm.
The Cadbury Report (1992) defined corporate governance as „a whole system of

controls by which a company is directed and controlled.‰ Accordingly, the focus of
corporate governance is on the roles of the board of directors and the roles of
shareholders as owners of the company in providing appropriate governance of
the company. The board of directors is considered one of the corporate governance
mechanisms. Other governance mechanisms include markets for control, auditors,
law and regulations.
The Organisation for Economic Co-operation and Development (OECD, 1999) has
a broader definition of principals which includes other stakeholders. It is defined
as „...a set of relationships between a companyÊs board, its shareholders and other

TOPIC 1 THEORETICAL ASPECTS OF CORPORATE GOVERNANCE W 3
stakeholders. It also provides the structures through which the objectives of the
company are set, and the means of attaining those objectives and monitoring
performance are determined.‰
Sheilfer and Vishny (1997) focused on the scope of corporate governance to specific
stakeholders who are the suppliers of finance. Corporate governance is defined as
„...the ways in which suppliers of finance assure themselves of getting a return on
their investment.‰ The Higgs Report (2003) relates corporate governance to
corporate accountability which considers both board structures and processes to
manage shareholdersÊ interests.
In Western countries, companies are characterised as having diffused ownership

where shares are held by many shareholders in small quantities. However, in
emerging Asian countries, companies are characterised as having concentrated
ownership where shares are held by a small number of shareholders in large
quantities. In a family business firm, the controlling shareholders may also be the
managers. There is a difference between corporate governance in concentrated
ownerships and that of diffused ownerships.
In concentrated ownerships, the concern is potential conflicts of interest between

controlling and minority shareholders. The decisions made may be in favour of
controlling shareholders. In this situation, corporate governance is used to protect
minority shareholders from expropriation by controlling shareholders. The
definition of corporate governance by La Porta et al. (2000) is more relevant here,
which is, „a set of mechanisms through which outside investors protect themselves
against expropriation by the insiders (managers and controlling shareholders).‰
In Malaysia, the Malaysian Code on Corporate Governance (MCCG) was first

issued in March 2000. It marked a significant milestone in corporate governance
reformation in Malaysia. The Code was revised in 2007 to strengthen the roles
and responsibilities of the board of directors, audit committees and the internal
audit function. In 2012, the Malaysian Code was again revised whereby the main
focuses were on strengthening board structure and composition while
recognising the role of directors as active and responsible fiduciaries.
The directors have a duty to be effective stewards and guardians of the company,
not just in setting strategic direction and overseeing the conduct of business, but
also in ensuring that the company conducts itself in compliance with laws and
ethical values as well as maintains an effective governance structure to ensure the
appropriate management of risks and levels of internal control.

Despite being revised, the MCCG 2012 retains the definition of corporate
governance as set out in the High Level Finance Committee Report 1999 whereby
corporate governance is defined as:
„The process and structure used to direct and manage the affairs of the
business towards enhancing business prosperity and corporate
accountability with the ultimate objective of realising long-term shareholder
value, whilst taking into account the interests of other stakeholders.‰
It is observed that the definitions of corporate governance mainly have to do with

concerns about the interaction between various groups ă which can be categorised
into internal group and external group board members ă in directing a firm for
value creation. Internal actors are those who make decisions and take actions and
external actors are those who seek to influence and control decisions. Those in
management positions are usually considered as internal actors while shareholders
are considered as external actors.
Board members can be internal and/or external. Stakeholders too can be internal
and external. The definition of internal and external is not always easy to
determine. As in the case of a family firm, family members who are involved in
management are usually considered as insiders (executives) and non-family
executives are considered as outsiders. For board members, executive members are
commonly referred to as internal and non-executive members as external.
1.1.2 Why is Corporate Governance Important?

Mallin (2007) highlights that corporate governance is important because of the
following reasons:
(a) Having good corporate governance is widely recognised as an essential
attribute to attract investment in competitive companies and efficient
financial markets. It instils confidence and trust in companies and financial
markets which would attract the inflow of foreign direct investment in a
country;
(b) A corporate governance system ensures that an adequate and appropriate
system of controls (internal control systems) operate within a company. This
will ensure that the company is well-managed for both the interests of the
shareholders and other stakeholders;
(c) A corporate governance system should be able to prevent any individual
from having too powerful an influence. The corporate governance code
requires at least one third of the board members to be independent directors
and separate positions are created for the chief executive and the chairman of
the board. If combined roles (CEO duality) are adopted, there should be a
strong independent element on the board; and
(d) Corporate governance systems are largely concerned with the relationship
between a companyÊs management, the board of directors, shareholders and
its other stakeholders. It encourages transparency, disclosure and
accountability, which would instil investorsÊ confidence in terms of corporate
management and corporate performance. Examples are disclosures related to
third party transactions and family relationships.
The key to corporate governance is having effective monitoring mechanisms to

protect the interests of shareholders and other stakeholders. Some examples of
monitoring mechanisms are having a good control system (for example, internal
audit, risk management, external audit), an effective board composition and
structure as well as an effective board committee (audit committee, nomination
committee, remuneration committee).
In the MCCG 2012, there were eight principles and 26 corresponding

recommendations. The principles and recommendations focus on, among other
things, laying a strong foundation for the board and its committees to carry out
their roles effectively. It also has to do with promoting timely and balanced
disclosure, safeguarding the integrity of financial reporting, emphasising the
importance of risk management and internal controls as well as encouraging
shareholder participation in general meetings. Let us now look at the eight
principles and their recommendations.
(a) Principle 1 ă Establish Clear Roles and Responsibilities

The following are recommendations of Principle 1:
(i) Recommendation 1.1
The board should establish clear functions reserved for the board and
those functions delegated to management.
(ii) Recommendation 1.2
The board should establish clear roles and responsibilities in
discharging its fiduciary and leadership functions.
(iii) Recommendation 1.3
The board should formalise ethical standards through a code of
conduct and ensure its compliance.
(iv) Recommendation 1.4
The board should ensure that the companyÊs strategies promote
sustainability.

(v) Recommendation 1.5

The board should have procedures to allow its members access to
information and advice.
(vi) Recommendation 1.6
The board should ensure it is supported by a suitably qualified and
competent company secretary.
(vii) Recommendation 1.7
The board should formalise, periodically review and make public its
board charter.
(b) Principle 2 ă Strengthen Composition

The board should establish a nominating committee which should
comprise exclusively of non-executive directors, a majority of whom
must be independent.
The nominating committee should develop, maintain and review the
criteria to be used in the recruitment process and annual assessment
of directors.
The board should establish formal and transparent remuneration
policies and procedures to attract and retain directors.
(c) Principle 3 ă Reinforce Independence

The board should undertake an assessment of its independent
directors annually.
The tenure of an independent director should not exceed a cumulative
term of nine years. Upon completion of the nine years, an
independent director may continue to serve on the board subject to
the directorÊs re-designation as a non-independent director.
The board must justify and seek shareholdersÊ approval in the event it
retains as an independent director, a person who has served in that
capacity for more than nine years.

(iv) Recommendation 3.4

The positions of chairman and CEO should be held by different
individuals, and the chairman must be a non-executive member of the
board.
(v) Recommendation 3.5
The board must comprise a majority of independent directors where
the chairman of the board is not an independent director.
(d) Principle 4 ă Foster Commitment

The board should set out expectations on time commitment for its
members and protocols for accepting new directorships.
The board should ensure its members have access to appropriate
continuing education programmes.
(e) Principle 5 ă Uphold Integrity in Financial Reporting

The audit committee should ensure financial statements comply with
applicable financial reporting standards.
The audit committee should have policies and procedures to assess
the suitability and independence of external auditors.
(f) Principle 6 ă Recognise and Manage Risks

The board should establish a sound framework to manage risks.
The board should establish an internal audit function which reports
directly to the audit committee.
(g) Principle 7 ă Ensure Timely and High-Quality Disclosure

The board should ensure the company has appropriate corporate
disclosure policies and procedures.


The board should encourage the company to leverage on information
technology for effective dissemination of information.
(h) Principle 8 ă Strengthen Relationship Between Company and Shareholders

The board should take reasonable steps to encourage shareholder
participation at general meetings.
The board should encourage poll voting.
The board should promote effective communication and proactive
engagements with shareholders.
ACTIVITY 1.2
1. What constitutes good corporate governance in a company?
2. What constitutes an effective board?
3. How does full disclosure relate to good corporate governance?
4. Why should owners of a company be concerned with putting

monitoring mechanisms in the company?
1.2 THEORIES ASSOCIATED WITH THE

DEVELOPMENT OF CORPORATE
GOVERNANCE
The development of corporate governance is complex as it is influenced by legal,
cultural, structural and ownership differences of a particular country. For
example, countries under common law adopt different corporate governance
practices compared to countries under civil law. Countries under common law,
which are characterised by a high volume of shareholder protection, have
developed better corporate governance practices than countries under civil law
which are characterised by a low volume of shareholder protection. Thus, in
implementing corporate governance, one should consider these factors. There is
no corporate governance structure that fits all situations.

Many disciplines influence the development of corporate governance such as

corporate law, economics, finance, organisational theory and sociology. There are
several theories associated with the development of corporate governance. The
main theories are agency theory, transaction cost economics, stewardship theory
and stakeholder theory. Figure 1.1 lists the four main theories associated with the
development of corporate governance.
Figure 1.1: Main theories on development of corporate governance

Source: Mallin (2007)
There are also other theories which relate to board tasks such as the legalistic
perspective, resource dependency theory, resource-based view and managerial
hegemony theory.
1.2.1 Agency Theory

Agency theory originates from the economics and finance disciplines. The theory
views a firm as a nexus of contract which is a connected series of contracts
among various groups such as contracts between employees and the firm.
Agency theory is about the agency relationship which involves the principal
(shareholder or owner) delegating the management of the company to another

party (agent or manager). The theory assumes that the interests of managers are
not necessarily aligned with the interests of shareholders.
The focus in agency theory is how the principal can reduce the agency costs
associated with the agentÊs actions. The theory assumes that managers have
information asymmetry and opportunism and that the managers act to maximise
their self-interest. The theory recognises the imperfection of existing governance
structures in protecting shareholdersÊ interest and concerns as well as the
consequences from the conflict of interests between managers and shareholders.
The theory explains various incentives that align with the interests of managers
and with the interests of the shareholders. Among the incentives is that the board
of directors may be considered as an efficient mechanism for monitoring the
firmÊs managers on behalf of its shareholders.
1.2.2 Transaction Cost Economics

Transaction cost economics (TCE) is often viewed as being closely related to agency
theory. TCE views the firm as a governance structure. The firm size influences the
transaction costs incurred. As the firm grows in size, it needs to achieve economies of
scale where it requires more capital and a wider shareholder base. Coarse (1937)
examines the efficiencies of the firm to conduct transactions internally rather than
externally as the firm gets certain economic benefits, for example, it can produce a
product at a lower price. However, the efficiency to have transactions done internally
is only applicable at a certain point.
As the firm becomes larger, transactions externally will become cheaper and will
be carried out more efficiently. The firm may need to get financing from external
markets. Thus, the separation between ownership and control becomes larger.
The contract between the principal and the agent may be incomplete and may
need to be revisited. According to Williamson (1984), having governance
structures rather than merely aligning incentives may reduce agency costs. Hart
(1995) indicates that a governance structure can be an effective mechanism to
control the moral hazards and adverse selections of managersÊ actions.
1.2.3 Stakeholder Theory

Stakeholder theory is about the balance and management of stakeholder interests
and the avoidance of opportunism from certain groups. This is done by
negotiation and compromise. The question of „who„ or „what„ really counts.
Thus, the main task is to determine the most important stakeholder with regard
to the companyÊs core economic interests. Stakeholders with similar interests are

usually classified in the same group. Stakeholders such as employees,

management, the public and customers are usually considered as major
stakeholders. This theory is considered as a common agency theory with
multiple principals.
Under the stakeholder theory, the task of the board is to ensure that corporate
social responsibility covers a broader set of stakeholders including employees,
management and society. The interests of stakeholders are protected through the
development of specific laws or regulations such as codes of best practice for
environmental performance.
1.2.4 Stewardship Theory

Stewardship theory originates from the organisational theory. It describes the
board as a good steward of the corporation. The theory views managers as good
stewards who work for high corporate returns. The Board of Directors (BOD) is
responsible to ensure the stewardship of corporate assets. Insider directors
(executive directors) dominating the board are more capable than outside
directors in terms of carrying out the strategic functions of the company.
1.2.5 Legalistic Perspective

The legalistic perspective originates from corporate law. It focuses on board tasks
or roles as persons responsible for corporate leadership. Accordingly, the boardÊs
function is to carry out its legally mandated responsibilities. BODs are not
supposed to interfere in the day-to-day operations of the company, which are run
by the CEO of the company. Examples of legal duties are to represent the
interests of shareholders, to select and replace the CEO, to provide advice and
counsel to top management and to serve as a control mechanism by monitoring
managersÊ decisions and company performance.
1.2.6 Resource Dependency Theory

Resource dependency theory originates from organisational theory and
sociology. It proposes that the board has the ability to span the firmÊs boundaries.
The board is viewed as a vehicle to interact with the external environment and
thus act as a co-optation mechanism for seeking access to external resources. The
board is viewed as a facilitator of strategy formulation or implementation.
Directors who have links with outsiders are likely to have access to external
resources which are pertinent to ensure performance enhancement.

1.2.7 Resource-Based View of the Firm

The resource-based view of the firm considers the board as an internal resource
that is significant for competitive advantage. The theory suggests that the
resource and knowledge tasks of boards may be important for long-term
strategic growth and survival. There are two basic assumptions of this theory:
(a) Resources are distributed heterogeneously across the firm; and
(b) The firm will incur costs if the productive resources are transferred to other
firms.
From this theory comes the knowledge-based view and competence-based view
of the firm. Knowledge, competence and capability are all used interchangeably
in the resource-based view. Capability here means the coordinated use of
resources to act competently when the firm is facing problems and challenges.
Dynamic capability includes not only the knowledge or competence of the board
members but also whether the board has the capability to transform the
knowledge into actual task performance.
1.2.8 Managerial Hegemony Theory

Managerial hegemony theory describes the board as legal fiction. The board
exists to fulfil mandatory requirements. It is considered as the creation of the
CEO and the task of the board is to enhance the welfare of the CEO. The selection
of board members is usually controlled by the management. In this situation, the
board lacks independence. It is not expected to protect the interests of
shareholders.
ACTIVITY 1.3
1. Differentiate between agency theory and stewardship theory.
2. Differentiate between resource dependency theory and

resource-based view of a firm.
3. Explain the similarities between agency theory and transaction

cost economics.

SELF-CHECK 1.1
Explain what you understand by the following terms:
(a) Board of directors;
(b) Diffused ownership;
(c) Concentrated ownership;
(d) Differences between common law and civil law; and
(e) Board committee.
1.3 SEPARATION OF OWNERSHIP AND

CONTROL
Separation of control and ownership occurs in a situation where shares are
widely dispersed or where the shareholders are not involved in the management
of the company. This situation is inevitable in a public company. Shareholders
who own shares in the company are known as the owners while the directors
who manage the company are said to have control over the entities. Berle and
Means (1933) discussed the concept of control and ownership in their book The
Modern Corporation and Private Property.
According to Berle and Means (1933) and Herman (1981), a greater dispersion of
share ownership would cause a decrease in the shareholders' power and interest
in the company. This is known as the separation of ownership from control. They
argued that as a result of the separation of ownership from control, shareholders
would no longer have control of the direction of the company and the directors
are vested with wider power in developing the company (Sheikh & Chatterjee,
1995). Consequently, there will be a divergence of interests between the
managers and owners in certain situations.
According to Sheikh and Chatterjee (1995):
„The divergence of interest between ownership and control had created a

division of functions. Within the corporation, shareholders had only interests
in the enterprise while the directors had power over it. The position of the
shareholders had been reduced to that of having a set of legal and factual
interests in the enterprise.‰

When there is separation between the owners and the controllers in a company,
there is a possibility that the interests of the shareholders will not be addressed
since they have no control over the running of the company. In other words, such
divergence would cause the company to depart from the traditional theory of
profit maximising behaviour (Sheikh & Chatterjee, 1995; Monsen & Downs,
1965).
This is because the directors who are the managers have control and would act
towards maximisation of their own lifetime incomes (Sheikh & Chatterjee, 1995).
Control, according to Herman (1981), relates to power ă the capacity to initiate,
constrain, circumscribe or terminate action, either directly or by influence
exercised on those with immediate decision-making authority.
Thus, the directors might disregard the interests of the shareholders which
should be their paramount consideration. Though the directors may own some
shares, their ownership is usually the result of their executive positions rather
than the cause of their holding such positions (Herman, 1981). Therefore, these
directors who operate the business of the company are primarily motivated by
their own self-interest, which may not coincide with the interest of the owners
(Herman, 1981).
Moreover, there is separation of ownership from control limited owners to being

satisfiers instead of maximisers. This means the shareholders will be satisfied
with the dividend received without participating in the management of the
company for the purpose of obtaining maximum profit. When the owners lack
control of the company, they become unfamiliar with its policies. As a result, the
managers may aim to achieve a steady growth of earnings instead of maximising
profits for the owners (Herman, 1981). This situation is also known as
shareholders passivity.
The Cohen Committee acknowledged that the lack of active participation from
shareholders was due to the separation of ownership from control. Furthermore,
the dispersion of capital among an increasing number of small shareholders
made them pay less attention to their investments and they became content with
the dividends which were forthcoming (Cohen Committee, 1945). Both the
Cohen Committee and the Jenkins Committee which was set up in 1962
recommended disclosure of the companyÊs activities to remedy any possible
abuse of power by directors.
The separation of ownership from control is inevitable but directors should not
abuse the control and, in turn, shareholders should be allowed to monitor it only
to a certain extent so as to not interfere with the directors' freedom. This means to
do what they think is best in the interest of the company. This is supported by the

Cohen Committee (1945) and Lipton and Rosenblum (1991) who viewed the
relationship between managers and shareholders as a problematic one in the
modern public company and believed there should be a system whereby these
two parties can work cooperatively towards the companyÊs long-term success.
The separation of ownership and control is considered problematic under the

agency theory as managers would lack the incentives to operate the company in
the same manner as owner-managers. Managers may be involved in moral
hazards and adverse selections. Jensen and Meckling (1979) considered the
separation as the agency problem which leads to agency cost.
In the agency approach, the agents (managers) usually want to maximise

personal utilities which are distinct from the principals (shareholders) and there
is concern for managerial behaviour. Incentive schemes are then developed to
align the managersÊ objectives with the principalsÊ objectives. These schemes
require corporate governance to monitor and reward performance (remuneration
system). The costs incurred are the sum of monitoring costs, bonding costs and
the residual loss from the divergence of behaviour.
The monitoring costs include having a board of directors, the use of auditors and
the use of rules. Bonding costs include constraints to managerial decision making
and behaviour such as having contractual arrangements with „golden
parachutes‰. The residual loss in agency costs shows that the agency cost exists
and somehow the managers cannot assuredly maximise the interest of
shareholders.
The remuneration system, such as the salary and bonus of executives which are
linked to performance, is one of the incentives available to reduce agency costs.
The pay-for-performance system is used as a motivation for executives to
maximise efforts towards increasing shareholdersÊ wealth. Managerial ownership
can also be used to align the interests of shareholders and executives from an
agency theory perspective.
Managerial or inside owners are executives and directors who own shares in a
company. They will direct all their efforts towards maximising the companyÊs
value. Fama and Jensen (1983) argue that by having a significant share of
ownership in a company, the executive who is also the owner is motivated to
keep his strategy parallel with the interest of other owners.
The existence of the market for corporate control will force managers to take
action to maximise share value or risk a takeover, resulting in the loss of their
jobs. Thus, incompetent managers will be removed through the takeover process.
Under this situation, the capital market can be used to reduce the agency costs as

the managerial performance is reflected in the share price. However, the working
of this mechanism depends on the efficient market hypothesis. If the market is
not efficient, then the correlation between the managerial performance and stock
prices is weak. Another issue is that the share price may not reflect the
fundamental value of a firm because other factors or news may influence the
share price.
ACTIVITY 1.4
1. Explain how the concept of separation of ownership and control

relates to corporate governance.
2. Explain the costs that may be incurred by having the separation

of ownership and control.
3. Analyse the role of managerial ownership in the case of publicly

held corporations to reduce agency costs associated with
SELF-CHECK 1.2
Explain the following terms:
(a) Moral hazard;
(b) Adverse selection;
(c) Efficient market hypothesis;
(d) Golden parachutes; and
(e) Non-executive directors.
Ć Corporate governance is needed to tackle agency costs associated with the

Ć Various corporate governance mechanisms such as monitoring mechanisms
and incentive schemes are used to mitigate agency costs.
Ć The development of corporate governance around the world is influenced by
various factors such as legal, cultural, ownership and other structural
differences.

Agency theory Higgs Report

Board leadership Managerial hegemony
Board of directors Minority interests
Cadbury Report Resource-based view of the firm
CEO duality Resource dependency theory
Concentrated ownership Separation of ownership and control
Controlling shareholders Stakeholder theory
Corporate governance Stewardship theory
Diffused ownership Transaction cost economics
Berle, A. A., & Means, G. C. (1933). The modern corporation and private
property. New York, NY: Macmillan.
Board of Trade. (1945). Report of the Company Law Committee, (Cmnd 6659).
London, England: Cohen Committee.
Coarse, R. H. (1937). The nature of the firm. Economica, IV, 13-16.
Davies, A. (2006). Best practice in corporate governance: Building reputation and

sustainable success. Hants, England: Gower Publishing Company.
Demsetz, H. (1988). Ownership control and the firm. Oxford, England: Basil
Blackwell Ltd.
Fama, E. F., & Jensen, M. C. (1983). Separation of ownership and control. Journal
of Law and Economics, XXVI, 301-325.
Hart, O. (1995). Corporate governance: Some theory and implications. The

Economic Journal, 105 (430), 678-679
Herman, E. S. (1981). Corporate control, corporate power. New York, NY:

Cambridge University Press.

Huse, M. (2007). Boards, governance and value creation. New York, NY:
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial

behaviour, agency costs and ownership structure. Journal of Financial
Economics, 3(4), 305-360.
Lipton, M., & Rosenblum, S. A. (1991). A new system of corporate governance:

The quinquennnial election of directors. The University of Chicago Law
Review, 58 (1), 187-253.
Mallin, C. A. (2007). Corporate governance (2nd ed.). New York, NY: Oxford
University Press.
Monsen, R., & Downs, A. (1965). A theory of large managerial firms. The Journal
of Political Economy, 73 (3), 221-236.
Sheikh, S., & Chatterjee, S. K. (1995). Perspectives on Corporate Governance. In

Sheikh, S. & Rees, W. (Eds.), Corporate Governance and Corporate Control
(pp. 1-56). London, England: Cavendish Publishing Limited.
Williamson, O. E. (1984). Corporate governance. Yale Law Journal, 93.

Topic X Development
2 of Corporate
Governance
Codes
LEARNING OUTCOMES
1. Describe corporate governance in the UK;
2. Discuss the OECD Principles of Corporate Governance;
3. Describe the role of the Commonwealth Association for Corporate
Governance;
4. Describe the role of the Basel Committee; and
5. Describe the Sarbanes-Oxley Act 2002.
X INTRODUCTION
In Topic 1, the definitions of corporate governance have been discussed. In
addition, the theoretical aspect underlying the development of corporate
governance has also been covered.
Topic 2 presents the development of corporate governance codes applied in the

UK, OECD and Commonwealth countries as well as in the US. This topic will
also discuss the corporate governance code for the banking industry. In general,
the codes outline recommendations on corporate governance for companies. It is
assumed that by following the recommended codes, the companies would have
good governance practices in place as a monitoring mechanism. As a result,
shareholdersÊ wealth can be maximised.

20 X TOPIC 2 DEVELOPMENT OF CORPORATE GOVERNANCE CODES
Let us read on to find out more about the corporate governance codes.
2.1 CORPORATE GOVERNANCE IN THE UK

In this subtopic, we will discuss corporate governance in the UK in greater detail.
2.1.1 Financial Reporting Council

Corporate governance in the UK started in the early 1990s. The corporate
collapses of the BCCI bank and the Robert Maxwell pension fund turned the
attention of many towards corporate governance issues. Since then, many
initiatives, including the introduction of the code of corporate governance, have
been taken to ensure proper governance of companies.
To monitor the development of the corporate governance code in the UK, the
Financial Reporting Council (FRC) was established. Responsible for promoting
high standards of corporate governance, the FRC has specific objectives as shown
in Figure 2.1.
Figure 2.1: Objectives of Financial Reporting Council

TOPIC 2 DEVELOPMENT OF CORPORATE GOVERNANCE CODES W 21
Check the following website for further information on the FRC:

http://www.frc.org.uk.
2.1.2 Chronological Development of the Corporate

Governance Code
The corporate governance code is a dynamic document which has undergone
revisions and improvements to cater to current situations. A committee was
established to review and revise the code before the updated or current code of
corporate governance was published. Table 2.1 outlines the history of corporate
governance codes in the UK.
Table 2.1: Chronological Development of Corporate Governance Codes in the UK
Year Report or Code

1992 Cadbury Report
1995 Greenbury Report
1998 Hampel Report
1999 Turnbull Report
2003 Higgs Report (non-executive directors)
2003 Smith Report (audit committee)
2003 Combined Code
2006 Combined Code (June)
2010 UK Corporate Governance Code
Source: Financial Reporting Council (2006)
2.1.3 The UK Corporate Governance Code (2010)

After several revisions, the current code of corporate governance for the UK was
created, which is, the UK Corporate Governance Code (2010). This code applies
to accounting periods beginning on or after 29 June 2010.
This code applies the „comply or explain‰ approach. This approach requires
companies to comply with the rules and recommendations; otherwise, they need
to explain their non-compliance. It consists of principles (main and supporting)
and provisions. Figure 2.2 lists five main principles of the code and the
supporting principles for each main principle:


Figure 2.2: Main principles of the UK Corporate Governance Code (2010)

Source: Financial Reporting Council (2010)

SELF-CHECK 2.1
1. List the reports or codes established in relation to corporate

governance in the UK.
2. List five main principles outlined by the UK Corporate

Governance Code (2010).
2.2 OECD PRINCIPLES OF CORPORATE

GOVERNANCE
This subtopic will introduce you to the OECD Principles of Corporate
Governance.
2.2.1 Background of Organisation for Economic

Co-operation and Development (OECD)
The Organisation for Economic Co-operation and Development (OECD) was
established to promote policies that will improve the economic and social well-
being of people around the world. This organisation celebrated its 50th
anniversary in 2011, with a current membership of 34 countries worldwide, as
shown in Figure 2.3.
Figure 2.3: OECD membership

Source: www.oecd.org
Visit the following website for further information on the OECD:

http://www.oecd.org.

2.2.2 OECD Principles of Corporate Governance

One of the policies is the OECD Principles of Corporate Governance, which was
published in 2004. The code outlines six major principles as shown in Figure 2.4:
Figure 2.4: OECD principles of corporate governance

Source: OECD (2004)

SELF-CHECK 2.2
1. What is the aim of the OECD? How long has this organisation
been established?
2. List six main principles outlined by the OECD Principles of

Corporate Governance Code.
2.3 COMMONWEALTH ASSOCIATION FOR

CORPORATE GOVERNANCE
In this subtopic, we will learn about the Commonwealth Association for
Corporate Governance.
2.3.1 Background of the Commonwealth

The Commonwealth is an association consisting of 54 countries located
throughout six continents. It has been established since the 1870s to enhance
democracy and development among its members. Figure 2.5 presents the
national flag of each member of the Commonwealth Association.
Figure 2.5: Commonwealth countries

Source: www.thecommonwealth.org
Go to the following website for further information on the Commonwealth:
http://www.thecommonwealth.org.
2.3.2 Commonwealth Association for Corporate

Governance (CACG) Guidelines: Principles for
Corporate Governance in the Commonwealth
The CACG Guidelines were developed to assist both private sectors and state-
owned enterprises. Although the recommended principles of the CACG
Guidelines are not mandatory, they are essential in facilitating good governance
practices among Commonwealth countries. Figure 2.6 summarises the 15
principles suggested by the CACG Guidelines:


Figure 2.6: CACG guidelines

Source: CACG (1999)
SELF-CHECK 2.3
1. Identify the Commonwealth countries.
2. List the 15 main principles outlined by the CACG Guidelines.
2.4 BASEL COMMITTEE

In this subtopic, we will discuss the Basel Committee in greater detail.
2.4.1 Background of Basel Committee on Banking

Supervision
The Basel Committee on Banking Supervision is a platform established to
enhance the supervision of the banking industry. The aim of this committee is to
promote and strengthen supervisory and risk management practices globally.
The committee comprises representatives from various countries worldwide. The
permanent secretariat is located at the Bank for International Settlements (BIS) in
Basel, Switzerland.
2.4.2 Principles for Enhancing Corporate Governance

The Basel Committee on Banking Supervision established the initial guidance
and the revised principles of corporate governance in 1999 and 2006. Then, in
October 2010, the committee published the latest Principles for Enhancing
Corporate Governance. The guidance covers six major components with 14 main
principles. The following are the components and principles:
(a) Board Practices

The following are the principles of this component:

(i) Principle 1: BoardÊs Overall Responsibilities
The board has overall responsibility of the bank, including approving
and overseeing the implementation of the bankÊs strategic objectives,
risk strategy, corporate governance and corporate values. The board is
also responsible for overseeing senior management.
(ii) Principle 2: Board Qualification
Board members should be and remain qualified, which includes
having thorough training for their position. They should have a clear
understanding of their role in corporate governance and be able to
exercise sound and objective judgement about the affairs of the bank.
(iii) Principle 3: BoardÊs Own Practices and Structures
The board should define appropriate governance practices for its own
work and have in place the means to ensure that such practices are
followed and periodically reviewed for ongoing improvement.
(iv) Principle 4: Group Structures
In a group structure, the board of the parent company has the overall
responsibility for adequate corporate governance across the group
ensuring that there are governance policies and mechanisms appropriate
to the structure, business and risks of the group and its entities.
(b) Senior Management

(i) Principle 5
Under the direction of the board, the senior management should
ensure that the bankÊs activities are consistent with the business
strategy, its risk tolerance and policies approved by the board.
(c) Risk Management and Internal Control

(i) Principle 6
Banks should have an effective internal control system and a risk
management function (including a chief risk officer or equivalent)
with sufficient authority, stature, independence, resources and access
to the board.
(ii) Principle 7
Risks should be identified and monitored on an ongoing firm-wide
and individual entity basis, and the sophistication of the bankÊs risk
management and internal control infrastructure should keep pace
with any changes to the bankÊs risk profile (including its growth) and
to the external risk landscape.

(iii) Principle 8
Effective risk management requires robust internal communication
within the bank about risk, both across the organisation and through
reporting to the board and senior management.
(iv) Principle 9
The board and senior management should effectively utilise the work
conducted by internal audit functions, external auditors and internal
control functions.
(d) Compensation
The principles of compensation are as follows:
(i) Principle 10
The board should actively oversee the compensation systemÊs design
and operation and should monitor and review the compensation
system to ensure that it operates as intended.
(ii) Principle 11
An employeeÊs compensation should be effectively aligned with
prudent risk taking; compensation should be adjusted for all types of
risk; compensation outcomes should be symmetric with risk
outcomes; compensation pay-out schedules should be sensitive to the
time horizon of risks; and the mix of cash, equity and other forms of
compensation should be consistent with risk alignment.
(e) Complex or Opaque Corporate Structures

(i) Principle 12
The board and senior management should know and understand the
bankÊs operational structure and the risks that it poses (i.e. „know-
your-structure‰).
(ii) Principle 13
Where a bank operates through special-purpose, related structures or
in jurisdictions that impede transparency or do not meet international
banking standards, its board and senior management should
understand the purpose, structure and unique risks of these
operations. They should also seek to mitigate the risks identified (i.e.
„understand-your-structure‰).

(f) Disclosure and Transparency

(i) Principle 14
The governance of the bank should be adequately transparent to its
shareholders, depositors, other relevant stakeholders and market
participants.
Visit the following website for further information on the Basel Committee:
http://www.bis.org/bcbs.
SELF-CHECK 2.4
1. Identify the representative countries of the Basel Committee.
2. List the six components and 14 main principles outlined by

the Principles for Enhancing Corporate Governance (2010).
2.5 SARBANES-OXLEY ACT OF 2002

This subtopic will explain further the Sarbanes-Oxley Act of 2002.
2.5.1 Background of Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 was enacted by the Senate and House of
Representatives of the United States of America. The purpose of this law is to
protect investors by improving the accuracy and reliability of corporate
disclosures made pursuant to security laws as well as for other purposes.
2.5.2 Major Elements in the Sarbanes-Oxley Act of

2002
The Sarbanes-Oxley Act of 2002 contains 11 titles and these in turn are divided
into sections. The titles and sections in this Act is as follows:
(a) Title I: Public Company Accounting Oversight Board

Title I consists of the following nine sections:
(i) Section 101: Establishment; administrative provisions.
(ii) Section 102: Registration with the Board.

(iii) Section 103: Auditing, quality control and independence standards

and rules.
(iv) Section 104: Inspections of registered public accounting firms.
(v) Section 105: Investigations and disciplinary proceedings.
(vi) Section 106: Foreign public accounting firms.
(vii) Section 107: Commission oversight of the Board.
(viii) Section 108: Accounting standards.
(ix) Section 109: Funding.
(b) Title II: Auditor Independence

Title II consists of nine sections as follows:
(i) Section 201: Services outside the scope of practice of auditors.
(ii) Section 202: Preapproval requirements.
(iii) Section 203: Audit partner rotation.
(iv) Section 204: Auditor reports to audit committees.
(v) Section 205: Conforming amendments.
(vi) Section 206: Conflicts of interest.
(vii) Section 207: Study of mandatory rotation of registered public accounting
firms.
(viii) Section 208: Commission authority.
(ix) Section 209: Considerations by appropriate State regulatory
authorities.
(c) Title III: Corporate Responsibility

Title III consists of the following eight sections:
(i) Section 301: Public company audit committees.
(ii) Section 302: Corporate responsibility for financial reports.
(iii) Section 303: Improper influence on conduct of audits.
(iv) Section 304: Forfeiture of certain bonuses and profits.
(v) Section 305: Officer and director bars and penalties.
(vi) Section 306: Insider trades during pension fund blackout periods.
(vii) Section 307: Rules of professional responsibility for attorneys.
(viii) Section 308: Fair funds for investors.

(d) Title IV: Enhanced Financial Disclosures

Title IV consists of nine sections as follows:
(i) Section 401: Disclosures in periodic reports.
(ii) Section 402: Enhanced conflict of interest provisions.
(iii) Section 403: Disclosures of transactions involving management and
principal stockholders.
(iv) Section 404: Management assessment of internal controls.
(v) Section 405: Exemption.
(vi) Section 406: Code of ethics for senior financial officers.
(vii) Section 407: Disclosure of audit committee financial expert.
(viii) Section 408: Enhances review of periodic disclosures by issuers.
(ix) Section 409: Real time issuer disclosures.
(e) Title V: Analyst Conflicts of Interest

Title V consists of only 1 section as follows:
(i) Section 501: Treatment of securities analysts by registered securities
associations and national securities exchanges.
(f) Title VI: Commission Resources and Authority

Title VI consists of four of the following sections:
(i) Section 601: Authorisation of appropriations.
(ii) Section 602: Appearance and practice before the Commission.
(iii) Section 603: Federal court authority to impose penny stock bars.
(iv) Section 604: Qualifications of associated persons of brokers and
dealers.
(g) Title VII: Studies and Reports

Title VII consists of five sections as follows:
(i) Section 701: GAO study and report regarding consolidation of public
accounting firms.
(ii) Section 702: Commission study and report regarding credit rating
agencies.
(iii) Section 703: Study and report on violators and violations.
(iv) Section 704: Study of enforcement actions.
(v) Section 705: Study on investment banks.
(h) Title VIII: Corporate and Criminal Fraud Accountability

The VIII comprises of seven sections as follows:
(i) Section 801: Short title.
(ii) Section 802: Criminal penalties for altering documents.
(iii) Section 803: Debts non-dischargeable if incurred in violation of
securities fraud laws.
(iv) Section 804: Statute of limitations for securities frauds.
(v) Section 805: Review of Federal Sentencing Guidelines for
obstruction of justice and extensive criminal fraud.
(vi) Section 806: Protection for employees of publicly traded companies
who provide evidence of fraud.
(vii) Section 807: Criminal penalties for defrauding shareholders of
publicly traded companies.
(i) Title IX: White-Collar Crime Penalty Enhancements

Title IX includes six sections as follows:
(ii) Section 902: Attempts and conspiracies to commit criminal fraud offenses.
(iii) Section 903: Criminal penalties for mail and wire fraud.
(iv) Section 904: Criminal penalties for violations of the Employee
Retirement Income Security Act of 1974.
(v) Section 905: Ammendment to sentencing guidelines relating to certain
white-collar offenses.
(vi) Section 906: Corporate responsibility for financial reports.
(j) Title X: Corporate Tax Returns

Title X comprises of one section as follows:
(i) Section 1001: Sense of the Senate regarding the signing of corporate
tax returns by chief executive officers.
(k) Title XI: Corporate Fraud and Accountability

Title XI includes the following seven sections:
(ii) Section 1102: Tampering with a record or otherwise impeding an
official proceeding.

(iii) Section 1103: Temporary freeze authority for the Securities and
Exchange Commission.
(iv) Section 1104: Amendment to the Federal Sentencing Guidelines.
(v) Section 1105: Authority of the Commission to prohibit persons from
serving as officers or directors.
(vi) Section 1106: Increase criminal penalties under Securities Exchange
Act of 1934.
(vii) Section 1107: Retaliation against informants.
SELF-CHECK 2.5
1. Identify the titles outlined by the Sarbanes-Oxley Act of 2002.
2. List the subsections outlined by the Sarbanes-Oxley Act of 2002.
• The UK Corporate Governance Code (2010) outlines five main principles and
18 supporting principles.
• The OECD Principles of Corporate Governance (2004) outlines six main principles.
• The CACG Guidelines (1999) outlines 15 main principles.
• The Principles for Enhancing Corporate Governance (2010) of Basel

Committee outlines six main components and 14 main principles.
• The Sarbanes-Oxley Act of 2002 outlines 11 main titles and the sections of
each title.

Basel Committee OECD Principles

Board of Directors Sarbanes-Oxley Act 2002
CACG Shareholders
Corporate Governance Code
Bank for International Settlements. (2010). Basel committee on banking

supervision: Principles for enhancing corporate governance. Retrieved from
www.bis.org/bcbs
Commonwealth Association for Corporate Governance. (1999). CACG

guidelines: Principles for corporate governance in the commonwealth.
Retrieved from www.thecommonwealth.org
Financial Reporting Council. (2006). The UK approach to corporate governance.

Retrieved from www.frc.org.uk
Financial Reporting Council. (2010). The UK corporate governance code.

Organization for Economic Co-operation and Development. (2004). OECD

principles of corporate governance. Retrieved from www.oecd.org
Sarbanes-Oxley Act. (2002). Sarbanes-Oxley Act. Retrieved from

www.sec.gov/about/laws/soa2002.pdf

Topic X Shareholders
3 and
Stakeholders
LEARNING OUTCOMES
1. Differentiate between shareholders and stakeholders;
2. Explain the types of shareholders and stakeholders;
3. Discuss arguments on stakeholders;
4. Explain the rights and interests of shareholders; and
5. Discuss the roles of stakeholders.
X INTRODUCTION
Good corporate governance is a shared responsibility, that is, between
stakeholders and shareholders. Shareholders of companies have equal
responsibilities to protect and advance their own interests by exercising the
rights accorded to them to ensure that the companies they invested in are well-
governed. On the other hand, the stakeholder is a person, group or organisation
that has a direct or indirect stake in an organisation because it can affect or be
affected by the organisation's actions, objectives and policies.
3.1 WHO ARE SHAREHOLDERS AND

STAKEHOLDERS?
In this subtopic, we will discuss further the definition of shareholders and
stakeholders and also the types of shareholders and stakeholders.

TOPIC 3 SHAREHOLDERS AND STAKEHOLDERS W 39
3.1.1 Shareholders
The following are some definitions of shareholders:
(a) Any person, company, or other institution that owns at least one share in a
company. Shareholders are the owners of a company. They have the
potential to earn profit if the company does well, but that comes with
potential losses if the company does poorly (The Companies Act, 1965).
(b) An individual or institution (including a corporation) that legally owns any

part of a share of stock in a public or private corporation (Fama, 1980).
Shareholders are granted special privileges depending on the class of stock.

These rights may include:
(i) The right to sell their shares;
(ii) The right to vote for the directors nominated by the board;
(iii) The right to nominate directors (although this is very difficult in
practice because of minority protections) and propose shareholder
resolutions;
(iv) The right to dividends if they are declared;
(v) The right to purchase new shares issued by the company;
(vi) The right to what assets remain after liquidation; and
(vii) The right to attend general meetings, the right to have the
memorandum and articles of association observed and the right of
accounts of the companies.
3.1.2 Types of Shareholders

The following are detailed explanations on the types of shareholders such as
substantial shareholders, majority shareholders and minority shareholders.
(a) Substantial Shareholder

A substantial shareholder can be described as follows:
(i) This is when the shareholder has an interest or interests in one or
more voting shares in the company and the nominal amount of that
share, or the aggregate of the nominal amounts of those shares, is not
less than five percent of the aggregate of the nominal amounts of all
the voting shares in the company (Section 69D of CA 1965).

40 X TOPIC 3 SHAREHOLDERS AND STAKEHOLDERS
(ii) This is a situation where the company share capital is divided into
two or more classes of the shares and the shareholder has an interest
or interests in one or more voting shares included in one of those
classes. The nominal amount of that share, or the aggregate of the
nominal amounts of those shares, is not less than five percent of the
aggregate of the nominal amounts of all the voting shares included in
that class (Section 69D of CA 1965).
(b) Majority Shareholder

A majority shareholder can be described as follows:
(i) A person or entity that owns more than 50 per cent of a company's
outstanding shares.
(ii) This is often the founder of the company, or in the case of long-
established businesses, the founder's descendants.
(iii) Has a very significant influence in business operations and the strategic
direction of the company.
(iv) In this situation, some continue to be heavily involved in the daily
operations of the company, others may prefer to take a hands-off
approach and leave the management of the company to the executives
and managers.
(v) They often wish to exit their business or dilute their positions so that he
or she may make overtures to their competition or private equity firms,
with the objective of getting a good price for their stake.
(c) Minority Shareholder

The following are the descriptions of minority shareholders:
(i) They do not have a controlling interest in the company.
(ii) They have to be actively involved in the company to preserve their
shareholder rights.
(iii) Shares held by minority shareholders are generally illiquid.
(iv) It is found that their lack of corporate control is exploited for the
financial benefit of majority shareholders.
(v) The Companies Act 1965 provides minority shareholders with the
right to participate and vote at company meetings on matters such as
the election of directors and amendments of articles of associations,
particularly when an insider has an interest in the sale of company
assets or a merger and acquisition deal.

ACTIVITY 3.1
1. Why do we need shareholders and stakeholders in an

organisation? Discuss.
2. Who is a majority shareholder? Does he or she have the power

to manage a company?
3. Discuss two privileges given to a shareholder.
3.1.3 Stakeholders
The following are detailed explanations on who are stakeholders.
(a) A person, group or organisation that has direct or indirect stake in an
organisation because it can affect or be affected by the organisation's
actions, objectives and policies.
(b) Includes creditors, customers, directors, employees, government (and its
agencies), owners (shareholders), suppliers, unions and the community
from which the business draws its resources.
(c) Is usually self-legitimising (those who judge themselves to be stakeholders
are stakeholders) and all stakeholders are not equal and different
stakeholders are entitled to different considerations. For example, a
companyÊs customers are entitled to fair trading practices but they are not
entitled to the same consideration as the company's employees.
Table 3.1 explains some examples of a company's stakeholders.
Table 3.1: Examples of a Company's Stakeholders and their Interests
Stakeholders Examples of Interests

Government Taxation, legislation, low unemployment, truthful reporting.
Employees Rates of pay, job security, compensation, respect, truthful
communication.
Customers Value, quality, customer care, ethical products.
Suppliers Providers of products and services used in the end product for the
customer, equitable business opportunities.

Creditors Credit score, new contracts, liquidity.

Community Jobs, involvement, environmental protection, shares, truthful
communication.
Trade Unions Quality, staff protection, jobs.
Owner(s) Have interest in the success of his or her business.
Who are these Stakeholders?

The following are detailed explanations on who are considered stakeholders.
(a) People who will be affected by an endeavour and can influence it but who
are not directly involved with doing the work.
(b) In the private sector, people who are (or might be) affected by any action
taken by an organisation or group.
(c) Any group or individual who can affect or who is affected by the
achievement of a group's objectives.
(d) An individual or group with an interest in a group's or an organisation's
success in delivering intended results and in maintaining the viability of the
group or the organisation's product and/or service.
(e) Any organisation, governmental entity, or individual that has a stake in or
may be impacted by a given approach to environmental regulation,
pollution prevention and energy conservation.
(f) A participant in a community mobilisation effort, representing a particular
segment of society. School board members, environmental organisations,
elected officials, chamber of commerce representatives, neighbourhood
advisory council members and religious leaders are all examples of local
stakeholders.
3.1.4 Types of Stakeholders

There are two types of stakeholders: market or primary stakeholders and non-
market or secondary stakeholders (refer to Figure 3.1).

Figure 3.1: Two types of stakeholders
Now, let us look at the details for each type of stakeholder.
(a) Market (or Primary) Stakeholders

The following are the descriptions of market shareholders:
(i) Internal stakeholders are those who engage in economic transactions
with the business.
(ii) This includes shareholders, customers, suppliers, creditors and
employees.
(b) Non-Market (or Secondary) Stakeholders

The following are the descriptions of non-market sharefolders:
(i) External stakeholders are those who ă although they do not engage in
direct economic exchange with the business ă are affected by or can
affect its actions.
(ii) This includes the general public, communities, activist groups,
business support groups and the media.
3.1.5 Arguments on Stakeholders

The following are arguments on stakeholders from different perspectives.
(a) From the management perspective, the word "stakeholder‰ refers to a
person or organisation with legitimate interest in a project or entity.
(b) Involved in the decision-making process for institutions ă including large
business corporations, government agencies and non-profit organisations.
(c) Everyone with an interest (or "stake") in what the entity does which
includes vendors, employees, customers and members of a community.

(d) A "stakeholder" not only includes the directors or trustees on its governing
board (who are stakeholders in the traditional sense of the word) but also
all persons who "paid in" the figurative stake and the persons to whom it
may be "paid out" (in the sense of a "payoff" in game theory, meaning the
outcome of the transaction).
(e) Proponents in favour of stakeholders may base their arguments on the
following four key assertions:
(i) Value can best be created by trying to maximise joint outcomes. For
example, according to this thinking, programmes that satisfy both
employees' needs and stockholders' wants are doubly valuable because
they address two legitimate sets of stakeholders at the same time.
(ii) Debt holders, employees and suppliers also make contributions and
take risks in creating a successful firm.
(iii) Stockholders (shareholders) have complete control in guiding the
firm. However, many believe that due to certain kinds of structures in
the board of directors, top managers like CEOs are mostly in control
of the firm.
(iv) By attempting to fulfil the needs and wants of many different people
ranging from the local population and customers to their own
employees and owners, companies can prevent damage to their image
and brand, prevent losing large amounts of sales and disgruntled
customers as well as prevent costly legal expenses.
3.2 SHAREHOLDERS’ RIGHTS AND INTERESTS

The Organisation for Economic Cooperation and DevelopmentÊs (OECD)
Principles of Corporate Governance (2004) state that shareholders should have
the right to participate in and be sufficiently informed in decisions concerning
fundamental corporate changes such as:
(a) Amendments to the statutes, articles of incorporation or similar governing
documents of the company;
(b) The authorisation of additional shares; and
(c) Extraordinary transactions, including the transfer of all or substantially all
assets that in effect result in the sale of the company.
The rights are as follows:

(a) The form of shareholder approvals that are affected through resolutions in
general meetings.

(b) As owners, shareholders must engage in debate and challenge in order to

ensure that the board pursues a strategy that is focused on sustainable
value creation.
(c) It is essential, therefore, that shareholders exercise their right to participate
in the companyÊs decision-making process by participating and voting in
general meetings.
3.2.1 Shareholders’ Approval

The law recognises the interest of shareholders in the conduct of the affairs of a
company and provides rights to them in a variety of situations.
The Companies Act 1965 (CA) provides that the shareholderÊs approval must be
obtained before a company:
(a) Issues additional shares (Section 132D CA);
(b) Proceeds to make any amendments to its memorandum or articles of
association, whereby at least three-quarters of shareholders attending and
voting at the meeting must have voted in favour of the proposed
amendments; and
(c) Effects any substantial property transaction involving a director or a
substantial shareholder of the company or its holding company or with a
person connected with such persons (Section 132E CA). Bursa Malaysia
Listing Requirements also provides for additional safeguards against
abusive-related party transactions (RPTs) (Topic 10, Bursa MalaysiaÊs Main
Market Listing Requirements).
This includes requiring the related party or persons connected with the
related party to abstain from voting in the general meeting that was
convened to approve the transaction. An independent adviser must also be
appointed to advise minority shareholders on how they should vote in
respect of the transaction.
The Company Act 1965 further provides shareholders with the following rights
in respect of participating and voting in general meetings:
(a) To attend, speak and vote at general meetings (Section 148, CA);
(b) To requisition the company to convene a general meeting (section 144, CA);
(c) To place items on the general meeting agenda (Section 151, CA);

(d) To appoint up to two proxies when the shareholder is unable to attend the
general meeting (Section 149, CA);
(e) For a corporate shareholder ă To attend the general meeting through its
corporate representative (Section 147(3), CA).
3.2.2 Shareholders and General Meetings

Shareholders cannot control directors directly but instead operate indirectly by
acting together in the general meeting.
General meetings can only interfere with the board's exercise of management
power by altering the articles of association by special resolution or if the
opportunity arises, by refusing to re-elect the directors (refer to Article 73 of the
Articles of Association).
Since very few shareholders turn up at general meetings, the board is

consequentially the most powerful entity in the company's management
structure. It is, therefore, important that the board upholds high standards of
corporate governance in managing the company.
Shareholders can play a strategic role in enhancing corporate governance if they

realise the opportunities provided by Annual General Meetings (AGMs) to
exercise their rights for corporate democracy and public scrutiny of directors.
The exercise of specialised or technical knowledge or business experience by the

shareholders is not required. It is merely the exercise of their rights in the AGMs
that is needed.
AGMs give shareholders direct access to the board, not counting the size of their
shareholding.
3.2.3 Shareholders’ Rights

The law provides shareholders with several basic rights. The following are the
key rights related to general meetings:
(a) Requisition for, convene and attend general meetings;
(b) Appoint a proxy and speak at general meetings, vote at general meetings
and use information such as the Registers of Substantial Shareholders, the
Register of Debentures, the Instruments and Register of Charges, the
Register of Directors' Shareholdings, the Register of Directors, Managers

and Secretaries, the Minute Book of General Meetings, the Registrar and
Index of Members; and
(c) A copy of audited financial statements must be circulated to shareholders
at least 14 days prior to the meeting to enforce these rights.
3.2.4 Rights and Responsibilities of Shareholders in

Relation to General Meetings
The following are the rights and responsibilities of shareholders in relation to
general meetings:
(a) Shareholders' Rights to Requisite for and Convene General Meetings

(i) Two or more members holding not less than 10 per cent of the issued
share capital may call for a meeting.
(ii) The shareholders must convene the general meeting and conduct
general meetings in accordance with the articles of the company.
(iii) The shareholders can send out the notice of the meeting but must do
all acts and bear all costs involved in convening the meeting.
(iv) The meeting must be conducted in the same manner as one convened
by the company.
(v) Members holding not less than 10 per cent of the paid-up share may
make a requisition for the convening of an Extraordinary General
Meeting (EGM).
(vi) The directors must proceed to convene an EGM as soon as possible,
within 21 days from the date of receipt of the requisition.
(vii) EGM shall be held no later than two months after the date of receipt
of the requisition.
(viii) If the directors fail to convene the EGM as requisitioned by the
members within 21 days after the date of the requisition was received,
any of the requisitionists representing more than one-half of the total
voting rights of all the requisitionists may proceed to convene the
EGM.
(ix) The EGM so convened must be held within three months from the
date of deposit of the requisition.

(b) Shareholders' Rights to Attend, Appoint Proxy and to Speak at General

Meetings
(i) Every member has a right to attend any general meeting of the
company and to speak and vote on any resolution before the meeting
notwithstanding any provision in the memorandum and articles.
(ii) A member, whose calls are in arrears, may be barred from attending a
meeting if the articles state so.
(iii) A member may attend any general meeting of the company or class
meeting (if he is entitled to attend) personally or by proxy.
(iv) A proxy means a lawfully constituted agent. Every member of a
company who is entitled to attend and vote at a meeting of a company
is entitled to appoint another person or persons (whether a member or
not) as his proxy to attend and vote on his behalf. The proxy shall
have the same right as the member to speak at the meeting. However,
unless the articles state otherwise:
• A proxy shall not be entitled to vote except on a poll, that is, the
proxy cannot vote using a show of hands;
• A proxy shall be a member, or if he is not a member of the
company, he shall be an advocate, an approved company auditor
or a person approved by the Registrar of companies; and
• A member shall not appoint more than two proxies to attend and
vote at the same meeting; and if two proxies are appointed, the
appointment shall be invalid unless he specifies the proportions of
his holdings to be represented by each proxy.
3.2.5 Shareholders’ Rights to Vote at General Meetings

The following are ways that shareholders can exercise their rights through
voting:
(a) Every shareholder has a right to vote at any general meeting of the
company.
(b) Each equity share issued by a public company or a subsidiary of a public
company shall confer the right to one vote at a poll at any general meeting.
(c) The business of general meetings is decided by voting.
(d) Two common ways of voting at general meetings are by show of hands and
through polls.

The two common ways of voting at general meetings are described as follows:
(a) Voting by Show of Hands

The following are descriptions of voting by show of hands:
(i) Each person at the meeting has one vote.
(ii) Article 51 Table A in The Company Act 1965 provides that at any
general meeting, a resolution put to vote shall be decided by a show
of hands in the first instance unless a poll is demanded.
(iii) Unless the company's articles provide otherwise, a proxy cannot vote
by show of hands.
(iv) Article 54 of Table A clearly states that every member or his proxy
present shall have one vote each on a show of hands.
(b) Voting by Poll

The following are descriptions of voting by poll:
(i) Voting by written ballot.
(ii) Votes are given proportionately to the number of shares held. The manner
on how a poll should be demanded is usually provided in the articles.
(iii) Article 51 of Table A provides that a poll may be demanded before or on
the declaration of the result of show of hands by any of the following:
• The chairman;
• At least three members present in person or by proxy;
• Any member or members present in person or by proxy holding
or representing not less than 10 per cent of the total voting rights
of all the members present at the meeting; or
• Any member or members holding shares (in the company
conferring a right to vote at the meeting) of aggregate sum which
has been paid up equal to or not less than 10 per cent of the total
sum paid up on all the shares conferring that right.
(iv) Demand for a poll may be withdrawn if the articles provide so.
However, if the articles do not contain such a provision, then the poll
once demanded properly and accepted by the chairman cannot be
withdrawn.
(v) A casting vote is provided in the articles of some companies where
the chairman of the meeting is entitled to exercise a second or a
casting vote.

(vi) A casting vote is a second vote given to the chairman to resolve the
situation where there is an equality of votes (whether on show of
hands or on a poll).
3.2.6 Shareholders’ Rights to Inspect Register of

Directors’ Shareholdings at AGM
The following are detailed explanations on shareholdersÊ rights to inspect the
Register of DirectorsÊ Shareholdings at the AGM.
(a) Shareholders have the right to access the Register of Directors'

Shareholdings and Interests which are made available for inspection at each
AGM.
(b) The Register must be produced at the commencement of each AGM of the
company and kept open and accessible during the meeting to all persons
attending the meeting.
3.2.7 Shareholders’ Rights: Meeting and Resolutions

The following are shareholdersÊ rights which can be categorised in terms of
meetings and resolutions.
(a) Meetings
Pursuant to the Companies Act, a shareholdersÊ meeting may be convened:
(i) By two or more members holding not less than one tenth of the
issued share capital of a company; and
(ii) By the requisitions, where the directors of the company have failed to
convene a meeting, without justification, having been properly
requested to do so.
(b) Resolutions
ShareholdersÊ rights in relation to resolutions are as follows:
(i) A special resolution is required (which must be passed by a majority
of at least three-quarters of the members voting in person or by
proxy), where a decision by majority vote (ordinary resolution) will
suffice.
(ii) Under the Companies Act, special resolutions are required for a
reduction in share capital.

3.2.8 Protection of Minority Shareholders

Minority shareholders in Malaysia may enforce their rights under common law
or statute, provided the relevant criteria have been met.
Shareholders may file a petition for cessation of or a remedy against oppression

of the minority under Section 181 of the Companies Act where:
(a) The companyÊs affairs or the directorsÊ powers are exercised in an
oppressive manner or in disregard of the interests of shareholders; or
(b) A resolution of the shareholders, debenture holders or any class thereof has
been passed or is proposed; or an act of the company has been executed or
is threatened which is unfairly discriminatory or prejudicial to one or more
shareholders.
The shareholders may also petition to have the company wound up pursuant to
Section 218 of the Companies Act on the grounds that the directors have acted in
their own interests rather than those of the shareholders as a whole, or in any
other manner which appears unfair or unjust to other shareholders.
The remedy available to minority shareholders under common law is the

derivative action, which enables a shareholder to bring an action for the benefit
of the company in certain circumstances.
A shareholder may institute a derivative action irrespective of whether or not he

was a shareholder at the time the alleged wrongs were committed (Section 181A
of Companies Act 1965). An action under section 181A can only be instituted
with the leave of the court. Under section 181A, a complainant must also
demonstrate that he is a complainant within the meaning of section 181A (4).
However, the derivative action cannot be continued once he ceases to be a
shareholder.
3.2.9 Who is Responsible for Protecting and

Managing Shareholders’ Interests?
The following are explanations on the roles of the board of directors in protecting
and managing shareholdersÊ interests.
(a) The shareholder is not involved in the day-to-day operations of the
company and relies on several parties to protect and further his or her
interests.

(b) These parties include the company's employees, its executives and its board
of directors.
(c) However, each one of these parties has its own interests, which may
conflict with those of the shareholder.
(d) The board of directors is elected by the shareholders of a corporation to
oversee and govern management and to make corporate decisions on their
behalf.
(e) The board is directly responsible for protecting and managing shareholders'
interests in the company (Refer to Article 73 of Articles of Association).
(f) Board needs to be objective and proactive in its policies and dealings with
management.
(g) Helps to ensure that management is generating shareholder value.
(h) Directly participate in business decisions on the management level.
SELF-CHECK 3.1
1. What is the difference between stakeholders and shareholders?
2. Identify shareholdersÊ rights in an AGM.
3.3 ROLES OF STAKEHOLDERS

The following is a discussion on stakeholders, decision making and direct
management of stakeholders.
(a) Stakeholders
(i) In a business, a stakeholder is usually an investor whose actions
determine the outcome of the businessÊ decisions.
(ii) Stakeholders do not have to be equity shareholders.
(iii) They can also be the employees, who have a stake in your companyÊs
success and have an incentive for products to succeed.
(iv) They can be business partners who rely on your success to keep the
supply chain going.
(v) Every business takes on a different approach to stakeholders. The
roles of stakeholders differ between businesses, dependent on the

rules and responsibilities laid out at the founding of the company or

as the business evolves over the years.
(vi) The most common definition of a stakeholder, however, is a large
investor that has the clout to hold a viable „stake‰ in the company.
(b) Decision Making

(i) The board of directors are an example of stakeholders in a publicly
traded company, comprising high-ranking executives and occasional
outsiders who hold large amounts of equity in the company.
However, for private companies, decision making is totally for the
interest of the owners or directors of the company as the company
belongs to them. So, decision making in terms of the roles of the board
differs between public and private companies.
(ii) Has the power to disrupt decisions or introduce new ideas to the
company.
The board of directors has the power to appoint all levels of senior
management, including the CEO and remove them if necessary.
(iii) Members of the board dictate the future of the company and are
involved in all major business decisions.
(c) Direct Management

(i) Some stakeholders prefer the „hands on‰ approach by directly
assuming management positions.
(ii) Stakeholders can take over certain departments ă such as human
resources or research and development ă to micro manage the
business and insure success.
(iii) In privately owned and publicly traded companies, large investors
often directly participate in business decisions at the management
level.
SELF-CHECK 3.2
1. How long must it take for a copy of audited financial statements
to be circulated to shareholders?
2. Explain two common ways of voting at general meetings.
3. How can stakeholders affect decision making? Explain.

• A shareholder is any person, company or other institution that owns at least

one share in a company. Shareholders are the owners of a company and have
the potential to earn profit if the company does well, but that comes with
potential losses if the company does poorly.
• Stakeholders may include a person, group or organisation that has direct or

indirect stake in an organisation because it can affect or be affected by the
organisation's actions, objectives and policies.
• There are two types of stakeholders ă market or primary stakeholders and

secondary stakeholders. Primary stakeholders are internal stakeholders that
engage in economic transactions with the business. Non-market or secondary
stakeholders are external stakeholders who do not engage in direct economic
exchange with the business, but are affected by or can affect its actions.
• Shareholders have the right to requisition for and convene general meetings,
to attend meetings, appoint a proxy and speak at general meetings, vote at
general meetings and must be given a copy of audited financial statements at
least 14 days prior to the meeting to enforce these rights.
• Stakeholders are not involved in decision making but their interests are to be
considered in decision making.
Annual general meeting Register of directorsÊ shareholdings

Companies Act 1965 Rights
Majority shareholder Shareholders
Malaysian Code on Corporate Stakeholder view theory
Governance
Stakeholders
Market or primary stakeholders
Substantial shareholder
Minority shareholder
Voting by poll
Non-market or secondary stakeholders
Voting by show of hands

Ameer, R., & Abdul Rahman, R. (2009). The impact of minority shareholder watchdog
group activism on the performance of targeted firms in Malaysia. Asian
Academy of Management Journal of Accounting and Finance, 5 (1), 67ă92.
Arjunan, K. (2006). Company law in Malaysia. Selangor, Malaysia: LexisNexis.
BBC News. (2008). Why do councils love jargon? Retrieved from

http://news.bbc.co.uk/2/hi/uk_news/magazine/7234435.stm
Berle, A. (1962). Modern function of the corporate system. Columbia Law Review
62, 433.
Companies Act 1986 (Act 125) & Subsidiary Legislations. (2000). Kuala Lumpur,
Malaysia: International Law Book Services.
Corporate Governance Blueprint. (2011). Retrived from http://www.sc.com.my/

corporate-governance-blueprint-2011
Freeman, R. E., & Reed, D. L. (2006). Stockholders and stakeholders: A new

perspective on corporate governance. California Management Review,
25(3), 88-106.
Learning and Skills Council. (n. d.) Jargon buster - Stakeholder. Retrieved from
http://www.lsc.gov.uk/
Malaysian Code on Corporate Governance. (2012). Retrieved from

http://www.sc.com.my/malaysian-code-on-corporate-governance-2012
Malaysian Code on Corporate Governance. (Revised 2007). Retrieved from

http://www.ecri.org/codes/documents/cg_code_malaysia_2007_en.pdf
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http://www.timesonline.co.uk/tol/news/politics/article6493420.ece

Topic X Family-owned
4 Firms
LEARNING OUTCOMES
1. Explain the ownership structure of firms around the world;
2. Identify the ownership structure of firms in Malaysia;
3. Describe family firms and family ownerships;
4. Discuss the characteristics of family firms; and
5. Discuss family-owned firms and governance.
X INTRODUCTION
Ownership structure is an important factor in shaping the corporate governance
system. The degree of ownership concentration in a company is based on the
distribution of power between its managers and shareholders. The concentration
of ownership is beneficial to companies as large shareholdings allow for greater
monitoring of managers (Jensen & Meckling, 1976). Thus, the absence of
separation between ownership and control reduces conflicts of interest and
increases shareholdersÊ value (Morck, Shleifer & Vishny, 1988).
4.1 OWNERSHIP STRUCTURES AROUND

THE WORLD
Ownership structure is a primary determinant of the agency problems in the
controlling of inside and outside investors which, in turn, has an important
implication for the valuation of the firm (Lemmons & Lins, 2003).

58 X TOPIC 4 FAMILY-OWNED FIRMS
Kirchmaier and Grant (2005) conducted research on European countries

(Germany, UK, Spain, Italy and France) which revealed that ownership varies
considerably across the largest European economies and that ownership has a
significant impact on a firm's performance.
A study done on 203 Turkish firms in 2005 found a high concentration of

ownership in Turkey. The unlisted holding companies have the highest average
percentage of shares, which supports the belief that individuals or families
establish holding companies to control their listed firms (Mandaci & Gumus,
2010).
The advantages of controlling insiders are as follows:

(a) Investment of resources in good projects where the firmÊs value increases
and insiders can increase their wealth in proportion to their claims on the
firm.
(b) Achievement of their consumption goals are more effective through the
firm than privately; the welfare of the diffused owners may be threatened
(Demsetz & Lehn, 1985).
(c) A strong economic incentive to monitor managers and decrease agency
costs (Demsetz & Lehn, 1985).
Concentrated ownership is more pronounced in (La Porta et al., 1998):

(a) Continental Europe;
(b) East Asian countries;
(c) Latin America; and
(d) Africa, which has inadequate shareholder protection.
Table 4.1 shows the proportion of family businesses worldwide.
Table 4.1: Family Businesses Worldwide
Proportion of
Country
Family Firms
United States 80% to 90%
United Kingdom 65%
Chile 75% to 90%
Austria 80%
Belgium 83%

TOPIC 4 FAMILY-OWNED FIRMS W 59
Czech Republic 80% to 95%

Estonia 90%
Finland 90%
France 83%
Germany 79%
Hungary 70%
Spain 85%
Italy 73%
Luxembourg 70%
Brazil 70%
Greece 80%
Cyprus 85% to 90%
Middle East 90%
Gulf countries 98%
Turkey 90%
Australia 67%
Source: FFI (2011)
In East Asia, companies are usually controlled by families or the state.

Controlling shareholders have power, primarily, through the use of pyramids
and participation in management (La Porta et al., 1999).
A study done by Claessens et al. (2000) in nine East Asian countries (Hong Kong,
Indonesia, Japan, South Korea, Malaysia, the Philippines, Singapore, Thailand
and Taiwan) reports that more than two-thirds of the firms are controlled by a
single shareholder.
About 60 per cent of the concentrated firmsÊ top management is related to the
family of the controlling shareholder and there is extensive family control in
more than half of East Asian firms.
A study in Thailand done by Yammeesri and Lodh (2004) found that firms with
controlling ownerships have higher performance than those with non-controlling
ownerships. Results also show that family-controlling ownerships enhance the
firmÊs performance.

4.2 OWNERSHIP STRUCTURE IN MALAYSIA

The ownership structure in Malaysia is more concentrated where the shares are
held by the state, families or individuals.
In 1997, the trend of ownership structure held by nominee companies was 45.6
per cent of the total shares held by the top five shareholders. However, the
ownership pattern has changed little over time and the majority of shareholdings
by the nominee companies and institutions are owned by families (Zhuang,
Edwards & Capulong, 2001).
Reports from the Observance of Standards and Codes (ROSC) by the World Bank
indicate that 67.2 per cent of the shares in Malaysia were in family hands, 37.4
per cent were in the hands of controlling shareholders and 13.4 per cent were
state controlled.
A study by Hui (1981) found that 0.8 per cent of shareholders owned 69 per cent
of all shares in the 62 largest Malaysian firms between 1974 and 1976.
La Porta et al. (1998) found that 54 per cent of ownership is owned by the three
largest owners who were from the 10 largest Malaysian non-financial listed
companies.
Pricewaterhouse Coopers (1998) shows that almost 97 per cent of Malaysian

public-listed companies (PLCs) are substantial shareholders with 33 per cent of
them involved in management.
Abdullah (2001) found that the single largest shareholder held 36 per cent of the
firmÊs shares.
Che-Ahmad et al. (2003) studied 236 PLCs in 1995 and found that the block-
holders held 60.75 per cent of company ownership.
Abdullah and Mohd-Nasir (2004) determined that the average shareholding by

the top 20 shareholders was 73 per cent.
A few actions were taken by the Securities Commission (SC) which announced a
revision in February 1998 to the regulations governing the distribution of
shareholdings of companies seeking listing on Bursa Malaysia. Companies
seeking main board listing are required to ensure that at least 25 per cent of
shares are held by a minimum number of dispersed public shareholders holding
not less than 1,000 shares each. The minimum number is 750 or 1,000, depending

on whether a company has paid-up capital of less or more than RM100 million
(KLSE Listing Requirements, paragraph 8.15 (1) and (1A)). Thus, the imposition
of rules and regulations by regulatory bodies does help protect minority rights.
In Asia, literature shows that family firms enhance the economy (Filatotchev,
Lien & Piesse, 2005; La Porta et al., 1999). Names like the Ayala family
(Philippines), Li Ka-Shing (Hong Kong) and Kyuk Ho Shin (South Korea) are
well-known among family group companies. In Malaysia, Robert Kuok (Kuok
Brothers) and Lim Kok Thay (Genting Group) are among the prominent family
businesses in the Malaysian market.
A study by Claessens et al. (2000) revealed that most concentrated firms in

Malaysia are dominated by family founders and their descendants. Khan (2004)
also found that most companies in Thailand and Malaysia have the „family-
based corporate governance model‰.
In East Asia, there is a preponderance of family-based firms that are not

necessarily controlled by banks or by equity markets. Nevertheless they do
operate economic entities within the context of a relationship-based system
which could be considered the family-based corporate governance system.
(Khan, 2004, p. 100)
Family businesses are financed largely by internal funds. The ultimate power
remains with the family groups (Khan, 2004).
Abdul Rahman (2006) determined that listed firms in Malaysia are owned or
controlled by family and that these companies appear to be inherited by their
own descendants.
Research indicates that 59 per cent of businesses in Malaysia are still managed by
the founder, while 30 per cent are run by the second generation where the
majority are the founderÊs children (Shamsir Jasani, 2002).
Evidently, from Ibrahim and Abdul Samad (2010), the development of family
businesses in Malaysia has contributed in producing a number of tycoons within
their respective fields such as Syed Mokhtar Al-Bukhary, Robert Kuok Hock
Nien and Ananda Krishnan. The report from a national survey covering 225
companies conducted by Grant Thornton and the Malaysian Institute of
Management in 2002 stated that the majority of family businesses in Malaysia are
small-scale enterprises generally managed by the founder (Shamsir Jasani, 2002).

Manufacturing, retailing or construction are the notable sectors into which family
businesses ventured most. It is also found that most of the family businesses
were initiated by people having six or more years of work experience. This
indicates that in Malaysia, it is people with appropriate experience that
commenced family businesses.
The report also underlines the characteristics of family businesses in Malaysia,

which can be summarised as follows:
(a) 59 per cent of the business is still run by the founder and 30 per cent is run
by the second generation, the majority of whom are the founderÊs children.
(b) 65 per cent of small-scale enterprises are managed by the founders.
(c) 55 per cent of family businesses in small-scale enterprises employ fewer
than 51 persons.
(d) 35 per cent of family businesses in medium-scale enterprises employ 51 to
250 persons.
(e) 10 per cent of family businesses from large-scale enterprises employ more
than 250 persons.
(f) The main activity of family businesses lies in manufacturing (35 per cent),
followed by retailing (12.9 per cent) and construction (10 per cent).
Concerns in Family Businesses

The report of the survey highlighted two main concerns in a family business
structure:
(a) Means to finance the business; and
(b) Involvement or participation of family members.
Although these two factors are distinct, in practice, they are actually interrelated
with one another. Often, in starting up, carrying out and expanding the business,
family businesses not only face the challenge of getting sufficient financing but
also finding the appropriate source of finance.

Figure 4.1: Concerns over losing control if outsiders were to be involved in

financing the business
Figure 4.1 shows that it is in the small-scale business that members are most
concerned about losing control if they obtain external finance. For the large-scale
business, the concern on external participation is not much on the financing
aspect but rather on the possibility of change in the management system. In fact,
52 per cent of the respondents from the large-scale business expressed their
concern on the possibility of changes in the way the business is run if outsiders
come into the picture.
Family Relationship
With regard to family involvement, the surveyÊs report stated that 48 per cent of
large-scale enterprises seemed less concerned about bringing family members
into business compared to small-scale (31 per cent) and medium-scale enterprises
(29 per cent). Nevertheless, the majority of the respondents, regardless of the size
of business, strongly agree that:
(a) Children should be introduced to the business at an early age;
(b) Children's education should be geared towards the needs of the business;
(c) There can only be one management successor;
(d) Criteria should be set up to decide how family members join and leave the
business;
(e) The business is stronger with family members involved;
(f) Parents should retire when the children are ready to take over the business;

(g) Founder and subsequent generations should always have a formal role in
the business;
(h) Family and business affairs should be kept separate; and
(i) Professional advisers should understand the unique issues facing the
family business.
With regard to the participation of children, the report highlighted that:

(a) 21 per cent of the respondents wanted their children to be involved in the
business.
(b) Of the 24 per cent of children involved in the family-run business:
(i) 46.5 per cent was the first child;
(ii) 28.2 per cent was the second child;
(iii) 13.7 per cent was the third child; and
(iv) 11.4 per cent was the fourth child.
(c) 52 per cent of respondents were of the opinion that their children should
join the business only if they wanted to. This was especially true for
respondents in large-scale enterprises (69 per cent).
The survey also sought responses on outsidersÊ participation in the family

business. It was found that only 39 per cent of the respondents from the large-
scale business were concerned about outsiders coming into the business and
taking control of the business while in the medium scale business, 43 per cent of
the respondents expressed their concern about external participation in the
family business. In addition, 44 per cent of the respondents in the medium-scale
business expressed their worry over losing control if outsiders were allowed to
be in the family business.
4.3 FAMILY OWNERSHIP

There are many writings which describe and define family business. Generally, it
refers to a business structure in which the ownerships, the management and the
decision-making power are retained and intended for the family members only.
The restrictions are structured as such from the beginning as it is meant to
establish a legacy of the family name.
According to BDO Stoy Howard, a family business centre in the UK, a business
shall fit in as a family business if at least one of the following conditions applies
(„Is Yours a Family Business?‰):

(a) A single family holds more than 50 per cent of the voting shares, supplies a
significant proportion of the company's senior management and is effective
in controlling the business;
(b) More than one generation is involved in the business; and
(c) The family regards the business as a family business.
A website publication of Purdue University highlighted that to understand

family business and its unique character, one has to consider the three different
but interrelated components of the structure, as shown in Table 4.2.
Table 4.2: Three Different but Interrelated Components in the

Family Business Structure
Components Description
Family The first component of family refers to a group of two or more persons
related by blood (biology) and/or by legal relationship (marriage,
adoption, in some states common law marriage). An emotional bond
usually accompanies this relationship. The nature of this bond and its
strength varies widely among families. The purpose of a family is
oriented towards people and relationships. As a result, family members
may tend to approach relationships with one another in the same
manner as they do in their family, rather than as they might with a
business colleague who is not from the same family.
Business The second component is business. A business is an economic unit. It is a
commercial enterprise that produces, distributes and/or exchanges goods
and services with customers. The purpose of a business is to accomplish
specific tasks as efficiently as possible and to acquire a reasonable profit from
the accomplishment of those tasks. People in businesses tend to relate to one
another in a hierarchical manner based on defined roles (for example, job
descriptions) that are designed to further the business.
Ownerships The third component is ownership. An owner is someone who has legal
claim to the assets of the business and who may risk his or her own
personal assets in hopes of realising a profit. The purpose of ownership
of a business is generally to acquire a return on investment and to
minimise the risk involved in the investment. In many cases, ownership
in a family business may remain in the hands of one family member, or
within a small group of family members. In other cases, ownership may
include non-family members as when a company has incorporated and
sold shares.
In a family business structure, these three components will overlap and create
three types of domain.

In the single domain, it may involve (refer to Table 4.3):
Table 4.3: Three Types of Domain in a Family Business Structure
Types of Domain Description

Family Only This refers to family members who do not work in the
business or have ownership.
Business Only This refers to non-family employees.
Ownership Only This refers to outside shareholders.
People who are involved in a single domain will probably have less knowledge
of the other domains and may have different expectations. For example, a parent
who is not involved in the business will tend to support the business without
regard for that person's qualifications and experiences and will tend to make
decisions based on parental roles (or other family roles) rather than from the
basis of a business.
Non-family employees are also single domain players. They work for the
company but do not have the same interests as owners or family members. They
may feel a conflict between their own hopes and dreams and those of family
employees, particularly when family employees are promoted or when family
members discuss business issues at home, thus excluding non-family employees
from the discussion. In the double domain area, the combination could be:
(a) Family + Business ă This commonly refers to employed family members,
not owners.
(b) Family + Owner ă This commonly refers to family shareholders who do not
work in the business.
(c) Business + Owner ă This commonly refers to employee shareholders.
In the three domain areas, all three components overlap ă Family + Business +
Owner ă so family members are involved in all three domains. Family members
who work in the business and are owners have their feet planted in all three
domains. They are probably the most knowledgeable about the inherent
workings of all three domains because they have more frequent and intimate
interaction with these three domains. They may feel great responsibility or exert
greater authority when it comes to business issues. While they may do this
legitimately, it often leads to conflict with other family members who have a
stake in the business but have less access to information and decision making.
These family members probably have the clearest view about how profits should
be divided between salaries, retained earnings and shareholder dividends.

However, they may not understand the viewpoint of others who do not have the
perspective of all three domains.
The themes which underpin the family business are relationships and their
obligations, particularly those of a father to a son and a brother to a brother as
well as the values of reciprocity and respect. There are two main factors which
justify the survival of family businesses (Sheldrake, 1999):
(a) Decisiveness in the marketplace which allows the companies to be
aggressive and effective.
(b) Family ties or relationships ensure cohesiveness and trust that makes such
companies formidable adversaries.
Nonetheless, despite its secured tenure in the market place, the extension of
family businesses face two main threats (Sheldrake, 1999):
(a) The inability of succeeding generations to maintain the entrepreneurial
spirit and success of the founders; and
(b) The issue of sustainability.
A family business can expand only up to a certain size. Beyond that size, the
enterprise can only operate effectively through the application of more universal
rules, more impersonal processes and without reliance on individual links of
kinship. This second factor is actually the impetus behind this research which is
meant to highlight the possible diversion of ownership in the due course of
expansion of the family business.
The three dimensions of the family firm definition are the portion of capital
holding and voting rights or ownership, management position by family
members and company control (Villalonga & Amit, 2006).
Family firms have been defined by a single criterion, namely, ownership in

several studies (for example, Górriz & Fumas, 1996; Filatotchev et al., 2005; Ben-
Amar & Andre, 2006; Kowalewski et al., 2010).
Other studies employed multiple criteria in their definition of family businesses

such as ownership with governance (for example, Anderson & Reeb, 2003; Arosa
et al., 2010), ownership and management (for example, Smith & Amoako-Adu,
1999; Miller et al., 2007), and finally ownership, governance and management
(for example, Villalonga & Amit, 2006; Andres, 2008; Saito, 2008).

After understanding the debate on the definition of family firms, we need to

understand the percentage of family ownership held by these parties. Do we
have an ideal number for percentage of shareholding by families?
(a) Percentage of Family Shareholdings

Faccio and Lang (2002) note that firms in the UK and Ireland are 44.29 per
cent controlled by families.
Franks and Mayers (2001) report that family shareholdings account for one-
third of total shareholdings in Germany.
Andres (2008) found that 63 per cent of shares are owned by families in the
German market. The performance of family businesses is only better in
firms where the founding family is still active either on the executive or the
supervisory board.
(b) Family Performance

Findings from Achmad, Rusmin, Neilson and Tower (2009) reveal that the
presence of highly concentrated shareholdings by family members might
lower corporate performance. Family firms tend to act in the interest of
family members, which lead to expropriation of wealth from non-family
shareholders.
A study conducted in Taiwan by Chu (2009) showed that family ownership

enhanced performance. This positive association is strong particularly
when family members serve as CEOs, top managers, chairpersons or
directors of the firms. However, the association becomes weak when family
members are not involved in firm management or control. The findings
suggest that the potential family-ownership effects are more likely to be
realised when family ownership is combined with active family
management and control.
Lin and Chang (2010) in Taiwan found three threshold effects between
family ownership and firm value. The optimal family ownership is between
31.76 per cent and 33.61 per cent because at this level, the firm value is
maximised. Family ownership reduces classical agency problems between
managers and shareholders (Fama & Jensen, 1983).
Morck et al. (2000) argue that family ownership in Canada leads to poor
financial performance. Family control by heirs leads to slower growth
because of inefficiencies due to entrenchment, high barriers against outside
control and low investment in innovation. In line with these arguments, the
high family stake reduces the probability of bidding by other external

investors and leads to a lower market valuation (Barclay & Holderness,

1989).
La Porta et al. (1999) discovered that firms in Hong Kong are largely family-
controlled and there are few widely held firms. At a very high level of
ownership, if the family ownership can be controlled and made use of
appropriately, firm performance can be optimised. A firm with a high
ownership concentration should pay even more attention to improving
corporate governance practices in order to enhance the firmÊs performance
(Ng, 2005).
In India, Johl et al. (2010) found that low family ownership leads to better
performance, while high family ownership is related to lower performance.
If families have a large control of a firm, the potential for entrenchment and
poor performance is high.
In Malaysia, there have been empirical studies on ownership and firm

performance. Studies show that listed firms in Malaysia are owned or
controlled by family members and that these companies appear to be
inherited by their own descendants (Abdul Rahman, 2006). It is reported
that nearly 67.2 per cent of Malaysian companies are owned by families
(Claessens et al., 2000).
The World Bank study in 1999 (as cited in Backman & Butler, 2003) on PLCs
in Malaysia and other Asian countries found that single shareholders
control more than 50 per cent of PLC shares, and families control at least 60
per cent of PLC shares. Specifically, 67.2 per cent of shares are owned by
family firms, 37.4 per cent are in the hands of only one dominant
shareholder and 13.4 per cent are state controlled. Thus, family-controlled
firms dominate and control the majority of the Malaysian capital market.
According to a survey done in 1996, family firms in Malaysia control almost

60 per cent of PLCs (Soederberg, 2003) and the majority of Malaysian firms
have an ultimate controlling owner, particularly an individual or a family
(Ishak, 2004).
Mohd Sehat and Abdul Rahman (2005) found that the average shares held
by block-holders in the top 100 Malaysian listed companies was 55.84 per
cent.
The concentrated ownership structure in Malaysia may be influenced by

the familiesÊ business style, culture, race as well as the regulations imposed
in Malaysia.

Bursa Malaysia requires all listed companies to issue at least 25 per cent of
the shares to the public, including family businesses. Meanwhile, the
remaining shares can still be owned by family firms. Therefore, it is still
possible that the remaining 75 per cent of the company shares are held by
family members. Families can remain as the controlling shareholders as
long as they own the shares and control the company.
SELF-CHECK 4.1
1. Discuss two advantages of having family firms.
2. List three prominent Malaysian family businessmen.
ACTIVITY 4.1
1. What is the pattern of ownership in Malaysia?
2. What is the required percentage of public spread required by Bursa

Malaysia for companies in Malaysia? Discuss.
3. Why is there a debate on the definition of a family firm?
4. In your opinion, do you agree that the founder of a family firm has
greater impact on firm performance than the successor? Discuss.
4.4 CHARACTERISTICS OF FAMILY FIRMS

Family firms have unique characteristics such as the following:
(a) Family members and concentrated shareholders are actively involved in the
management and the board (Lane, Astrachan, Keyt & Mcmillan, 2006).
(b) There is a difference in management styles, foundersÊ motivation, family
culture and ownership structures (Daily & Dollinger, 1992; Chua, Chrisman
& Chang, 2004).
(c) They have different strategies and they rely on control systems more than
non-family firms (Daily & Dollinger, 1992; Chami, 1999).
(d) Uniqueness of family firms is based on family ties and the intention that the
ties will be long lasting (Litz, 1995).

(e) They are governed by family traits (Mishra, Randoy & Jenssen, 2001). The
family spirit is inculcated as early as childhood and serves as a monitoring
and controlling mechanism in family firms (Fama & Jensen, 1983; Kets de
Vries, 1993).
(f) Extensive knowledge about a firm by the family members encourages quick
and flexible decisions (James, 1999).
(g) There is greater efficiency, higher profitability and a different risk profile to
typical equity holders.
4.5 FAMILY-OWNED FIRMS AND GOVERNANCE

Corporate governance is a blend of internal and external corporate governance
mechanisms. In order for family firms to be competitive like non-family firms,
they also need to have strong governance mechanisms.
(a) Family Representation

For the establishment of the board of directors in family firms, the board
may be structured in two different ways:
(i) Completely staffed by members related to the family, either by blood
or marriage who practise in small and medium enterprises
(Voordeckers et al., 2007).
(ii) A group with insiders and outsiders as prevalent in public-listed
companies (He & Sommer, 2010).
(b) Board Independence

The following are explanations on board independence:
(i) In Malaysia, the boards of family-controlled companies are
dominated by family members or their close friends and there are few
truly independent directors.
(ii) Family firms do not generally employ non-executive directors
(Young, Tsai & Hsieh, 2008) and employ fewer shareholders and
directors than non-family firms (Cromie, Stephenson & Montieth,
1995; Abdul Samad et al., 2008).
(iii) Owners of family firms are reluctant to appoint independent directors
because they are afraid of losing control; they do not believe that non-
executive directors understand the firmÊs competitive situation; they
are afraid of opening up to new, external ideas and viewpoints; and
they feel that board work steals a lot of time from more urgent,
operational issues (Ward, 1991).

(c) Family Chairman

The following are explanations on the family chairman:
(i) The family chairman is established in family firms to get the upper
hand from non-family firms.
(ii) Reduction of owner-manager agency cost through chairman
monitoring is facilitated (Burkart et al., 2003).
(iii) At least one position of CEO or chairman should be held by a family
member.
(iv) Founder-CEO and founder-chairman both have a positive effect on
firm performance and the founder chairman contributes value to the
firm with a non-family CEO (Villalonga & Amit, 2006).
(d) Family Involvement in Succession

The following are explanations for family involvement in succession:
(i) The family firmÊs survival and succession is referred to as
transferring ownership and management from one generation to the
next (Ward, 1988; Bocatto et al., 2010).
(ii) Choosing a successor ă promotion from inside the organisation or
appointment of an external CEO (Urooj et al., 2010). Family firms
often opt to promote family members such as siblings or children
(Smith & Amoako-Adu, 1999). Such members have gathered enough
knowledge of the firm owing to his or her close relations with the
firmÊs founder (Smith & Amoako-Adu, 1999).
(e) Board Size

The following are explanations on board size:
(i) The Malaysian Code of Corporate Governance (2000) Part AA (XII)
states the sizes of boards. Every board should examine its size, in
order to determine the impact of this number upon its effectiveness
(p. 71).
(ii) A board should have a minimum of seven or eight members to
function effectively because boards with a small number of
individuals are more likely to agree on a particular outcome (Jensen,
1993; Lange, Demeo, Silverman, Weiss & Laird, 2000) and to engage
in genuine interaction and debate (Firstenberg & Malkiel, 1994).
(iii) Family firms have slightly smaller boards (Chen, Chen & Cheng,
2008). The smaller board size may be due to a trade-off between
growth and risk exposure faced by the firms. This is because of the

high concentration of shares in the hands of a few shareholders

(Gorriz & Fumas, 1996).
(f) Leadership Structure

The following are explanations on leadership structure:
(i) In Malaysia, The Code (2001) Part 2, AA (II) elaborates that for the
chairman and chief executive officer, there should be a clearly
accepted division of responsibilities at the head of the company which
will ensure a balance of power and authority, such that no one
individual has unfettered powers of division. Where the roles are
combined, there should be a strong independent element on the
board. A decision to combine the roles of chairman and chief
executive should be publicly explained.
(ii) The leadership structure can be either separate or dual. Duality arises
when the post of CEO and chairman are managed by one person.
Separate leadership refers to the positions of chairman and CEO being
held by two different individuals.
(iii) Dual leadership is a common practice in family firms (Chen, Cheung,
Stouraitis & Wong, 2005). Founder-CEOs are more concerned about
the survival of their firms and protecting their legacy for future
generations as well as achieving higher profits.
ACTIVITY 4.2
1. Explain what is dual leadership.
2. Based on your readings, if you are the CEO, would you prefer
to manage a smaller or larger board? Justify your reasons.
• From a worldwide aspect, ownership structure was found to be concentrated.
• Ownership structure in Malaysia tends to be concentrated and most are

family-owned firms.
• Family ownership in Malaysia is derived from the founder to the successor,

but there is problem in getting new family successors to manage family-
owned companies.

• In ensuring the survival of family firms, these firms need to have strong
governance such as family representation, board independence, family
chairman, family succession, board size and leadership structure.
Agency theory Insider

Blockholders Malaysian Code of Corporate Governance
Chairman Manager
Chief Executive Officer Outsider
Control Performance
Controlling shareholder Public-listed companies
Dual leadership Securities Commission
Family-owned Separate leadership
Family ownership Shareholders
Founder Substantial shareholders
Independent director Successor
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Topic X The Role of
5 Institutional
Investors in
Corporate
Governance
LEARNING OUTCOMES
1. Discuss the growth of institutional ownership;
2. Explain the influence of institutional investors;
3. Describe the tools of corporate governance; and
4. Discuss the relationship between corporate governance and
corporate performance.
X INTRODUCTION
Have you heard of institutional investors? Have you thought about the following
questions related to this group of investors?
(a) What is their current state in the Malaysian business environment?
(b) How can they influence business?
(c) Are they a part of corporate governance tools?
(d) Do they have any impact on corporate performance?
This topic will provide you with answers to the questions above.

TOPIC 5 THE ROLE OF INSTITUTIONAL INVESTORS IN W 81
5.1 GROWTH OF INSTITUTIONAL SHARE

OWNERSHIP
In this subtopic, we will discuss further the development of institutional share
ownership, specifically in Malaysia. We start with the definition of institutional
investors and the current trend of these shareholders in the Malaysian capital
market.
5.1.1 Definition of Institutional Investors

Investors are a very crucial element in a business. This is because investors
contribute capital and expect good returns from a business. Investors can be
classified into several categories such as retail, institutional, local and foreign
investors. This topic will focus on institutional investors.
Institutional investors are giant entities which invest large amounts of money,
either in shares, properties or other types of investments. They act as
beneficiaries on behalf of their capital contributors. Typical types of institutional
investors are banks, insurance companies, pension funds, investments advisors
and mutual funds.
In Malaysia, examples of huge institutional investors are Kumpulan Wang

Simpanan Pekerja (Employees Provident Fund of Malaysia), Lembaga Tabung
Angkatan Tentera (Armed Forces Fund Board), Permodalan Nasional Berhad
(National Equity Corporation), Pertubuhan Keselamatan Sosial (Social Security
Organisation), Lembaga Tabung Haji (Pilgrimage Board) and Khazanah
Nasional.
Because they hold a significant amount of shares in a particular company,

institutional investors generally have a significant influence over the firmÊs
operations. In other words, they have power in making business decisions,
especially through their voting power. In addition, they have the right of profit
sharing, the right to vote in the general meetings and the right to elect or dismiss
directors.
5.1.2 Current Trend of Institutional Investors

In the UK and the US, the trend is that the percentage of institutional investor
shareholding is increasing, in contrast to the percentage of shareholding of
individual investors. By having multiple investment portfolios, institutional
investors disseminate and minimise risk of investment. At the same time, they

82 X TOPIC 5 THE ROLE OF INSTITUTIONAL INVESTORS IN
have controlling power over business operations, thus assisting in promoting

business decisions in the best interest of shareholders.
Similarly, the percentage of institutional investor shareholding is significant in

Malaysia. Figure 5.1 illustrates the percentage of shareholding traded at Bursa
Malaysia for March 2012 based on type of investor. The chart shows that
institutional investors, both local and foreign investors, are the major category of
shareholders in Malaysia. The local institutional investors hold 42.25 per cent of
shares, while foreign investors contribute 21.75 per cent of shareholding. This is
the data as of March 2012 for the total value traded of RM37.2 billion.
Figure 5.1: Percentage of shareholding based on type of investor in Malaysia

Source: www.bursamalaysia.com
Figure 5.2: Buy and sell value based on type of investor in Malaysia
Source: www.bursamalaysia.com

In addition, Figure 5.2 displays the value (RM billion) of shares traded (buy and
sell) by different type of investors for March 2012. Consistent with Figure 5.1, the
chart exhibits that institutional (local and foreign) investors are the major players
of Malaysian capital market transactions. Local institutional investors bought
almost RM15 billion and sold about RM17 billion shares in March 2012. This is
followed by foreign institutional investors who bought and sold approximately
RM10 billion and RM6 billion of shares respectively. Both these diagrams
indicate that the institutional investors contribute a significant percentage of
shareholding in Malaysia.
Visit the following website for further information on the Malaysian capital
market: http://www.bursamalaysia.com
5.2 INFLUENCE OF INSTITUTIONAL

INVESTORS
In this subtopic, we will look at how institutional investors can influence
decision making in companies. This can be done through their roles and
responsibilities.
5.2.1 International Corporate Governance Network

(ICGN) Statement of Principles on Institutional
Shareholder Responsibilities
Institutional investors have significant influence over the companiesÊ operations
due to the large amount of shares that they hold. Thus, the roles of institutional
shareholders are essential to protect the shareholdersÊ best interest. To guide
shareholders in performing their roles, several guidelines have been outlined.
Among the guidelines is the ICGN Statement of Principles on Institutional

Shareholder Responsibilities. This statement provides a guideline on the
responsibilities of institutional shareholders. Members of ICGN are from over 38
countries from various regions including North America, Europe, East and South
Asia, Latin America, Africa and the Middle East.
There are five issues discussed in this statement, which are:

(a) Firstly, the statement outlines their key considerations. This includes their
view about key responsibilities of institutional investors.
(b) Secondly, the statement provides the definitions and examples of
institutional investors. This statement also describes the chain of

investment including a governing body, asset managers, service providers

and custodians.
(c) Thirdly, the four main elements of internal governance are explained. They
are oversight, transparency and accountability, conflicts of interest and
expertise.
(d) Next, the statement discusses the external responsibilities which include
application of consistent policies, engagement with companies, voting and
addressing corporate governance concerns.
(e) Finally, the conclusion is provided.
The statement covers the following issues as illustrated in Figure 5.3.
Figure 5.3: ICGN Statement of principles on institutional shareholder responsibilities

Source: ICGN (2007)
SELF-CHECK 5.1
1. Name several categories of investors in Malaysia.
2. Discuss the issues covered in the ICGN Statement of Principles

on Institutional Shareholder Responsibilities.

5.2.2 The Role of Institutional Investors in Malaysia

As for Malaysia, the Guide of Best Practices for Institutional Investors was issued
by the Institutional Investor Committee and Minority Shareholder Watchdog
Group (MSWG) from 2007. This guideline complements the Corporate
Governance Code. It provides the framework on institutional investorsÊ roles in
protecting their stakeholders.
In addition, the Securities Commission (SC) Malaysia published the Corporate

Governance Blueprint 2011 which consists of six chapters, including Chapter 2:
Role of Institutional Investors.
Chapter 2: Role of Institutional Investors suggests the role of institutional

investors from the perspective of leadership in governance and responsible
ownership. From the leadership in governance perspective, the institutional
investors:
(a) Have the ability to demand meetings with the senior management of
companies;
(b) Are able to challenge them on issues of concern;
(c) Are able to discuss strategies for achieving the companiesÊ goals and
objectives; and
(d) Can be the leading voice of shareholders in demanding corrective action
when wrongdoing occurs.
Institutional investors are urged to participate actively in the monitoring process,

leading by example and promoting good governance practices.
This chapter also describes the current state of the Malaysian environment in
relation to institutional investors. This includes providing examples of major
players and guidelines that govern institutional investors in Malaysia. In
addition, this chapter discusses the guidelines that are available internationally to
govern the institutional investors. These include the ICGN Statement of
Principles on Institutional Shareholder Responsibilities and The UK Stewardship
Code.
5.3 TOOLS OF CORPORATE GOVERNANCE

In this subtopic, we will discuss the role of institutional investors as a corporate
governance tool. Specifically, the focus is on the expectation of what institutional
investors should do.

Institutional Investors and Corporate Governance

Chapter 2: Role of Institutional Investors of the Corporate Governance Blueprint
2011 published by Securities Commission Malaysia discusses the need for a new
code for institutional investors. This is in line with high expectations towards the
institutional investorsÊ role in monitoring management decisions for the benefits of
fund contributors.
Thus, the Blueprint suggests the following issues as corporate governance tools for
institutional investors in Malaysia (refer to Figure 5.4).
Figure 5.4: Expectations of best practices under new code for institutional investors
Source: Corporate Governance Blueprint (2011)
5.4 CORPORATE GOVERNANCE AND

CORPORATE PERFORMANCE
In this subtopic, findings of research on related institutional investors will be
discussed. The discussions will shed some light on the relationship between
institutional investors and corporate performance.

Research findings on the relationship between institutional investors and

corporate performance
A lot of research has been done to determine the relationship between institutional
investors and corporate governance worldwide. This section will discuss some
findings of selected research.
Azlina Abdul Jalil and Rashidah Abdul Rahman (2010) came up with a research
paper entitled „Institutional investors and earnings management: Malaysian
evidence.‰ It investigates the impact of institutional shareholdings on earnings
management. They found that Permodalan Nasional Berhad (PNB) is the most
effective institutional shareholder within Malaysia Shareholders Watchdog Group
(MSWG) in reducing the earnings management.
Rashid Ameer (2010) studied specific categories of institutional investors, namely,

domestic and foreign banks. He investigated the decisions of these groups of
institutional investors in relation to the liquidity level of companies in his research
paper entitled, „The role of institutional investors in the inventory and cash
management practices of firms in Asia.‰ The paper proposes that the percentage of
shareholding by domestic and foreign banks have an impact on companiesÊ cash
and inventory level. Based on the findings, it can be concluded that higher
percentages of foreign shareholding will increase the cash holding and reduce the
inventory holding as compared to domestic banks.
Effiezal Aswadi Abdul Wahab, Mazlina Mat Zain, Kieran James and Hasnah
Haron (2009), in the paper entitled „Institutional investors, political connection and
audit quality in Malaysia‰, examined whether institutional investors and political
connections are associated with higher audit fees. In this paper, they suggest that
the total institutional shareholding is about 13 per cent of total Malaysian market
capitalisation as of 2003. Among major institutional shareholders in Malaysia are
EPF, PNB, Lembaga Tabung Angkatan Tentera, Lembaga Tabung Haji and
Pertubuhan Keselamatan Sosial. In contrast, institutional investors contribute just
about one per cent of the Malaysian capital market. The researchers propose that
higher institutional ownership is associated with higher audit fees. They found
that institutional ownership is positively related to audit fees, implying that firms
with institutional ownership ask for a better quality of audit as part and parcel of
their monitoring mechanisms.
Huson Joher, Mohd Ali and Nazrul (2006) carried out research on „The impact of
ownership structure on corporate debt policy: Two stage least square simultaneous
model approach for post crisis period: Evidence from Kuala Lumpur Stock
Exchange‰. They define institutional investors as pension funds, mutual funds, life
insurance companies, trust departments of commercial banks, property and

casualty insurance companies, closed-end funds, saving institutions, and

commercial bankers. They also define managerial ownership as companyÊs shares
directly held by directors, managers and other management team members. From
the findings, they conclude that institutional investors are effective in the
monitoring role, especially in the management of the company, which is reflected
by the percentage of management shareholding.
Navissi and Naiker (2006) in their article entitled „Institutional ownership and
corporate value‰ further investigate the impact of institutional ownership and the
firmÊs value. They classify institutional investors as passive and active investors
and propose that these two categories have different impacts on the companyÊs
performance. They conclude that shareholding of active institutional investors up
to 30 per cent improves the firmÊs value. The shareholding of more than 30 per cent
has the opposite impact. Passive institutional investors are found to be not
significant.
ACTIVITY 5.1
Key in the following keywords in any search engine:

(a) Institutional investors; and
(b) Firm performance.
What results do you get?
• Kumpulan Wang Simpanan Pekerja (Employees Provident Fund of

Malaysia), Lembaga Tabung Angkatan Tentera (Armed Forces Fund Board),
Permodalan Nasional Berhad (National Equity Corporation), Pertubuhan
Keselamatan Sosial (Social Security Organisation), Lembaga Tabung Haji
(Pilgrimage Board) and Khazanah Nasional are among the biggest
institutional investors in Malaysia.
• The ICGN Statement of Principles on Institutional Shareholder

Responsibilities, Guide of Best Practices for Institutional Investors by the
Institutional Investor Committee and Minority Shareholder Watchdog Group
(MSWG) and Chapter 2: Role of Institutional Investors of the Corporate
Governance Blueprint 2011 are among the guiding documents for institutional
investors.

• There has been a lot of research on the relationship between institutional

investors and firm performance.
Corporate Governance Blueprint 2011

ICGN Statement of Principles on Institutional Shareholder Responsibilities
Institutional Investor Committee and Minority Shareholder Watchdog Group
(MSWG)
Institutional investors
Voting power
Azlina Abdul Jalil, & Rashidah Abdul Rahman. (2010). Institutional investors and
earnings management: Malaysian evidence. Journal of Financial Reporting
and Accounting, 8(2), 110-127.
Bursa Malaysia. (n. d.). Retrieved from www.bursamalaysia.com
Corporate Governance Blueprint. (2011). Chapter 2: Role of institutional

investors. Retrieved from http://www.sc.com.my/corporate-governance-
blueprint-2011.
Effiezal Aswadi Abdul Wahab, Mazlina Mat Zain, Kieran James & Hasnah
Haron. (2009). Institutional investors, political connection and audit quality
in Malaysia. Accounting Research Journal, 22(2), 167-195
Huson Joher, Mohd Ali & M. Nazrul. (2006). The impact of ownership structure
on corporate debt policy: Two stage least square simultaneous model
approach from Kuala Lumpur Stock Exchange. International Business &
Economics Research Journal, 5(5), 51-64.
International Corporate Governance Network (ICGN). (2007). Statement of

principles on institutional shareholders responsibilities. Retrieved from
www.icgn.org

Minority Shareholder Watchdog Group (MSWG). (n. d.). Retrieved from

http://www.mswg.org.my/web/
Navissi, F., & Naiker, V. (2006). Institutional ownership and corporate value.
Managerial Finance, 32(3), 247-256.
Rashid Ameer. (2010). The role of institutional investors in the inventory and
cash management practices of firms in Asia. Journal of Multinational
Financial Management. 20, 126-143.
Securities Commission Malaysia. (n. d.). Retrieved from http://www.sc.com.my/

Topic X Socially
6 Responsible
Investment
(SRI)
LEARNING OUTCOMES
1. Explain what SRI is and why mutual fund investors are concerned
about SRI;
2. Describe the relationship between SRI and corporate governance;
3. Discuss some strategies for a company to become socially
responsive; and
4. Explain the impact of SRI on shareholder value.
X INTRODUCTION
Socially responsible investment (SRI) has been one of the concerns of institutional
investors. SRI recognises that corporate responsibility and societal concerns are
very important parts of investment decisions. SRI considers both aspects of
investments ă investorÊs financial needs and investmentÊs impact on society.
Growing concerns of investors regarding SRI have encouraged companies to
improve their practices and reporting on environmental, social and governance
issues.

92 X TOPIC 6 SOCIALLY RESPONSIBLE INVESTMENT (SRI)
6.1 SRI AND CORPORATE GOVERNANCE

Socially responsible investing is a term used to describe individuals and groups
who buy shares from companies that are known to be friendly to the
environment and are in support of animal life and human rights. One approach
to determine whether an investment is socially responsible is by referring to the
nature of business conducted. The common theme for socially responsible
investments (SRI) include avoiding investment in companies that produce or sell
addictive substances and services (like alcohol, gambling and tobacco) and
seeking companies engaged in environmental sustainability and alternative
energy or clean technology efforts. In other words, SRI considers ethical, social
and environmental performance of companies selected for investment (Mallin,
2007).
Socially responsible investment relates to the ethical concept, in which

"...investment is rooted in the notion of individual responsibility" (Gray et al.,
1996). Accordingly, if an individual or a group is concerned with ethical, moral,
religious or political principles, their investment decisions will follow their
principles (Miller, 1992). The development of the socially responsible investment
has been due to the proliferation of ethical and environmental mutual funds or
unit trusts which seek to base their investment portfolios on a number of social
criteria.
Business ethics is the application of general ethical ideas to business behaviour.

What is considered as ethical in one group may be different from another groupÊs
point of view. To be considered ethical, businesses must draw their ideas about
what is proper behaviour from the same sources as everyone else (Post et. al.,
1999). For example, if protecting others from harm is considered to be ethical, then
a company that recalls a dangerously defective product is acting in an ethical way.
The SRI was created by the mutual fund industry. This industry will not invest in
companies that pollute the environment, make addictive substances (such as
alcohol and tobacco), have bad corporate governance practices or do not respect
human rights. Some funds are devoted to investing based on religious beliefs or
other social causes. For example, in Islam, Shariah clearly defines a number of
aspects which are not permissible for Muslims such as the consumption of alcohol,
pork and transactions involving interest-bearing investments.
In an effort to support the increasing demand from Muslim investors (local and
foreign) on securities on Bursa Malaysia, the Shariah Advisory Council of the
Malaysian Securities Commission has undertaken the task of determining the
status of companies into Shariah compliant or non-Shariah compliant by using

TOPIC 6 SOCIALLY RESPONSIBLE INVESTMENT (SRI) W 93
specific criteria. The Securities Commission issues the Shariah approved list of
companies.
The growing awareness of SRI has led to the involvement of government via
legislation as institutional investors are becoming increasingly active in this field
by setting up special funds or screening existing and potential investments. In the
UK, from 3 July 2000 (Mallin, 2007), pension fund trustees have had to take
account of SRI in their Statement of Investment Principles. This means that pension
fund trustees must state the extent to which social, environmental or ethical
considerations are taken into account in the selection, retention and realisation of
their investments.
Effect of SRI on Corporate Governance

Various groups have contributed to the development of SRI. The most common
effort to curb unethical business practices is through government intervention and
regulation. This effort can enact stiff legislative control or empower government
agencies with more authority. The government can establish a minimum
requirement to guide proper behaviour or draw the line to control unethical action.
International organisations such as the United Nations and Organisation for

Economic Cooperation and Development Code (OECD) have developed
international codes of conduct for multinational corporations. Accordingly,
companies are urged to adhere to universal ethical guidelines when conducting
business throughout the world. The ethical issues addressed are economic
development, technology transfer, regulatory action, employment, human rights,
environmental protection, consumer protection and political action (Post et al.,
1999).
Institutional investors such as pension funds are concerned with investing their
money in SRI companies. Other groups such as trade unions and local authority
pension funds have been at the forefront of development in socially responsible
investing. For example, the funds have established investment policies on non-
financial matters. They actively lobby companies in which they hold shares in issues
of social and environmental concerns (Gray et al., 1996).
Banks as a major supplier of finance to the industry would clearly have the potential
to play a major role in the promotion of corporate social and environmental
accountability. In the beginning, the focus was on the issues of loan security. Later,
the concerns were on important issues such as the importance of environmental
criteria in lending decisions and the need to promote employee, customer and
general public awareness of the developing environmental agenda.

ACTIVITY 6.1
1. Discuss the extent of SRI activities in Malaysia.
2. Describe the role of the government in the context of SRI.
SELF-CHECK 6.1
Explain the following terms and provide some examples of each term:
(a) Institutional investors;
(b) Mutual Fund;
(c) Financial products;
(d) Regulated industry; and
(e) Shariah-compliant companies.
6.2 STRATEGIES FOR SRI

In response to pressure, businesses have increased their efforts in managing the
corporate social environment which are influenced by various community and
government groups. Some firms may be more vulnerable to social group
pressure and social regulation than others. Some factors which are identified as
contributing to this vulnerability are:
(a) A large-sized or well-known company which presents a big target;
(b) Located in an urban area and under increased scrutiny by the media and
social groups;
(c) Producing a public-oriented product;
(d) Providing a product or service that may cause harm or injury to the user;
(e) Part of a heavily regulated industry that is expected to meet high public
expectations.
The Ethical Investment Research Services (EIRIS) which was established in 1983
is a leading provider of independent research into corporate, social,
environmental and ethical performances with the aim of helping investors make
responsible investment decisions (Mallin, 2007). According to the Ethical
Investment Research Services (EIRIS) (2010), there is no specific model to

determine responsible investment. EIRIS identifies a number of approaches that

can be used separately or in combination. The approaches taken will depend on a
range of factors including resources available, the size of investments and the
objectives of the mutual fund or charity. The approaches are:
(a) Positive Screening
This approach involves positively selecting companies for investment that
have a commitment to responsible business practices and/or that produce
positive products or services. This approach could take a number of forms
including, for example, selecting companies for investment that
manufacture products that help to combat climate change such as
technology for renewable energy generation. Positive screening could also
take a best-in-class approach. This means excluding only a few sectors but,
within each sector selecting only the best performers on a range of criteria
such as their record on human rights or pollution.
(b) Negative Screening
This approach involves avoiding investing in companies or sectors that do
not meet the ethical criteria that the charity has set. An example may be a
health charity not wishing to invest in the tobacco industry.
(c) Engagement
This approach is also known as shareholder activism. This approach uses
the influence and rights of ownership to encourage more responsible
business practices. This takes the form of dialogue between investors, or
their fund managers and companies or the use of voting rights to enact a
change. Through shareholder advocacy they exercise their right as part-
owners of the company to attempt to influence behaviour. A common
practice is to participate in shareholder resolutions, which are petitions
drawn up by groups of shareholders that are presented to all the owners of
the company for a vote. They urge management or the board of directors to
take action on a particular concern.
(d) Other Financial Services
SRI can also be applied to other types of investments and financial schemes
where insurance policies, current accounts or corporate credit cards have
the most positive impact.
According to EIRIS (2010), there are six steps to be considered by the charity or
mutual fund if they want to move forward with the SRI. The information
gathered helps them respond to trustees and other decision makersÊ questions.
The steps are summarised in Table 6.1:

Table 6.1: Six Steps for the Charity or Mutual Fund to Take SRI
Steps Explanation
Clarify current The objective is to review the charityÊs starting point, address
situation concerns within the organisation and to be able to suggest how best
to proceed. Some factors to be considered are:
• Sizes of investments and where they are currently invested;
• Current investment policy;
• Any governing documents including any restrictions on;
investment policy;
• Latest agreement in place with investment managers;
• Available sources to develop and implement an SRI policy; and
• Activities done by other charities.
Get SRI on the The objective is to bring the issues onto the agenda with important
agenda stakeholders within the organisation. Some factors to be considered are:
• Discuss SRI at a trustee meeting;
• Discuss SRI at a senior management meeting;
• Make the case for why SRI would be a sensible choice for the
charity; and
• Invite experts to talk about the benefits of SRI to the organisation
and the processes involved.
Set aims The objective is to clarify why the charity should invest responsibly
and what it should seek to achieve. Some factors to be considered are:
• How the investment links to the charityÊs mission, strategy and
risk assessment;
• The charityÊs motivations for adopting SRI; and
• Nature of the charity and its activities with regards to key
stakeholders.
Develop, expand The objective is to prioritise and plot a course forward such as:
or update your • To determine which environmental, social, ethical and
SRI policy governance (ESG) issues to incorporate in investment decisions
(consider aims and mission); and
• To determine which approach to take (for example whether to do
screening or engagement).
Implement The objective is to ensure an SRI policy is carried out and the aims set
your SRI policy for it are achieved. It is an effective and ongoing monitoring process.
Review and It is an assessment of the impact of SRI and whether it has achieved its
report aims. For example an assessment on a number of factors is done including:
performance of fund managers, costs, which approach is best suited and
whether the key issues are addressed to relevant stakeholders.

Growing awareness on SRI gives a company no other choice but to become a

socially responsive company. Several strategies can be implemented in a
company in response to SRI, (Post et al., 1999):
(a) Top Management Philosophy
The top management philosophy in relation to SRI refers to the values and
beliefs of the company managers about their roles (or the roles of the
corporation) in a society. Having managers who are sensitive to the impact
of social forces means they will take into consideration the social as well as
economic context in their business policies and practices. In any decision,
they will consider not only the interest of their immediate shareholders but
also the interest of all the firmÊs stakeholders.
(b) Socially Responsive Strategy
A top management with a socially responsive strategy places emphasis on a
collaborative and problem-solving approach rather than solely on the firmÊs
interests. Under this approach, emphasis is on maintaining long-term
relationships based on trust and open communication with all the
companyÊs stakeholders. For example, managers may participate in
regulatory advisory committees and trade unions that seek mutual benefits.
Maintaining ongoing relationships with their stakeholders will ensure the
companyÊs long-term survival.
(c) Socially Responsive Structure
This strategy is about changing the organisational structure to be more
responsive to external social challenges. There are four aspects to
distinguish a socially responsive structure in an organisation: breadth,
depth, influence and integration. Breadth refers to the number of different
staff units specialised in socially responsive strategies. The number of staff
must be sufficient for the firm to adequately monitor and respond to the
demands made by social forces. Depth refers to the intensity of the
organisational learning process in response to the potential for social
challenges. Influence and integration refer to the quality of relationships
that exists among the companyÊs staff units. The ultimate effectiveness is
due to the degree of integration achieved among the staff units.
(d) Line Manager Involvement
The involvement of line managers in the companyÊs socially responsive
strategic process depends on the sophistication of the process. More
involvement from the line managers is required if the process is more
elaborate. The degree of involvement is influenced by top management
philosophy and consistent with the socially responsive strategy and
structure adopted by the company.

6.3 CORPORATE SOCIAL RESPONSIBILITY

(CSR)
This is an important area of responsibility under corporate governance and has
received substantial support. Social responsibility is observed as a natural
consequence of separate legal personality and limited liability (Dodd, 1932). This
means, as a legal person or citizen, the corporation should have a sense of
responsibility towards its surroundings that is, the community. Such an idea
evolved in the early 20th century in the US when business leaders of large
corporations mooted the idea that the business sector should use its powers and
control for social purposes and not merely for profit-making (Abdul Manaf Said,
1998).
Corporate social responsibility is also referred to as the involvement of a

company in solving social problems and its contribution towards the welfare of
the society (Abdul Manaf Said, 1997). This means a company should have a sense
of social responsibility towards the well-being of the community, besides profit
maximisation. A company with good corporate governance will anticipate the
needs of the society as well as solve these social problems.
Any social project that is going to be undertaken by a company should address

the needs of the society irrespective of whether such projects contain economic
implications or not (Abdul Manaf Said, 1997). In addition, a company is said to
be socially responsible when its actions go beyond the legal requirement for the
purpose of social good rather than the maximisation of profit (Slaughter, 1997).
It has been argued that the demand for social responsibility requires the
company to change its conventional management goal that is, profit
maximisation to multiple goals by considering the welfare of other groups of
people in the community. However, it is crucial that the management balances
the interests of all the affected groups as stated in the Watkinson committee
report (Parkinson, 1993):
„Boards should recognise obligations arising from the company's

relationship with creditors, suppliers, customers, employees and society at
large and in so doing to strike a balance between the interest of the
aforementioned groups and the interest of the proprietors of the company„
A company is said to adopt the corporate social responsibility objective when it is

held accountable for any of its actions that affect people, their communities and
their environment. Accordingly, adopting CSR implies that negative business

impacts on people and society are acknowledged and corrected if possible. To

some extent, the company may be required to forgo some profits if the activities
conducted have social impacts which are seriously harmful to some of its
stakeholders or if its funds can be used to promote a positive social good (Post et
al., 1996).
The objective of a firm is to maximise profits for its survival. However, a business
is responsible for not only achieving the economic objective but also the legal and
social objectives. It is a challenge for the management to blend all these
responsibilities into a comprehensive corporate strategy. In fact, corporate social
responsibility requires companies to balance the benefits to be gained against the
cost of achieving those benefits. Although these obligations may conflict at times,
a firm is considered successful if its management finds ways to meet each of its
critical responsibilities.
Theories on CSR Disclosures

Common theories which are used to support the reasons for companies
disclosing CSR information are as follows:
(a) Legitimacy theory;
(b) Stakeholder theory;
(c) Public interest theory;
(d) Political economy theory; and
(e) Signalling theory.
6.3.1 CSR Reporting

According to the World Business Council for Sustainable Development
(WBCSD)(2002), CSR is defined as „the commitment of business to contribute to
sustainable economic development, working with employees, their families, the
local community and the society at large to improve their quality of life‰. For
sustainable development, the business needs to ensure that the current
consumption will not destroy the resources for future generations.
Hackston and Milne (1996), define CSR as „the provision of financial and non-
financial information relating to an organisationÊs interaction with its physical
and social environment‰. CSR reporting has various virtual synonyms such as
social and environmental disclosure or reporting, environmental disclosure or
reporting, social review, social reporting and sustainability reporting.

Several themes of CSR have been identified such as human resources,

environment, community involvement, energy and service or product:
(a) Human Resource Disclosures
Human resource disclosures include employee remuneration, equal
opportunities, employee share ownership, health and safety as well as
employee training.
(b) Environment
Environment covers information about environmental policies and the
environmental impact of products or processes.
(c) Community Disclosure
Community disclosure refers to community involvement and public
welfare, sponsorship and charitable donations.
(d) Energy Information
Energy information refers to the companyÊs policy to reduce energy
consumption and how to use energy more efficiently.
(e) Product Information
Product information refers to product development, product safety and
product quality.
Many studies on CSR themes in the US, UK and Australian companies found
human resource as the most reported theme. The same findings were also
reported in Malaysian studies.
6.3.2 CSR in Malaysia

A decade ago, not much emphasis was given to corporate social responsibility in
Malaysia though its existence could be felt. However following the global trend,
at present, it is considered an important concept in MalaysiaÊs corporate scene.
There is nothing stated in the Companies Act 1965 that companies need to be
social responsible towards the society or any part of it. On the other hand,
reference to certain codes or regulation or other legislations reflect quite the
opposite.
Looking back, the element of corporate social responsibility could be traced in

the Company DirectorÊs Code of Ethics (1996) which enunciates that directors
should be conscious of the interests of employees, creditors and customers. Part
Three of the Code has outlined briefly that the director in performing his duties
should inter alia:
(a) Ensure effective use of natural resources and improve quality of life by
promoting corporate social responsibility;

(b) Be proactive to the needs of the society; and

(c) Ensure that the activities of the company do not harm the interest and well-
being of the society and assist in the fight against inflation.
In 1998, the Finance Committee Report on Corporate Governance defined

corporate governance as:
„...the process and structure used to direct and manage the

business⁄towards enhancing business prosperity⁄realising long term
shareholder value, whilst taking into account the interest of other
stakeholders‰.
The phrase „the interest of other stakeholders‰ refers to the element of corporate
social responsibility. This definition places the interests of stakeholders at par
with the interests of shareholders. Though the word „stakeholders‰ cannot be
outlined precisely, in general, it may cover employees, customers, suppliers,
environment and the local community. Following the report, in 2002, the
Malaysian Code on Corporate Governance was published. The Code provides
that information received by the board of directors should be:
„⁄not just historical or bottom line and financial oriented but information
that goes beyond assessing the quantitative performance of the enterprise
and looks at other performance factors such as customer satisfaction, product
and service quality⁄environmental performance and so on, when dealing
with any item on the agenda.‰
Consideration given to customer satisfaction and environmental performance are

parts of corporate social responsibility. Thus indirectly, corporate social
responsibility does exist though the term has not been specifically mentioned.
In 2004, Bursa Malaysia came out with the corporate social responsibility
framework, expecting it to be a guide for public-listed companies. Paragraph 2.17
of the Listing Requirement requires public-listed companies to disclose their
corporate social responsibility practices in their annual reports. Another bold
step taken by the government is the release of The Silver Book ă Achieving Value
Through Social Responsibility in September 2006 under the government-linked
companies transformation programme. The details about the Silver Book will be
discussed later.

In late 2006, ACCA Malaysia together with 19 organisations and the Securities
Commission set up CSR Malaysia (later known as the Institute of Corporate
Responsibility, Malaysia) which would be a network of corporate and regulatory
institutions to develop responsible business practices in Malaysia. Its mission is
to promote socially responsible business practices and encourage sustainable
development.
Its objectives, among others, are to provide resources for organisations to

integrate corporate social responsibility practices into their daily business and to
work with organisations to embed corporate social responsibility through
capacity building, sharing of information and exchange of experience. It should
be noted that the institute is known as the Institute of Corporate Responsibility
and the word „social‰ has been omitted. This is because they want to emphasise
that CSR is not merely about philanthropy and it is not about how a company
spends the money but it is about how it makes money. In its annual review
2006/2007, it is stated that:
„CSR Malaysia was renamed Institute of Corporate Responsibility, Malaysia to

better reflect the identity of the network as a catalyst to ensure that corporate
responsibility and sustainable development is not just a fad but is entrenched as
the way of business for companies in Malaysia (ICR Malaysia, 2006/2007).‰
In promoting responsible business, ICRM launched the ICR Malaysia Corporate

Responsibility Malaysia Awards in January 2008. The award recognises
companies that demonstrate outstanding corporate responsibility practices that
go beyond community and philanthropic activities.
Corporate social responsibility also received full support from the government.
In the 2008 Budget, the Prime Minister stated there would be tax deductions for
companies that provided significant benefits to the local community even if those
investments benefit the companies at the same time. He also mentioned that the
government would support the efforts in implementing CSR projects by
establishing a CSR fund, with an initial sum of RM50 million. The Prime Minister
also launched the Prime MinisterÊs CSR Award 2007 to involve more companies
in the private sector.
In the Malaysian Code on Corporate Governance, corporate social responsibility

is implied in particular where it states that besides financially-oriented
information, the board of directors should also receive information which
concerns customer satisfaction, product and service quality and environmental
performance. The Company Director's Code of Ethics has been formulated to
uphold the spirit of social responsibility and accountability in line with the

legislations, regulations and guidelines governing a company. This is expressly

delineated in Part Three of the Code, as mentioned earlier.
The Malaysian government is serious in enforcing CSR when it is included in the

governmentÊs plan of transforming government-linked companies (GLCs) into
high performing entities by 2020. The government through the Putrajaya
Committee on GLC High Performance (PCG) has undertaken two sets of actions
in materialising the transformation plan:
(a) Codification of Policy Guidelines consisting of five policy thrusts and
guidelines; and
(b) Translation of the Policy Guidelines into 10 specific initiatives which are
targeted at driving and enhancing GLC performance.
In the Policy Guidelines, there are five thrusts which are shown in Table 6.2.
Table 6.2: Thrusts in Policy Guidelines
Policy Thrusts Description

Thrust 1 Clarify the GLC mandate in the context of national development.
Thrust 2 Upgrade the effectiveness of Boards and reinforce the corporate
governance of GLCs.
Thrust 3 Enhance GLC capabilities as professional shareholders.
Thrust 4 Adopt corporate best practices within GLCs.
Thrust 5 Implementing the GLC Transformation Programme.
It is in Thrust 4 that CSR is explicitly relevant, whereby one of the guidelines is to

implement CSR and clarify social obligations and investment. The Silver Book
which contains a set of guidelines was introduced in September 2006 as one of
the 10 initiatives identified by the PCG in GLC Transformation Manual. The
Silver Book was specifically meant to assist GLCs in contributing to the society in
a responsible manner and creating a positive impact for both the businesses and
society. It also assists the GLCs in clarifying and managing social obligations in
the most efficient and effective manner. Nonetheless, despite this serious attempt
by the government, it is important to note that this only applies to GLCs.
Another interesting development of CSR in Malaysia is the establishment of the

Institute of Corporate Responsibility (ICR) Malaysia in 2007. ICR Malaysia is a
not-for-profit organisation which is supported by three giant conglomerates,
namely, the Securities Commission, Khazanah Nasional Berhad and Bursa
Malaysia Berhad. ICR Malaysia comprises member companies and regulatory

institutions which are committed to promoting responsible business philosophy

and practices which have a positive impact towards society and the environment.
Its main mission is to promote the development of responsible business practices
and raise business standards of Malaysian companies for the benefit of
stakeholders and to ensure sustainable development.
Bursa Malaysia defines CSR as open and transparent business practices that are
based on ethical values and respect for the community, employees, environment,
shareholders and other stakeholders. The aim of CSR is to deliver sustainable
value to society at large. It supports the Triple Bottom Line reporting which
emphasises the economic, social and environmental bottom-line wellness. CSR is
not about compliance or philanthropy or public relations. It often involves
cultural transformation in a company as it integrates CSR concepts into its
operations and decision making.
In terms of reporting, Bursa Malaysia does not specify a universal approach to

CSR, thus companies are free to adopt whatever approach that suits them.
However, under its CSR Framework, a company should focus on four themes of
CSR practices, the environment, the workplace, the community and the
marketplace. Ideally, companies should consider all the four CSR themes when
crafting their companiesÊ visions; however, it is not compulsory for them to do all
four activities.
(a) Environment
It focuses on a variety of issues concerning environment conservation such
as the efficient use of energy and efficient ways to reduce emissions which
may damage the climate, bio fuels, biodiversity and protect flora and fauna.
(b) Community
It focuses on activities related to employee involvement in the community,
supporting education such as adopting a school, contributing to children,
youth development and underprivileged citizens.
(c) Marketplace
It focuses on activities conducted by companies to interact responsibly with
their important stakeholders such as shareholders, suppliers and
customers. In order to meet the expectations of shareholders, the companies
will organise activities to support green products, engage in only ethical
procurement practices, develop suppliers and other vendors and meet the
standards of corporate governance.
(d) Workplace
It focuses on staff needs such as dealing with basic human rights, gender
issues, quality of work environment and quality of health and safety.

6.3.3 Benefits of CSR to Companies

Several reasons are given to support companiesÊ involvement in CSR activities
such as accountability to stakeholders and legitimising their products and
operations. Corporate social disclosure can be used to legitimise the companiesÊ
activities to the investors and reduce the cost of capital. Companies report their
social activities to show their good corporate governance and transparency
towards corporate socially responsible activities. Disclosure can be done through
various media such as annual reports, stand alone reports and their respective
websites. Such disclosures would assist stakeholders to know the extent to which
companies are involved in social activities.
From a marketing perspective, the CSR activities disclosed would enhance the
firmsÊ image and brand. These activities make their products known to the
consumers. Consumers with awareness on environmental issues would choose
environmental-friendly products.
From the finance perspective, CSR activities can assist a company to build up
relationship with investors and have ease of access to additional capital as the
activities are not against the interest of the public. The CSR activities can also
influence the companyÊs share price and profitability. Involvement in
environmental activities would lead to reduction in the operation costs, for
example the benefits gained from energy saving campaigns. The practice of CSR
in a companyÊs business operation can increase shareholders and other
stakeholdersÊ value. CSR can increase the companyÊs value in terms of positive
goodwill.
However, some companies may decide not to disclose CSR voluntarily because
the disclosure involves costs such as collection costs and competitive
disadvantage costs. Collection cost is related to the cost of preparing and
distributing the social and environmental report. The competitive disadvantage
cost involves indirect costs which exist when competitors use this proprietary
information. Thus, disclosure will be carried out if the benefits outweigh the cost
of such disclosure.

ACTIVITY 6.2
Do research on the following theories in the CSR context to learn
more about them:
(a) Legitimacy theory;
(b) Stakeholder theory;
(c) Public interest theory;
(d) Political economy theory; and
(e) Signalling theory.
Examples of CSR disclosures about employee or human resources are presented

in Figure 6.1.
Figure 6.1: Extract of employee or human resources

disclosure from AEON Co. (M) Bhd
Source: Bursa Malaysia (2011)

An example of environmental disclosure is presented in Figure 6.2.

Figure 6.2: Extract of environmental disclosure from AEON Co. (M) Bhd

An example of community disclosure is presented in Figure 6.3.

Figure 6.3: Extract of community disclosure from AEON Co. (M) Bhd.

An example of product disclosure is presented as follows (see Figure 6.4).
Figure 6.4: Extract of product disclosure from Dutch Lady Milk Industries Berhad
ACTIVITY 6.3
Get one annual report of a company listed on the main market of
Bursa Malaysia. You are required to answer the following questions:
(a) How does the company become more socially responsive?
Explain the initiatives taken by the company to be considered
as a socially responsive company.
(b) How does the company report its CSR activities? Identify the
themes disclosed and provide details of disclosure for each theme.

6.4 THE IMPACT OF SRI ON SHAREHOLDER

VALUE
Does investment in SRI create shareholder value? The answer relates to the
motivation for SRI investment. Investors have different motives to invest in SRI.
Investors with value-based SRIs want to implement their morals, values and
belief into their whole life and into their investment decisions as well. In the
screening process, the fund managers have to drop a stock which does not fulfil
the fund objectives even though the stock has potentially higher returns.
There is a group of value-based investors who can accept a lower return in

exchange for the implementation of their values. There are also other group of
investors which use SRI investments as an additional tool of risk management.
They want to reduce the universal risk by implementing the environmental,
social, and governance issues criteria in their portfolio with expectation that in
the long run, the risk-adjusted returns will be higher compared to the portfolio
without environmental, social, and governance issues criteria.
OECD (1998) believes that SRI will benefit the shareholder value because „acting
as a responsible citizen is consistent with this economic objective‰ which is to
generate long-term economic profit to enhance shareholder value. However,
evidence on the performance of SRI funds is found to underperform the non-
ethical funds and market (Mallin et al., 1995; Mallin, 2007). A study by Kreader et
al. (2005) in European countries also found that very few ethical funds
outperform the global trademark and yet they are not underperformed.
• SRI refers to investments or investment strategies which consider

environmental, social and governmental issues in their investment decisions.
• Some SRIs consider ethical standards which are derived from either personal
values or from religious teachings.
• Awareness on the SRI and CSR are growing which has led to the intervention
of the government and other regulators.
• Companies move in line with the trend to integrate their SRI and CSR
operations in their reporting for long-term economic benefits.

Bursa Malaysia Shareholder value

Corporate social reporting Shariah-compliant companies
Environmental reporting Socially responsible investment
Institutional investors Socially responsive strategy
Mutual fund industry Socially responsive structure
Risk assessment Sustainability reporting
Securities Commission Triple Bottom Line reporting
Abdul Manaf Said. (1997). Corporate social responsibility and the company
secretary. The Company Secretary, p.3.
Abdul Manaf Said. (1998). Corporate social responsibility ă A Malaysian

perspective. ROC Centennial International Conference On Corporate
Governance, Kuala Lumpur, Malaysia.
Bursa Malaysia. (2011). Annual reports. Retrieved from

http://www.bursamalaysia.com
Dodd, M. (1932). For whom are corporate managers trustees? Harvard Law
Review, 45 (7), 1145-1163.
Ethical Investment Research Services (EIRIS). (2010). Socially Responsible

Investment: A Practical Introduction for Charity Trustees. Retrieved from
www.charitysri.org
Gray, R., Owen, D., & Adams, C. (1996). Accounting & accountability: Changes
and challenges in corporate social and environmental reporting. Europe:
Prentice Hall.
Hackston, D., & Milne, M. J. (1996). Some determinants of social and

environmental disclosures in New Zealand companies. Accounting,
Auditing & Accountability Journal, 9(11), 77-108.
ICR Malaysia: Promoting Responsible Business, Annual Review 2006/2007, p 4.

Kreader, N., Gray, R. H., Power, D. M., & Sinclair, C. D. (2005). Evaluating the
performance of ethical and non-ethical funds: a matched pair analysis.
Journal of Business Finance and Accounting, 32 (7,8).
University Press.
Mallin, C. A., Saadouni, B., & Briston, R. J. (1995). The financial performance of
ethical investment funds. Journal of Business Finance and Accounting, 22
(4).
Miller, A. (1992). Green investment in green reporting: Accounting and the

challenge of the nineties. London, England: Chapman and Hall.
Parkinson, J. E. (1993). Corporate power and responsibilities. Oxford: Clarendon

Press.
Post, J. E., Lawrence, A. T., & Weber, J. (1999). Business and society: Corporate
strategy, public policy, ethics. Singapore: McGraw-Hill Companies.
Slaughter, C. M. (1997). Corporate social responsibility: A new perspective. The

Company Lawyer, 18(10), 313-321.

Topic X Directors and
7 Board
Structure
LEARNING OUTCOMES
1. Identify the roles, duties and composition of a board;
2. Differentiate between the subcommittees that exist in a company;
3. Discuss the importance of the audit committee, remuneration
committee, nomination committee and risk committee;
4. Differentiate between non-executive directors and independent non-
executive directors; and
5. Evaluate different tools used in director evaluation.
X INTRODUCTION
In an increasingly globalised market, good corporate governance is essential to
reinforce public confidence in companies and their boards. Boards play the role
of stewards and guardians of the company and also play a key role in raising
corporate governance standards. Boards need to move away from their role as
mere advisers to become more active and responsible fiduciaries. This topic will
explain further the directors and board structure in greater detail.
7.1 BOARD OF DIRECTORS

The Companies Act 1965 (CA) states that boards are obligated to play an active
role in directing management. The board of directors has all the powers
necessary for managing, directing and supervising the management of the
business and affairs of the company.

116 X TOPIC 7 DIRECTORS AND BOARD STRUCTURE
The companyÊs governance framework should be designed to:

(a) Enable the board to provide strategic guidance and effective oversight of
management;
(b) Clarify the roles and responsibilities of board members and management to
facilitate the boardÊs and managementÊs accountability to the company and
shareholders; and
(c) Ensure a balance of authority so that no single individual has unfettered powers.
Directors are also expected to have a firm grip on the companyÊs internal controls
processes and to heighten their vigilance in identifying, addressing and
managing risks that may have material impact on the financial statements and
operations of the company.
A board should be structured to protect the interests of shareholders and

relevant stakeholders while enabling the company to compete in a challenging
market environment.
Establishing Board
In establishing an effective board, a company may take certain key steps as
illustrated in Table 7.1.
Table 7.1: Five Key Steps in Establishing an Effective Board
Step Description
Step 1 Determine the boardÊs authority, access to timely information, independent
advice and companyÊs management, board size and committees in accordance
with the companyÊs purpose, objectives and strategies.
Step 2 Develop roles and responsibilities and identify core competencies and the mix
of skills required for the board and its committees.
Step 3 Establish a well-ordered process to elect and appoint board and board
committee members.
Step 4 Develop key performance indicators for directors.
Step 5 Annual assessment of the effectiveness and contribution of the board, its
committees and individual directors.
Source: Bursa Malaysia (n. d.)

TOPIC 7 DIRECTORS AND BOARD STRUCTURE W 117
SELF-CHECK 7.1
What are the elements of an effective board? Explain.
7.2 ROLE, DUTIES AND RESPONSIBILITIES OF

THE BOARD
In this subtopic, we will discuss the role, duties and responsibilities of the board
in greater detail.
7.2.1 Principal Responsibilities of the Board

The following are the main responsibilities of the board:
(a) To govern and set the strategic direction of the company rather than just
manage it;
(b) To manage the company in accordance with the strategic direction and
delegations of the board (role of senior management); and
(c) To oversee the activities of management in carrying out these delegated duties.
7.2.2 Director's Duties

A director has fiduciary duties similar in some respects to those of a trustee.
Directors must be allowed to make business judgments and business decisions in
the spirit of enterprise. There are two major aspects of a directorÊs duties:
(a) Fiduciary Duty

Fiduciary duties are owed individually by each director. There are four
major facets of a directorÊs fiduciary duties:
(i) The duty to act in good faith;
(ii) The duty to exercise power for a proper purpose;
(iii) The duty to exercise discretion properly; and
(iv) The duty to avoid conflict and self-dealing.

(b) Duty to Use Reasonable Care, Skill and Diligence

A director is required to exercise „reasonable care, skill and diligence‰
according to the knowledge, skill and experience which may reasonably be
expected of a director having the same responsibilities.
Guidelines for Discharging Duty of Care, Skill and Diligence

Directors ought to carry out their duty of care, skill and diligence in a
conscientious manner. To address this deficit, there are three critical areas which
the boards need to prioritise, as shown in Figure 7.1.
Figure 7.1: Three critical areas which boards need to prioritise
7.2.3 Constituting an Effective Board

In this subtopic, we will discuss constituting an effective board.
Chairman and Chief Executive Officer

The following are explanations for the chairman and the chief executive officer:
(a) A clearly accepted division of responsibilities at the head of the company
which will ensure a balance of power and authority, such that no one
individual has unfettered powers of decision.
(b) When the roles are combined, there should be a strong independent
element on the board. A decision to combine the roles of chairman and
chief executive officer should be publicly explained.

Board Balance
The following are explanations for board balance:
(a) At least one-third of the board membership should be independent.
(b) Non-executive directors should be persons of calibre and credibility who
have the necessary skills and experience to make independent judgements
on the issues of strategy, performance and resources, including key
appointments and standards of conduct.
(c) The principles on which the Code of Ethics relies are those that concern
transparency, integrity, accountability and corporate social responsibility.
SELF-CHECK 7.2
What is the fiduciary duty of a director? Discuss.
7.3 BOARD SUBCOMMITTEES

As managing and controlling companies have become more complex and
demanding, boards are resorting to committees to assist them in carrying out their
duties and responsibilities such as:
(a) Allowing directors to make better use of their limited time;
(b) Allowing more focus to be given to complex issues and recommending
courses of action; and
(c) Reinforcing the role of independent directors in monitoring company
activities.
However, the existence of board committees does not diminish the boardÊs
responsibility towards the affairs of a company. Boards can delegate powers to
committees but such delegation should be subject to the following:
(a) Delegated authority in accordance with the companyÊs Articles of
Association;
(b) Clearly established terms of reference, defining their responsibilities and
authority, which are approved by the board;
(c) The board must supervise its delegation; and
(d) The board must not merely adopt or rely on the committeeÊs
recommendations without proper assessment and testing or challenging
the same.

In addition to the audit committee, which is mandated by the Listing

Requirements, the CG Code recommends companies to establish nominating and
remuneration committees.
There are three main board subcommittees:

(a) Audit committee;
(b) Nominating committee; and
(c) Remuneration committee.
Each committeeÊs role should be spelt out in written terms of reference approved
by the board. Each year, the board, through the nominating committee, should
review the board committeesÊ effectiveness. The chairman of each board committee
should assess the performance of individual committee members on an annual
basis. These assessments can be used to facilitate the nominating committeeÊs
evaluation of board committeesÊ performance.
The skills and experience possessed by committee members are an important

aspect to consider in ensuring objective views are brought to the deliberation of the
committee.
SELF-CHECK 7.3
What is the function of board subcommittees? Explain.
7.4 AUDIT COMMITTEE

An audit committee is required in listed companies in Malaysia under Paragraph
15.10 of the Listing Requirements. An audit committee must be mindful of what
is happening within a company now and, at the same time, what may happen in
the future. Five „guiding principles‰ for best practices that are applicable to
every audit committee are as follows:
(a) Interaction with other participants of the audit process;
(b) Internal auditor communications;
(c) External auditor communications;
(d) Candid discussions with management, internal auditors and external
auditors; and
(e) Audit committee membership.

Functions of audit committees are:

(a) To underscore the boardÊs commitment in ensuring integrity of financial
information and reporting;
(b) To increase the emphasis on risk and control, including the levels of
authority delegated to management by the board;
(c) To give directors more insight into the companyÊs accounting and control
systems;
(d) To increase directorsÊ understanding of both external and internal audit
processes;
(e) To improve communication between the board and the external auditor;
(f) To help improve the quality of financial reporting;
(g) To create a forum for the chief financial officer or finance director to raise
issues of concern;
(h) To provide a mechanism for the external auditor to assert his independence
in the event of a dispute with management; and
(i) To strengthen the internal audit function by giving it greater independence
from management.
Characteristics of an Effective Audit Committee

The following are the explanations for board balance:
(a) Conducts its own affairs efficiently and responsibly and reviews its own
performance annually;
(b) Ensures effective communication among those involved with the audit
committee;
(c) Understands the companyÊs risks and the control systems aimed at
addressing those risks;
(d) Drives for complete and accurate financial and non-financial information
disclosures that reflect substance over form which can be issued on a timely
basis;
(e) Conducts meetings independently and separately when needed with
internal and external auditors;
(f) Varies the duration of time spent for meetings, as needed, in order to meet
changing and often increasing demands;
(g) Actively engages in the appointment, replacement or re-appointment of the
external auditor;

(h) Has a strong and candid relationship with the external auditors;
(i) Evaluates and assesses the performance of external auditors, including the
latterÊs independence;
(j) Determines the scope and fee of the external audit and ensures that the
audit is comprehensive;
(k) Determines the internal audit plan and adequacy of the internal audit
scope, functions and resources and whether the internal audit function has
the necessary authority to carry out its work;
(l) Uses internal audit to review the way management manages business risks
as well as how the risks are managed to enhance shareholder value;
(m) Evaluates the performance of the internal audit function, including having
an external review periodically to assess the competency of the function;
and
(n) Ensures management is responsive to internal and external audit
recommendations.
An effective audit committee should be critically aware of its responsibilities,

fully understand and embrace them and recognise what is necessary to fulfil
them (refer to Figure 7.2).
Figure 7.2: Key responsibilities of the audit committee

Composition of Audit Committee

The following are explanations for the composition of an audit committee:
(a) At least three members, a majority of whom are independent.
(b) All members of the audit committee should be non-executive directors.
(c) Paragraph 15.10 of the Listing Requirements mandates the listed company
to appoint an audit committee composing of no fewer than three members.
(d) All members of the audit committee should be financially literate and at
least one should be a member of an accounting association or body.
Independence of Members
The audit committee should comprise a majority of independent directors. As
prescribed by Paragraph 15.11 of the Listing Requirements, the chairman of the
audit committee should be an independent non-executive director.
Qualifications of Members
The committee should have candidates with the ability to understand and to
effectively challenge managementÊs assertions with respect to the following:
(a) Risk identification and evaluation;
(b) Internal control systems;
(c) Major accounting and reporting issues;
(d) Interpretation and implementation of the approved accounting standards;
and
(e) Roles of the internal and external auditors.
Financial Literacy of Members

The CG Code requires all members to be financially literate with at least one
member fulfilling the financial expertise requisite under the Listing
Requirements that are:
(a) The ability to read and understand financial statements, including a
companyÊs balance sheet, income statement and cash flow statement;
(b) The ability to analyse financial statements and ask pertinent questions
about the companyÊs operations against internal controls and risk factors;
and
(c) The ability to understand and interpret the application of approved
accounting standards.

Personal Qualities of Members

The following are the explanations for personal qualities of members:
(a) Individuals with a wide range of skills that go beyond mere familiarity
with financial statements.
(b) Personal and professional characteristics should be assessed to ensure the
effectiveness of the audit committee in providing independent, objective
and effective oversight.
Role of the Audit Committee Chairman

The audit committee chairman should assume, among other duties, the following
responsibilities:
(a) Planning and conducting meetings;
(b) Overseeing reporting to the board;
(c) Encouraging open discussion during meetings; and
(d) Developing and maintaining an active ongoing dialogue with senior
management and both internal and external auditors.
Who Should Attend the Audit Committee Meeting

The following are the explanations for who should attend the audit committee
meeting:
(a) Finance director, the head of internal audit and a representative of the
external auditors normally attend meetings.
(b) The chairman or CEO as and when required by the audit committee.
(c) Management or external professionals may also be called to attend
meetings when the agenda calls for their expertise.
Audit Committee Meetings

The following are the explanations for audit committee meetings:
(a) Disclose in an informative way, details of the activities.
(b) The number of audit meetings held in a year, details of attendance of each
director with respect to meetings and the details of relevant training
attended by each director.
(c) CG Code requires details of the audit committeeÊs activities, the number of
audit meetings held in a year and attendance of each individual director
with respect to the meetings to be disclosed in the annual report.

Audit Committee Relationships and Communication

The following are the explanations for audit committee relationships and
communication:
(a) Audit committees to be more focused than ever in enhancing their
efficiency and effectiveness.
(b) Audit committeeÊs working relationship with:
(i) The board of directors;
(ii) Management;
(iii) Internal auditors; and
(iv) External auditors.
SELF-CHECK 7.4
List four duties of an audit committee.
7.5 REMUNERATION COMMITTEE

The following are explanations on remuneration committees:
(a) To achieve a balance between setting the level and structure of the
remuneration package of executive directors so as to be able to attract and
retain the best against its interest in not paying excessive remuneration.
(b) To ensure that all the executive directors, CEO (where the CEO is not a
director of the company) and senior management are fairly rewarded for
their individual contributions to the companyÊs overall performance.
(c) To be responsible for ensuring that the compensation and other benefits
encourage executive directors to act in ways that enhances the companyÊs
long term profitability and value.
(d) To remunerate offers to the CEO (where the CEO is not a director of the
company) and senior management which are commensurate with the level
of executive responsibilities and is appropriate in light of the companyÊs
performance.
(e) To develop a policy on the remuneration of executive directors and propose
balanced packages to these directors so as to attract, retain and motivate
executive directors of the quality required, yet avoid paying more than is
necessary for this purpose.

Composition and Size

The composition and size of a remuneration committee are as follows:
(a) Consists wholly or mainly of non-executive directors.
(b) Appointed by the board.
(c) Comprise board members who will not benefit personally from their
decisions and who will give due regard to the interest of shareholders and
other stakeholders.
(d) Size of the remuneration committee will vary depending upon the needs
and culture of the company and the extent of responsibilities delegated to
the committee by the board.
(e) Appointment of remuneration committee members on three year terms,
with staggered expiration dates to ensure continuity.
Remuneration Committee Meetings

The following are the explanations for remuneration committee meetings:
(a) Held at times when attendance is maximised and quorum for meetings
established is met.
(b) Provided with sufficient resources to undertake its duties.
Setting Remuneration for Directors, CEO and Senior Management

In this subtopic, we will discuss further the setting of remuneration for directors,
CEO and senior management.
Remuneration Framework
The frameworks for remuneration are:
(a) To develop and agree with the board regarding a framework on the fee
structure and level of remuneration for executive directors of the board,
CEO (where the CEO is not a director of the company) and senior
management.
(b) To determine who its senior management are which may include the chief
operating officer, director of subsidiaries within the group, etc. as is
appropriate in the opinion of the board.
Developing the Framework for Remuneration

A remuneration framework should be designed in such a way that it supports
the strategies and long-term vision of the company as well as provides adequate
motivational incentive for directors to pursue the long-term growth and success
of the company.

Executive DirectorsÊ Remuneration

Remuneration packages for executive directors should involve a balance between
fixed and performance-linked (variable) elements.
Non-Executive DirectorsÊ Remuneration

A review of the fees for non-executive directors should take into account fee
levels and trends for similar positions in the market and time commitment
required from the director (estimated number of days per year).
A basic fee should be paid to non-executive directors and an additional fee

should be established for lead role positions such as chairman of the board,
committee chairman of the board or the senior independent non-executive
director.
Non-executive directors are normally remunerated by way of fees (in the form of
cash) which is approved by shareholders on an annual basis.
Non-executive directors should not receive share options or bonus payments, or

participate in schemes designed for the remuneration of executives or be
provided with retirement benefits since this could lead to a situation of impaired
independence.
CEO and Senior Management Remuneration

In determining the remuneration for the CEO and senior management, the
committee should ensure that the rewards are in line with the following key
objectives:
(a) The offer is sufficient to attract and retain the best candidate in the short
term;
(b) The incentives offered are appropriate to motivate the CEO and senior
management to perform at their maximum level on a continuous basis; and
(c) The CEOÊs and senior managementÊs remuneration is aligned with the
shareholder value while creating an effective „golden handcuff‰ in the long
term.
Disclosure of each DirectorÊs Remuneration

Chapter 9 Appendix 9C, Part A of the Listing Requirements specifies that all
listed companies are to disclose the remuneration of directors for the financial
year in the companyÊs annual report in the following manner:
(a) The aggregate remuneration of directors with categorisation into
appropriate components (for example, directorsÊ fees, salaries, percentages,
bonuses, commission, compensation for loss of office, benefits in kind

based on an estimated money value) distinguishing between executive and

non-executive directors; and
(b) The number of directors whose remuneration falls in each successive band
of RM50,000 distinguishing between executive and non-executive directors.
SELF-CHECK 7.5
What are the tasks of a remuneration committee?
7.6 NOMINATION COMMITTEE

The chair of the nominating committee should be an independent director, and
where a senior independent director position exists, the senior independent
director should assume the position of chair of the nominating committee.
The functions of a nomination committee are:

(a) To focus on recruitment, assessment and training.
(b) To develop, maintain and periodically review the criteria to be used in the
recruitment and screening process that takes into account the diversity of
prospective directors including the CEO.
(c) To conduct an assessment on independent directors annually, upon a
directorÊs readmission to the board and when any new interest or
relationship surfaces, as well as review the individual directorÊs time
commitment and ability to fulfil their responsibilities.
(d) To conduct training for directors.
Composition and Size

The composition and size of a nomination committee are:
(a) Wholly non-executive directors, a majority of whom are independent.
(b) Directors who are frank, outspoken and collegial in establishing an effective
committee.
(c) Appointment of nominating committee members on three year terms, with
staggered expiration dates to ensure continuity.
(d) Performance assessment of the nominating committee should be carried out
by the board, benchmarking the activities it carried out against its terms of
reference as approved by the board.

Nomination Committee Meetings

The following are the explanations for nomination committee meetings:
(a) Meet at least once a year to carry out the activities as enshrined in its terms
of reference, or more frequently when the need arises.
(b) Have access to the services of the company secretary on all nominating
committee matters including assisting the chairman in planning the
nominating committeeÊs work, drawing up meeting agendas, maintenance
of minutes and collection and distribution of information and provision of
any necessary practical support.
(c) Should be transparent with all proceedings recorded and actions
documented.
SELF-CHECK 7.6
What type of director can sit as the chairman of a nominating

committee?
7.7 RISK COMMITTEE

The following are explanations on risk committees:
(a) Actively identify, assess and monitor key business risks to safeguard
shareholdersÊ investments and companyÊs assets.
(b) Effectively monitoring the system of internal controls, commitment to
articulating, implementing and reviewing the companyÊs internal control
systems.
(c) Periodically testing the integrity of the internal control procedures and
processes that must be conducted to ensure the system set up is viable and
robust enough to assist management in realising company objectives.
ACTIVITY 7.1
Discuss with your coursemates the function of the risk committee in a

company.

7.8 NON-EXECUTIVE DIRECTORS

Non-executive directors (NEDs) are classified as follows:
(a) No direct or indirect pecuniary interest in the company other than their
directorsÊ emoluments and their „permitted‰ shareholdings in the
company.
(b) Not employees of the company or affiliated with it in any other way and
are not involved in the day-to-day running of business but may have
pecuniary interest in the company, whether direct or indirect.
(c) Not employees of the company but are standing as nominees for substantial
shareholders.
(d) A bridge between management and stakeholders, particularly
shareholders.
(e) Provide the relevant checks and balances, focusing on shareholdersÊ and
other stakeholdersÊ interests and ensuring that high standards of corporate
governance are applied.
SELF-CHECK 7.7
Explain is the requirements for a non-executive director.
7.9 INDEPENDENCE OF NON-EXECUTIVE

DIRECTORS
The following are explanations on independent non-executive directors:
(a) A listed company must ensure at least two directors or one-third of its
board (whichever is the higher) are independent directors.
(b) Comprises a group of non-executive directors who have no connection with
the company.
(c) Involved in protecting the interests of minority shareholders and can make
significant contributions to a companyÊs decision making by bringing in the
quality of detached impartiality.
(d) Are sound in judgement and have inquiring minds.

Senior Independent Non-Executive Directors

The duties would typically include the following:
(a) Ensure all independent directors have an opportunity to provide input on
the agenda, and advise the chairman on the quality, quantity and timeliness
of the information submitted by management that is necessary or
appropriate for the independent directors to perform their duties effectively;
(b) Consult the chairman regarding board meeting schedules to ensure the
independent directors can perform their duties responsibly and with
sufficient time for discussion of all items on the agenda;
(c) Serve as the principal conduit between the independent directors and the
chairman on sensitive issues, for example, issues that arise from
„whistleblowing‰; and
(d) Serve as a designated contact for consultation and direct communication
with shareholders on areas that cannot be resolved through the normal
channels of contact with the chairman or CEO.
Table 7.2 lists the rules on the number of independent directors on boards of
companies in Asia. Meanwhile Table 7.3 lists the number of independent
directors in other jurisdictions.
Table 7.2: Rules on the Number of Independent Directors on Boards of

Companies in Asia
Country Exchange Rules or Requirements

Singapore At least two independent directors
Hong Kong At least three independent directors
India At least one-third of the board
Thailand At least one-third and no less than three
Source: Asian Corporate Governance Association (ACGA) (2010)
Table 7.3: Number of Independent Directors in Other Jurisdictions
Country Best Practices

UK The Combined Code recommends that at least half of the board,
excluding the chairman, comprises independent non-executive
directors (INEDs)
Australia A majority of the board should be independent directors ă 2nd
edition, ASX Corporate Governance Council.

The board must establish a formal process in the selection of independent

directors. The goal is to ensure that the board remains independent and that,
collectively, it has the right skills to steer and oversee the company.
Intrinsic to our Asian context, there are a sizeable number of companies in the
hands of founding families. Given the proximity of controlling shareholders and
management of these family-owned companies, issues of related-party
transactions and independence can arise. Of particular concern are the strong
familial ties between the chairman who helms the board and board members with
executive powers. In order to address these challenges and issues, the following
areas are developed (see Figure 7.3):
Figure 7.3: Areas to focus in issues of related-party transactions and independence
Every director appointed by the board is subject to re-election by shareholders at

the next annual general meeting and each director is subject to re-election at least
once every three years.
The SC survey (refer to Table 7.4), reveals that over 60 per cent of our companies
have independent directors who have served on boards for less than nine years,
while the average length of service across all companies was approximately six
years.
Table 7.4: SC Survey on Malaysian Boards 2009
Tenure of Independent Non-Executive Directors (INEDs)
No. of Companies Total

Tenure
Main ACE
INEDs serving > 9 years 350 4 354
INEDs serving < 9 years 482 113 595
Total 832 117 949

SELF-CHECK 7.8
Explain what „independent‰ non-executive director means.
7.10 DIRECTOR EVALUATION

The following are explanations on what constitutes a directorÊs evaluation:
(a) Involves board members undertaking a constructive but critical review of
their own performance, identifying strengths, weaknesses and then
implementing plans for further professional development.
(b) Director evaluation questions are developed after a review of international
best practice governance guides.
(c) Performance evaluation is a tool used by managers and supervisors to
assess the performance of an individual employee.
(d) These assessments are typically used to evaluate a worker's performance
over a specific period and are often conducted yearly or quarterly.
A company needs to do a directorÊs performance evaluation for the following

reasons:
(a) To ensure that companies' boards of directors are delivering real value.
(b) Regularly board evaluations show sponsors and investors that
organisations are dedicated to ensuring the highest standards of integrity.
For further reading, visit the following website:

http://goo.gl/jqWAZg
The following are the tools used for director performance evaluation:
(a) 360 Degree Feedback Tool

Input on directors' performance is obtained from all levels of employees
who interact with company directors.

(b) Top-Down Director Evaluation Tool

This tool is utilised by corporate directors alone, or with the help of a
consultant to provide guidance on critical elements of success and how to
properly evaluate executive leadership.
(c) Director Self-Input Performance Tool

Values directors' self-assessments of goal attainment, quality of work
performed and leadership effectiveness.
To understand further, visit the following website:

http://www.ehow.com/list_6871537_tools-used-director-performance-
evaluation.html#ixzz2069Pino6
ACTIVITY 7.2
Discuss two reasons why a company needs to do a directorÊs evaluation.
• A board is the steward and guardian of a company. It has an active role in

directing the management. It needs to give importance to its roles and
responsibilities in running the company.
• There are several committees in a company such as audit committee,

remuneration committee, nomination committee and risk committee that
helps the board in carrying out its duties and responsibilities.
• The audit committee provides assurance of the quality and reliability of the
financial statement used by board and public.
• A remuneration committee ensures a balance between the level and structure

of the remuneration package of executive directors, CEO and senior
management.
• A risk committee identifies, assesses and monitors key business risks to

safeguard shareholdersÊ investments and assets.

• To enhance corporate governance, the board should appoint independent

non-executive directors, who have no conflict of interests in carrying out their
duties.
• The directorÊs evaluation tools such as the 360 degree, feedback, the top-
down director evaluation tool and the director self-input performance tool
are used to ensure the tools deliver real value.
Audit committee Internal auditor

Bursa Malaysia Listing Requirements Malaysian Shareholder Watchdog
Group
Chairman
Nomination committee
Chief Executive Officer
Non-executive director
Code of Ethics
Remuneration committee
Companies Act 1965
Risk committee
Companies Commission of Malaysia
Securities Commission
External auditor
Independent non-executive director
Bursa Malaysia. (n.d.). Corporate governance guide: Towards boardroom

excellence. Kuala Lumpur, Malaysia.
Bursa Malaysia Listing Requirements. (2012).
Malaysian Code on Corporate Governance. (2012).
Securities Commission malaysia. (2011). Corporate governance blueprint: Towards

excellence in corporate governance. Kuala Lumpur, Malaysia.

Topic X DirectorsÊ
8 Performance
and
Remuneration
LEARNING OUTCOMES
1. Explain the key elements of director remuneration;
2. Describe the role of the remuneration committee;
3. Explain the remuneration of non-executive directors;
4. Describe the disclosure of director remuneration; and
5. Discuss the international guidance on executive remuneration.
X INTRODUCTION
Executive remuneration has become one of the prominent topics in
contemporary corporate governance due to its controversial nature. Here, the
main issue is whether the pay rewards to executives are consistent with
shareholdersÊ interests. Negative coverage on grossly overpaid top management
is regularly featured in the international financial press. The controversy
surrounding this topic attracts the interest of many parties such as investors,
analysts, policy makers, journalists, academics, politicians and others. Hence,
what is the meaning of such remuneration which attracts the interest of many
parties including the international financial press?

TOPIC 8 DIRECTORS’ PERFORMANCE AND REMUNERATION W 137
Remuneration is money paid for work or a service (Oxford Dictionary, 1995).

Smith (1776) has asserted that the common wages of labour depend upon the
contract usually made between two parties whose interests are not the same. In
other words, workmen desire to get as much as possible but masters give as little
as possible. Here, both parties are trying to maximise their wealth based on their
contribution either through investment by the masters or work effort by the
workmen. The alignment of interest between the two parties is very crucial;
hence, remuneration has been used by masters as an incentive for workmen to
put their efforts into the company.
Remuneration is sometimes used interchangeably with compensation and pay.

The Malaysian Code of Corporate Governance (hereafter referred to as the Code)
which was first introduced in 2000 refers to remuneration as payment to the
director of the company, either the executive or non-executive director. In
particular, remuneration is referred to as payment for executive directors on the
board, who are assumed to possess a specific talent, expertise, knowledge, skill
and other relevant characteristics in managing and running the day-to-day
operations and activities of the company. They are highly paid due to their
demanding tasks and responsibilities.
8.1 KEY ELEMENTS OF DIRECTOR

REMUNERATION
The Code highlights the issue of the directorÊs remuneration under its principles
and best practices parts. The Code which was adapted from the Hampel Report
(2008) was developed based on the agency perspective or the principal-agent
framework. The mainstream view, derived from the principal-agent framework
(agency theory), is that a well-designed compensation contract helps to
incentivise executives to enhance shareholder value (for example, Jensen &
Murphy, 1990, Murphy, 1999). Strong pay-performance sensitivity is seen as the
key metric in aligning the divergent incentives of executives and shareholders.
In other words, the board of directors sets compensations that are in tandem with
armÊs length contracting. However, recently, there is a more sceptical view which
sees the compensation contract as a perverse instrument of greed rather than a
shareholder-friendly incentive mechanism (Bebchuk & Fried, 2003). One form of
managerial opportunism, or private benefits of control, is when CEOs and top
management reward themselves with stupendous pay-without-performance
measures much to the detriment of shareholders.

138 X TOPIC 8 DIRECTORS’ PERFORMANCE AND REMUNERATION
Executive Remuneration
The key element of executive remuneration is how significant the contribution of the
executive is towards the companyÊs performance. Shareholders are less concerned
about how much the executive is being paid, but rather, they are very sensitive on
how the executive is being paid. They will be satisfied if the executiveÊs pay is aligned
with the performance of company since the main objective of the shareholder is to
maximise wealth. Shareholders rely on the executiveÊs effort and commitment to
adopt policies and strategies that maximise their value. Fixing remuneration for an
executive director is a challenging task for a company.
In practice, companies prefer to hire capable executives who normally demand a

higher pay due to their knowledge, skill, experience and the difficulties of the tasks
while, at the same time, the company needs to ensure that the executives will put in
maximum effort and commitment towards the companyÊs growth. There is no limit in
terms of pay for the executive director of a company compared to a government
servant, in which case the pay is normally determined by the authority. The
executiveÊs pay in a company is left to the company to decide. Hence, the most
appropriate benchmark for determining the pay for an executive is based on his
contribution towards the companyÊs performance.
However, agency theorists such as Smith (1776) and Jensen and Murphy (1990) argued
that human beings are self-interested and will engage in activities that increase their
own well-being. Hence, based on this assumption, shareholders believe that
executives have the tendency and opportunity to misuse their power by rewarding
themselves with excessive pay instead of maximising shareholdersÊ wealth even
though they are bound by a contract.
Furthermore, in this context, contracts are difficult to enforce because it requires

complete observation of the executivesÊ efforts, which is almost impossible to be
undertaken by shareholders. It becomes worse when the executives have full access to
company information and know most of the companyÊs activities compared to
shareholders. Besides, the executives can selectively disclose information to
shareholders. In overcoming these conflicts, shareholders control executives using pay
practices (that is, executive remuneration) that align the interests of shareholders and
executives. Many studies support this alignment between pay and performance.
SELF CHECK 8.1
What is executive remuneration? Explain.

ACTIVITY 8.1
1. What is the main issue in the directorÊs performance and the

executivesÊ remuneration? Explain.
2. What is the dominant theory in executive remuneration?
3. Why is it crucial to align the pay to performance in determining

executive remuneration? Discuss.
8.2 THE ROLE OF REMUNERATION

COMMITTEE
The remuneration committee, as a committee of the main or supervisory board,
acts under a delegated authority to provide an independent influence on
executive pay. The delegation of responsibilities to a committee of the board,
constituted entirely of independent non-executive directors, provides a
significant degree of security for shareholders. It also increases the efficiency of
the board by removing certain processes from its remit and ensures that the work
of the committee is free from conflict. Under best practices in corporate
governance, the Code recommends companies to establish a remuneration
committee consisting of wholly or mainly of non-executive directors.
The committee will monitor, supervise and advise the companyÊs decision
regarding executive remuneration. In addition, the committee reviews the
remuneration packages of executive directors based on their responsibilities and
scope of work as well as corporate and individual performances. The committee
is allowed to get advice from consultants relating to the executive directorsÊ
remuneration and recommend to the board an appropriate remuneration for the
executive directors. The Code recommends that:
„Boards should appoint remuneration committees, consisting wholly or

mainly of non-executive directors, to recommend to the board the
remuneration of the executive directors in all its forms, drawing from
outside advice as necessary. Executive directors should play no part in
decisions on their own remuneration. Membership of the remuneration
committee should appear in the directorsÊ report.‰

In ensuring the effectiveness of the committee, it should be independent from

executivesÊ influence. Therefore, members should consist of non-executive
directors. However, independence is difficult to judge when it comes to the
relationships of executive directors and non-executive directors. These
relationships are questionable due to several factors such as the CEO nomination
of non-executive directors, non-executive directors who must rely on the
executives for most of the information they receive, and indeed, non-executive
directors who need good relationships with the executives if they are to function
well in guiding corporate policy. Often, directors share similar backgrounds and
interests with a companyÊs executives. Frequently, they are senior executives in
other companies.
Hence, the role of remuneration committees in monitoring executives from

determining their own remuneration is doubtful. It is possible that remuneration
committees may not discuss remuneration matters under armÊs length,
bargaining with the board of directors, particularly, executive directors. The
executives have influence on remuneration matters right from the beginning of
the process if they are also members of the remuneration committee.
In addition, although the remuneration committee is given the responsibility to

discuss and recommend the executiveÊs remuneration to the board, it is up to the
board whether to accept or reject the recommendation since the final say still
rests with the board. From this standpoint, it is important for a company to have
an effective board of directors, which is independent in its judgment and
decisions, and acts on an armÊs length basis.
SELF-CHECK 8.2
1. Why is the remuneration committee important in handling
remuneration matters? Explain.
2. Why is independence a crucial issue for remuneration committee

members?
8.3 REMUNERATION OF NON-EXECUTIVE

DIRECTOR
Remuneration for non-executive directors and executive directors are different in
the sense that remuneration for non-executive directors is clearly provided by
Bursa Malaysia Listing Requirements (hereafter referred to as the Listing) while,
remuneration for executive director is determined by the board with the

recommendation of the remuneration committee. The Listing under Paragraph

7.25 clearly states that fees payable to non-executive directors should be a fixed
sum, and not payable by commission or percentage of profits or turnover.
Normally, the level of remuneration for non-executive director reflects the
experience and level of responsibilities undertaken by them. In addition,
Paragraph 7.26 requires that any increment of the directorÊs fee should be with
approval of shareholders in the companyÊs annual general meeting. However,
shareholders are not really concerned with the remuneration of non-executives
since the fee is only a small portion of the total compensation package as shown
in Table 8.1. They are more concerned with executive remuneration since they
have very limited influence in determining the executive pay as compared to
non-executive remuneration. Ms Lee of Stamford Law (Xiang, 2009) comments
that „bizarre independent directorsÊ pay gets sent up to shareholders, but the
huge amount that executive directors get paid does not go to shareholders‰.
Table 8.1: Illustration of the Details of the Aggregate Remuneration of Directors

Categorised into Appropriate Components
Salaries and
Other Benefits in-
Fees in RM Total in RM
Emoluments in Kind in RM
RM
Executive 76,500 2,295,238* 70,400 2,542,138
director
Non-executive 72,000 91,840 20,200 184,040
directors
*Note: This includes the aggregate remuneration of a non-executive director of the
company who is an executive director of certain subsidiary companies.
Source: Insas Berhad Annual Report (2009)
8.4 DISCLOSURE OF DIRECTOR

REMUNERATION
The introduction of the Code and the disclosure requirement on director
compensation in the Listing and the Code itself have brought about a better
perspective about director remuneration in Malaysia, although it is still behind
the level that it is in the UK, Australia and the US. The development in the
director compensationÊs disclosure is expected to promote the important
principles of fairness and accountability for directors and shareholders. Under
the broad principles of corporate governance, the Code addresses three matters:

(a) The level and make-up of remuneration (in the case of executive directors,
the component parts of remuneration should be structured so as to link
rewards to corporate and individual performance).
(b) Procedure (companies should establish a formal and transparent procedure
for developing policy on executive remuneration and for fixing the
remuneration packages of individual directors).
(c) Disclosure (companyÊs annual report should contain details of the
remuneration of each director).
In the context of Malaysia, the Code strongly highlights the importance of linking
pay to performance as emphasised within the principles. The Code recommends
that companies disclose in their annual report whether or not they implement the
pay for performance in practice. The importance of director remuneration is not
just highlighted by the Code but also by the Listing. The Listing requires that
companies include in their annual report a narrative statement of how they apply
the relevant principles to their particular circumstances. In the case of non-
compliance, companies are required to give justification for not doing so.
The recommendation by the Code and the requirement to disclose in the annual
report by the Listing implies that Malaysian authorities, in particular the
Securities Commission which are directly involved in the securities market
perceive this issue as an important aspect in maintaining a good environment for
the development of the securities market in Malaysia. Companies which practise
pay for performance as recommended by the Code tend to disclose it in the
annual report as compared to non-practices of pay for performance. This is
because the disclosure of such information gives a signal that managers of higher
quality firms will wish to distinguish themselves from lower quality firms
through voluntary disclosures.
Apart from the lack of pay for performance, shareholders are also concerned
about the adequacy of the disclosure on executive remuneration by Malaysian
companies. Relating to this issue, the Code as per Principle CIII, Part 1 and the
Listing as per Appendix 9c, Part A (10) makes it mandatory for companies to
disclose remuneration information in their annual reports. The Code is a
voluntary requirement; however, Chapter 15 of the Listing, paragraph 15.26
makes it compulsory for companies to disclose the extent of compliance with the
best practices set out in the Code, while allowing for some flexibility in its
implementation.
With respect to remuneration, companies are required to disclose the aggregate

remuneration of directors with categorisation into appropriate components (for
example, directorsÊ fees, salaries, percentages, bonuses, commission,

compensation for loss of office, benefits in kind based on estimated money value)
distinguishing between executive and non-executive directors in their annual
report. Then, companies are also required to disclose the number of directors
whose remuneration falls in each successive band of RM50,000 distinguishing
between executive and non-executive directors as well. This information is
expected to provide a basis for shareholders to evaluate whether the executives
are excessively paid or not compared to their performance and the dividend
received by the shareholders. However, companies are still lacking in the
disclosure of the individual directorÊs pay as required by the Code.
SELF-CHECK 8.3
1. What are the regulations governing a directorÊs remuneration

in Malaysia?
2. What are the important matters that need to be disclosed by the

company in relation to the directorÊs remuneration? Explain.
3. Why is the disclosure of such information important to the

shareholders?
8.5 INTERNATIONAL GUIDANCE ON

EXECUTIVE REMUNERATION
Agency theorists have long highlighted the importance of sound corporate
governance in monitoring CEOs and executives in the running of companies.
However, the steps in formalising the corporate governance code only started in
1992 with the formation of CadburyÊs Committee in the UK. Sir Adrian Cadbury,
Chairman of CadburyÊs Committee, noted that the harsh economic climate is
partly responsible for the formation of the committee, since it exposed company
reports and accounts to unusually close scrutiny.
Furthermore, the continued concern about standards of financial reporting and

accountability, heightened by the collapse of Bank of Credit and Commerce
International (BCCI) and Maxwell in 1991 and the controversy over directors'
pay, has kept corporate governance in the public eye (Cadbury, 1992). The
central objectives of the Cadbury Report is to reinforce director integrity and
board effectiveness in promoting good quality and reliable financial information
to users of the account.

Since then, the UK government has seriously considered corporate governance

issues in securing their economy and business activities. In 1995, another
committee was set up to specifically review the issue of the directorÊs
remuneration in the UK and produced a report known as Greenbury Report
(Greenbury, 1995). The report looks at the question of directorsÊ pay, the role of
the remuneration committee in setting remuneration levels, guidelines on
remuneration policy, the level of disclosure in financial statements and the
question of terms of service contracts paying compensation when directors are
dismissed for poor performance.
After three years, in 1998, the Hampel Report was introduced to reinforce points
made in the original Cadbury Report, in particular, the separation of the roles of
chairman and managing director and the balance of the composition of the board
between executive and non-executive directors. Later, in the same year, the
Greenbury Report and Hampel Report were combined and known as the
Combined Code, 2003.
In 2002, the UK government put in force a new legislation known as the

DirectorsÊ Remuneration Report Regulations 2002, which gives shareholders the
right to vote on resolutions relating to the remuneration report with effect from
financial year ended on or after December 2002 (Berwin, 2002). This new
legislation requires that the remuneration report must be put to shareholders at
the companyÊs annual general meeting. The legislation was designed to provide
shareholders with a clearer link between company performance and directorsÊ
remuneration.
The resolution is merely advisory and the remuneration of the directors is not
conditional on the shareholdersÊ vote. However, it is likely to be of great concern
to the company if shareholders do not give strong support for, or even vote
against, the resolution to approve the remuneration report. In addition, the
legislation also requires that the companyÊs auditor confirms whether the
auditable information in the remuneration report has been properly prepared.
Realising the importance of executive remuneration in influencing the US

economy and politics, the SEC has taken several actions in handling this issue
(Murphy, 1994). Among the actions are amending the executive officer and
director compensation disclosure requirements which apply to proxy statements,
periodic reports (such as annual reports on forms 10-k) and registration
statements in 1992. The amendments are designed to furnish a more
understandable presentation of the nature and extent of remuneration to
executive officers and directors. The SEC Executive Compensation Disclosure
Rules require that the reporting companies:

(a) Compare their financial performance to an industry benchmark with table

and performance graphs;
(b) Disclose, in a tabular form, the annual and long term compensation for the
CEO and the four other most highly paid executives;
(c) Provide the estimates of the present value of managerial stock options
granted; and
(d) Provide a report by compensation committee explicitly identifying quantitative
or qualitative performance measures used to evaluate managers.
In October 2006, the SEC (2006) released additional requirements on executive

and director remuneration disclosures. The new disclosures require a company
to disclose a single number for the total remuneration of the CEO, CFO, and the
three next highest paid executives. Apart from the usual compensation such as
salary, bonus, fees, other components such as defined-benefit pension, perks
such as use of corporate jet and membership of golf club, severance pay and
deferred compensation are also included into a single headline figure. These
amendments provide investors with a clearer and more complete picture of
remuneration to principal executive officers, principal financial officers, the other
highest paid executive officers and directors through both tabular and narrative
reporting.
For the past few years, the UK government has introduced the „say on pay‰ law
in relation to the executive directorÊs remuneration. This practice which is
known as a non-binding advisory vote on the executive directorsÊ compensation
is common place in the UK. Section 439 of the UK Companies Act 2006 mandates
a vote on directorsÊ pay by shareholders at the yearly accounts meeting. This
practice provides an opportunity for shareholders to voice their concern on
executive remuneration although it is a non-binding advisory vote on executive
directorsÊ compensation.
The introduction of „say on pay‰ has recently created a new debate in executive
remuneration. This new regulation, which seems reasonable to protect the
interest of shareholders in the UK and the US, is openly opposed by the CEOs. It
is likely to impose costs with little additional benefit. Some argue that with the
new proposal, companies having no problems with excessive pay would be
forced to have a vote as well.
Many studies find that less than 10 per cent of shareholders abstained or voted
against the mandated DirectorsÊ Remuneration Report (DRR) resolution. Studies
also find little evidence that the CEO pay is lower in firms that previously
experienced high levels of shareholder dissent. In conclusion, there is limited
evidence that on average, „say on pay‰ materially alters the subsequent level and

design of CEO compensation. Some researchers conclude that „say on pay‰ is

not functioning as expected in mitigating the excessive pay to executive
remuneration. However, the proposal of „say on pay‰ is still new to the
companies and shareholders, where the impact might not be seen in short period.
Meanwhile, the Sarbanes-Oxley Act in 2002 also made a few changes in their
executive remuneration rules. There are three new provisions of the Act that
affect executive compensation arrangements and benefits:
(a) First, a company may not extend or arrange personal loans to executive
officers and directors, or modify or renew personal loans already in effect
before July 30, 2002.
(b) Second, Form 4 reports (statement of changes in beneficial ownerships)
must be filed within two business days following a change in stock
ownership and Form 4 reports must be filed electronically with the SEC
and posted on the company's website.
(c) Third, executive officers and directors may not trade during pension plan
blackout periods.
Reforms in executive remuneration also happened in Australia especially after

the collapse of the HIH Insurance in 2000. The HIH Royal Commission which
was involved in investigating the insurance company called for an urgent review
of the assorted disclosure-related rules and principles in Australia to ensure that
together they achieve the clear and comprehensive disclosure of all remuneration
or other benefits paid to directors in the various forms.
In accordance with this recommendation, executive remuneration became a

central tenet in the Corporate Law Economic Reform Program (Audit Reform
and Corporate Disclosure) Act 2004 (the CLERP 9 Act). This is AustraliaÊs
principal regulatory response to corporate scandals. The CLERP 9 reforms are
designed to strengthen existing disclosure rules, remedy perceived flaws and
loopholes in the operation of those rules and promote greater linkage between
pay and performance. The reforms included a requirement that listed companies
must disclose details of director and executive remuneration in a dedicated
section of the annual directorsÊ report.
The development of corporate governance in the UK and US has also led to the
establishment of corporate governance codes throughout the world. For example,
French law has also required the directorsÊ annual report to indicate the total
amount of compensation and benefits rewarded to each corporate officer. The
board of directors must also submit in the shareholdersÊ annual general meeting
a special report concerning stock options and stock grants to directors. The
report indicates the number of options or shares which executive directors are

allowed to either exercise or purchase during the year, the expiration date and
exercise price.
Although the remuneration report is not required in Italy, the Italian Exchange
recommends short summary information on the remuneration system adopted,
specifying whether the remuneration paid to executive directors and senior
managers is linked to the company results. It also recommends that the
achievement of specific objectives also be included in the Corporate Governance
Report. Similar information should also be provided on stock option plans.
Listed companies must also indicate in the notes to the accounts the
remuneration paid to each director, member of the board of auditors and general
manager. Such information must be presented in tabular form.
Furthermore, in Germany, information on directorsÊ remuneration (management

board and supervisory board) is included in the notes of the financial statements.
German companies are required by the Commercial Code to publish the total,
aggregate remuneration (salaries, profit sharing, dividend rights, expense
allowances, insurance payments, commissions, and fringe benefits of every kind)
of the management board membership separately from the aggregate
remuneration figure for the supervisory board membership.
The Cromme Code recommends that the compensation of the management

board members reported in the notes be subdivided according to fixed salary,
performance related and long-term incentive components and be disclosed on an
individual basis. The same information should be published in the notes with
respect to the compensation of the supervisory board members. Latest
developments require public limited companies to provide a breakdown of total
earnings of each member of the management board. Companies can opt out
where three quarters of shareholders vote to do so and only for a maximum of
five consecutive years (Federal Ministry of Justice Germany, 2009).
• Executive remuneration is a global controversial issue.
• The remuneration for an executive director is expected to be based on his or

her performance towards the companyÊs growth.
• Pay for performance originates from agency theory.

• The director's remuneration disclosure is governed by the Listing and the

Code.
• Remuneration for non-executive directors is normally determined based on

their level of experience and responsibilities undertaken.
Corporate governance Pay for performance

Executive remuneration Remuneration committee
Non-executive remuneration
Bebchuk, L. A., & Fried, J. (2003). Executive compensation as an agency problem.

Centre for Economic Policy Research: 3961.
Berwin, S.J. (2002). DirectorsÊ remuneration: the new disclosure regime for listed
companies. Retrieved from http://www.sjberwin.com
Cadbury, A. (1992). Report of the committee on the financial aspects of corporate

governance (Cadbury Report). London, England: Gee & Co.
Crowther, J., Kavanagh, K. & Ashby, M. (Eds.). (1995). Oxford Advanced

LearnerÊs Dictionary (5th ed.).UK: Oxford University Press.
Federal Ministry of Justice Germany. (2009). Disclosure of board managementÊs

remuneration. Retrieved from www.bmj.bund.de/enid
Greenbury, R. (1995). DirectorÊs remuneration (A report of study group on

director remuneration) (Greenbury Report). London, England: Gee and Co.
Hampel, R. (1998). Committee on corporate governance: final report: the final

report (Hampel Report). London, England: Gee & Co. Ltd.
Jensen, M. C., & Murphy, K. J. (1990). Performance, pay and top management
incentives. Journal of Political Economy, 98(2), 225-264.

Jordon, B. (2005) Lean organizations need FAT people. Texas, TX: Wynot Books.
Murphy, K. J. (1994). Politic, economic and executive compensation. Harvard

Business School, working paper series.
Murphy, K. J. (1999). Executive compensation. In Ashenfelter, O. and Card, D.

(Eds.), Handbook of Labor Economics, 3. Amsterdam: North Holland.
Remuneration committee option scheme cartoon. Retrieved from http://www.

independentaudit.com/
Smith, A. (1776). An inquiry into the nature and causes of the wealth of nations.
Cannan, E. (Ed.). New York, NY: The Modern Library.
The Bursa Malaysia Listing Requirement. Retrieved from http://www.

bursamalaysia.com
The Malaysian code on corporate governance (The Code). (2000 & 2007). Finance
Committee on Corporate Governance. Retrieved from http://www.
sc.com.my
Xiang, C. (2009). Update of Chapter 9 to keep up with the times will temper clear
risk of abuse. The Business Times Singapore.

Topic X Corporate
9 Governance in
Malaysia
LEARNING OUTCOMES
1. Explain the corporate governance background in Malaysia;
2. Discuss the corporate governance structure in Malaysia;
3. Describe governing bodies and regulations in Malaysia; and
4. Discuss the corporate governance issues and challenges in Malaysia.
X INTRODUCTION
Corporate governance is a protection mechanism for participants against abuse by
other parties in economic activities. It is an umbrella that covers the way in which
companies are directed and controlled. This issue is two-fold ă it concerns both the
effectiveness and accountability of the board of directors. The effectiveness of the
board of directors is seen from the quality of leadership and direction that it provides
to the company. It is measured by performance and ultimately, by enhanced
shareholder value. Alternately, accountability includes all the issues surrounding the
disclosure and transparency of company activities. The participants in the economic
activities are the corporations or companies, managers, shareholders and the general
public. It is important to highlight the protection issue because participants have their
own objectives and interests.
In corporations, different objectives or interests exist due to the separation of

ownership and control. John and Senbet (1998) argue that the separation of ownership
and control (or stake holding and management) is widespread in a market economy
and how stakeholders control management is certainly the subject of corporate
governance. In the context of Malaysia, the Malaysian Code on Corporate Governance

TOPIC 9 CORPORATE GOVERNANCE IN MALAYSIA W 151
(MCCG) 2012 defines corporate governance as „the process and structure used to
direct and manage the business and affairs of the company towards enhancing
business prosperity and corporate accountability with the ultimate objective of
realising long term shareholder value, while taking into account the interests of other
stakeholders.‰
SELF-CHECK 9.1
What is corporate governance? Explain.
9.1 CORPORATE GOVERNANCE BACKGROUND

IN MALAYSIA
Malaysia was one of the Southeast Asian countries severely hit by the financial
crisis in mid-1997. A large number of business corporations in these Southeast
Asian countries, including Malaysia, experienced severe difficulties. Business
activities and revenue collection dwindled and debt problems became rampant.
Large numbers of workers were displaced. The above scenario has been
associated with weak corporate governance. In addition, during that time,
Malaysia was still lacking shareholder protection under the Malaysian
Companies Acts and the Listing Requirements by Bursa Malaysia (formerly
known as Kuala Lumpur Stock Exchange or KLSE) which governed the business
activities and practices prior to the introduction of the Malaysian Code on
Corporate Governance (hereafter referred to as the MCCG) in 2000.
Normally, the courts would intervene in cases of management theft and asset
diversion, and they would surely intervene if managers diluted existing
shareholders through an issue of equity to themselves. However, the courts are
less likely to intervene in cases of excessive pay and in line with the business
judgement rule (that keeps the courts out of corporate decisions) and are very
unlikely to second guess managersÊ business decisions, including the decisions
that hurt shareholders (for example, empire-building). In addition, more than 50
per cent of companies in this region are family-owned which makes it difficult to
practise the separation of ownership and control. This situation exposes minority
shareholders to expropriation by larger shareholders who are normally part of
the management team.
Efforts towards good governance in Malaysia have been undertaken long before
the Southeast Asian countries faced the financial crisis in 1997. The introduction
of the Malaysian Code on Takeovers and Mergers 1987 and subsequently various
practice notes were issued to regulate corporate activities on takeovers and

152 X TOPIC 9 CORPORATE GOVERNANCE IN MALAYSIA
mergers. In 1993, a corporate body known as Securities Commission was

incorporated via the Securities Commission Act 1993.
Vested with investigative and enforcement powers, the Securities Commission

was established to protect investors, besides its regulatory function, and had the
no less important mission of promoting the development of the securities and
futures markets in Malaysia. In addition, attention has been given to issues of
independent directors and audit committees and actions have been taken
regarding these issues. Furthermore, in 1996, the Code of Ethics for Directors was
introduced. This code adopted the principles of transparency, integrity,
accountability and corporate social responsibility, and covered three main areas:
(a) Corporate governance;
(b) Relationship with shareholders, employees, creditors and customers; and
(c) Social responsibilities and the environment.
On 24 March 1998, the High Level Finance Committee on Corporate Governance

was established as part of a series of measures announced by the Minister of
Finance to boost and stabilise the Malaysian economy (Finance Committee
Report 1999). The Committee sat down quickly to carry out its tasks and released
the Finance Committee Report in 1999.
The establishment of the Committee can be considered the most significant single
event in institutionalising corporate governance reforms in Malaysia. In March
1998, congruent to the establishment of the Committee, the Malaysian Institute of
Corporate Governance (MICG) was incorporated with a grant of RM250,000 from
the Securities Commission. Its objectives were to enable its members to address
corporate governance issues in the public arena and its chairman was
immediately included in the Committee.
The MCCG was revised in 2007 where the key amendments were aimed at
strengthening the board of directors and audit committees, and ensuring that the
board of directors and audit committees carry out their roles and responsibilities
effectively. Securities Commission Malaysia (SC) released a new MCCG in 2012
which sets out the desired corporate governance landscape for the future.
Essentially, the aim of the MCCG is to achieve excellence in corporate

governance through strengthening self and market discipline and promoting
good compliance and corporate governance culture. Boards and shareholders
must embrace the understanding that good business is not just about achieving
the desired financial bottom line by being competitive, but is also about being
ethical and sustainable.

ACTIVITY 9.1
1. What is the reason for the establishment of the code of corporate
governance in Malaysia?
2. What are the governing bodies that initiate and are actively
involved in the establishment and development of the code of
corporate governance in Malaysia?
9.2 CORPORATE GOVERNANCE STRUCTURE IN

MALAYSIA
The MCCG, which was first issued in March 2000, marked a significant milestone
in corporate governance reform in Malaysia. In January 2001, the MICG came out
with the MCCG, which is largely based on the Hampel Report (1998) issued in
the UK. The Committee considered the Hampel approach to be the most suited
for the Malaysian context for two reasons.
First, best practice prescriptions are necessary. The work of the Committee has
proceeded on the basis that standards of corporate governance in Malaysia are
lacking and that there is a need to raise these standards. Therefore, to go to the
other extreme of merely requiring disclosure of existing corporate governance
practices of Malaysian companies (such as that required by the Australian Stock
Exchange in respect of its listed companies) is not sufficient. To take this route,
one would have to be fairly comfortable with the standard of corporate
governance practiced in public listed companies.
In this respect, it is equally important that these prescriptions be accompanied by

a rule requiring disclosure of the extent to which listed companies have complied
with the prescriptions and where they have not, the reasons why. It is not
proposed that companies should be required to comply strictly with the
prescriptions developed. Each company should have the flexibility to develop its
own approach to corporate governance. While the prescriptions establish a
sound approach to corporate governance, companies may develop alternatives
that may be just as sound. Nevertheless, the prescriptions set the standard that
companies must measure up to. Such a rule also ensures that the investment
community receives an explanation for the companyÊs approach to governance
so that it is in a position to support the approach or work to influence change.
Second, these companies must be encouraged to consciously address their

governance needs. This was the thrust of the Cadbury Report (1992). The
Cadbury Report turned out to be a great influence on the development of many
corporate governance codes globally. Starting from the 1990s, many countries
came out with a set of corporate governance codes of conduct and best practices.
The introduction of corporate governance codes has generally been motivated by
a desire for more transparency and accountability and to increase investor
confidence (both of potential and existing investors) in the stock market.
Hence, various bodies have issued their own codes of corporate governance.
They are from committees appointed by government departments (which
comprises prominent respected figures from businesses and industries,
representatives from the investment community, representatives from
professional bodies and academics); to stock exchange bodies; various investor
representative groups; and professional bodies such as those representing
directors or company secretaries. However, the experience in the UK suggests
that too often companies comply with a strict letter of the best practice
prescriptions without having the spirit of doing so.
The MCCG essentially aims to set out principles and best practices on structures
and processes that companies may use in their operations towards achieving the
optimal governance framework (MCCG, 2001). These structures and processes
exist at a micro-level which include issues such as the composition of the board,
procedures for recruiting new directors, remuneration of directors, the use of
board committees, their mandates and their activities. The MCCG sets out four
forms of recommendations, namely:
(a) The broad principles of good corporate governance;
(b) Best practices in corporate governance;
(c) Roles of other participants in corporate governance such as investors and
auditors in enhancing corporate governance; and
(d) Mere best practices.
The recommendations are as follows:

(a) Principles ă Companies will be required by the Listing Requirements to
include in their annual report a narrative statement of how they apply the
relevant principles to their particular circumstances. In the case of not
complying, companies are required to give justification for not doing so.
(b) Best practices in corporate governance ă Compliance with best practices is
voluntary, however, companies will be required as a provision of the
Listing Requirements to state in their annual reports the extent to which
they have complied with the best practices set out in Part 2 of the MCCG.
(c) Addressed to investors and auditors to enhance their roles in corporate
governance.

(d) Explanatory notes and „mere best practices‰.
The significance of the MCCG is that it allows for a more constructive and
flexible response to raise standards in corporate governance as opposed to the
more black and white response engendered by statutes or regulations. It is in
recognition of the fact that there are aspects of corporate governance where
statutory regulation is necessary and others where self-regulation, complemented
by market regulation, is more appropriate.
The MCCG codified the principles and best practices of good governance and
described optimal corporate governance structures and internal processes. Since
the release of the MCCG, the Malaysian corporate scene has made significant
strides in corporate governance standards (MCCG, 2007). The mandatory
reporting of compliance with the MCCG has enabled shareholders and the public
to assess and determine the standards of corporate governance by listed
companies.
The MCCG was revised in 2007 and then in 2012 representing the continued
collaborative efforts between the government and the industry (MCCG, 2007;
2012). The amendments focus on both the role and responsibility of the board in
terms of the appointment of directors as well as the role of the nominating
committee members and audit committee members. The MCCG (2012) focuses
on strengthening board structure and composition recognising the role of
directors as active and responsible fiduciaries.
Directors have a duty to be effective stewards and guardians of the company, not
just in setting strategic direction and overseeing the conduct of business, but also
in ensuring that the company conducts itself in compliance with laws and ethical
values and maintains an effective governance structure to ensure the appropriate
management of risks and level of internal controls.
Boards and the management must be mindful of their duties and to direct their
efforts and resources towards the best interest of the company and its
shareholders while ensuring that the interests of other stakeholders are not
compromised. Disclosure and transparency are essential for informed decision
making. The timely availability of quality and accurate information including the
reporting of financial performance are key facets of investor protection and
market confidence.
According to Bursa Malaysia, in drafting the MCCG (2012), the views of many
stakeholders were sought to understand the practicalities, challenges and
expectations of inculcating high standards of corporate governance in listed
companies and to ensure that necessary principles and recommendations of best

practices meet those standards. In addition, internal audit functions are now
required in all Public Listed Companies (PLCs) and the reporting line for internal
auditors is clarified.
ACTIVITY 9.2
1. What is the main focus of the code of corporate governance in
Malaysia?
2. Why are the role and responsibilities of the board crucial in

corporate governance agendas? Discuss.
9.3 GOVERNING BODIES AND REGULATIONS

IN MALAYSIA
Various governing bodies have actively taken part in establishing and
monitoring companies, particularly in relation to corporate governance.
Information provided here is taken from the respective homepage of the
Securities Commission, Bursa Malaysia, the Malaysian Institute of Corporate
Governance (MICG) and the Minority Shareholder Watchdog Group (MSWG).
9.3.1 Securities Commission (SC)

The Securities Commission was established on 1 March 1993 under the Securities
Commission Act 1993. The SC is a self-funding statutory body with investigative
and enforcement powers. Reports are made to the Minister of Finance and its
accounts are tabled in Parliament annually. The SCÊs many regulatory functions
include:
(a) Supervising exchanges, clearing houses and central depositories;
(b) Registering authority for prospectuses of corporations other than unlisted
recreational clubs;
(c) Approving authority for corporate bond issues;
(d) Regulating all matters relating to securities and future contracts;
(e) Regulating the take over and mergers of companies;
(f) Regulating all matters relating to unit trust schemes;
(g) Licensing and supervising all licensed persons;

(h) Encouraging self-regulation; and

(i) Ensuring proper conduct of market institutions and licensed persons.
Underpinning all these functions is the SCÊs ultimate responsibility of protecting

the investor. Apart from carrying out its regulatory functions, the SC is also
obliged by statute to encourage and promote the development of the securities
and futures markets in Malaysia.
9.3.2 Bursa Malaysia

Bursa Malaysia through its Listing Requirements (hereafter referred to as the
Listing) of Chapter 15 emphasises the importance of good corporate governance
practices in underpinning the sustainable growth of the Malaysian capital
market. In relation to this, the Listing focuses on five parts which are:
(a) Part A (General)

This part introduces Chapter 15 which sets out the requirements that must
be complied with by a listed issuer and its directors with regard to
corporate governance.
(b) Part B (Directors)

This part focuses on the existence of directors on the board in strengthening
and emulating good practices of corporate governance in the company as a
proxy of the shareholder. This part highlights the composition of the board
of directors, its undertaking as well as letters by the directors, rights of
directors, qualifications, vacation of office and removal of directors,
restriction on directorships and directorsÊ training.
(c) Part C (Audit Committee)

This part highlights the presence of audit committees on the board which
are expected to play an effective role in matters related to the fairness of
financial statement and audit. Among others things, this part stresses on the
composition of the audit committee, chairman of the audit committee,
written terms of reference, functions of the audit committee, attendance of
other directors and employees, procedures of the audit committee, audit
committee reports, reporting of breaches to the Bursa Malaysia, rights of
the audit committee and so on.
(d) Part D (Auditors)

This part considers the role of external auditors in providing reasonable
assurance on the reliability and accuracy of financial statements. Among
other duties, a listed issuer must appoint a suitable accounting firm to act as

its external auditor, remove external auditors, review statements and

request for meetings.
(e) Part E (Corporate Governance Disclosure)

This part requires that a listed issuer ensures that its board of directors
makes the following statements in relation to its compliance with the
Malaysian Code on Corporate Governance in its annual report:
(i) A narrative statement of how the listed issuer has applied the
principles set out in Part 1 of the Malaysian Code on Corporate
Governance to their particular circumstances; and
(ii) A statement on the extent of compliance with the Best Practices in
Corporate Governance set out in Part 2 of the Malaysian Code on
Corporate Governance in which the statement shall specifically
identify and give reasons for any areas of non-compliance with Part 2
and the alternatives to the Best Practices adopted by the listed issuer,
if any.
In addition, a listed issuer must ensure that its board of directors makes the
following additional statements in its annual report:
(i) A statement explaining the board of directorsÊ responsibilities for
preparing the annual audited accounts; and
(ii) A statement about the state of internal control of the listed issuer as a
group.
The Listing has been amended to encourage a stronger corporate governance

culture among listed issuers through strengthening their board structure and
composition as well as enhancing transparencies in their corporate governance
practices. The salient corporate governance amendments made are in the areas of
aligning disclosure of corporate governance statements with the MCCG 2012 in
annual reports and limiting the number of directorships in listed issuers from ten
to five. Also, the Listing now requires the establishment of a nomination
committee and disclosure of its activities as well as enhancing disclosures in
annual reports in relation to directorsÊ training.
9.3.3 Malaysian Institute of Corporate Governance

(MICG)
MICG was established in March 1998 by the High Level Finance Committee on
Corporate Governance. It is a non-profit public company limited by guarantee,
with founding members consisting of the Federation of Public Listed Companies

(FPLC), Malaysian institute of Accountants (MIA), Malaysian Association of

Certified Public Accountants (MICPA), Malaysian Institute of Chartered
Secretaries and Administrators (MAICSA), and Malaysian Institute of Directors
(MID). MICGÊs mandate was to raise the awareness and implement good
corporate governance in Malaysia.
MICG was given a start-up capital of RM50,000 and later in 1999 was given a
contribution of RM79,000 from the Registrar of Companies. Other than these
monies, MICG had been operating on revenues from its programmes and private
donations ever since. MICG usually runs a balanced budget every year, thus,
there are usually very little surplus funds to bring forward to the next year. The
Report on Corporate Governance published by the High Level Finance
Committee on March 1999 has stipulated MICG as „The Recognised Corporate
Governance Training Centre‰ (CGTC).
Bursa Malaysia Berhad also took part in the effort of enhancing corporate
governance in Malaysia by revamping its Listing Requirements. For instance,
Chapter 15 of the Revamped Listing Requirements addresses issues on corporate
governance and one of the paramount requirements spells out that a listed issuer
must ensure that his board of directors make the following statements in relation
to its compliance with the Malaysian Code on Corporate Governance in its
annual report:
(a) A narrative statement of how the listed issuer has applied the principles set
out in Part 1 of the Malaysian Code on Corporate Governance to their
particular circumstances.
(b) A statement on the extent of compliance with the Best Practices in
Corporate Governance set out in Part 2 of the Malaysian Code on Corporate
Governance in which the statement shall specifically identify and give
reasons for any areas of non-compliance with Part 2 and the alternatives to
the Best Practices adopted by the listed issuer, if any.
The requirement was aimed towards regulating companies to be more

transparent and accountable in their actions in order to gain investorsÊ
confidence. It is hoped that this would reduce the effects of the agency theory
and signalling theory, thus paving the way for a more efficient capital market.
Indirectly, it is also envisaged that these efforts would in turn boost the countryÊs
economic growth as well as encourage inflow of foreign direct investments.
In other words, good corporate governance is the key to a robust and competitive
corporate sector, which serves as a source for sustainable economic growth.

The missions of the MICG are to:

(a) Facilitate business and corporate governance development in the country.
(b) Improve corporate governance best practices.
(c) Fine tune the corporate governance concept and ensure that practices suit
the needs of our own nation.
(d) Achieve a satisfactory level of corporate governance practice and
compliance.
(e) Promote voluntary disclosure of corporate governance best practices.
(f) Strengthen corporate governance principles and compliance effort.
The objectives of MICG are to:

(a) Be a leading organisation for enhancement of corporate governance
development and best practices through continuing education programmes
for company directors, chief executive officers, company secretaries,
company advisers, company auditors, accountants, lawyers, members of
audit committees and investors in Malaysia.
(b) Be a recognised organisation for corporate governance issues through
roundtable forums and dialogues, public seminars and conferences as well
as lecture series for corporations, institutional investors, educational
institutions, business and professional bodies.
(c) Establish linkages and networking with the leading corporate governance
references and research organisations.
(d) Be an authoritative facilitator and the organisation for advisory, technical
and support services on implementation of corporate governance best
practices and to work in collaboration with relevant authorities and
regulatory agencies to pursue this objective.
(e) Work closely with various stakeholders as well as company directors,
private investors, institutional investors, business and professional bodies,
educational institutions, relevant authorities and regulatory agencies.
(f) Complement the regulators such as the Securities Commission, Companies
Commission Malaysia and Bursa Malaysia with regard to corporate
governance matters. MICG to the best of its ability works closely and
reciprocates with these organisations as well as with the Malaysian Institute
of Integrity and other related bodies in the uplifting of integrity and
governance in the corporate sector.
(g) Act as an independent body to conduct corporate governance ratings
ensuring the ratings are credible, especially for public listed entities.

(h) Be independent, fair and truthful in providing input or information to

enhance the performance of public listed companies to intended investors,
from within and outside Malaysia.
9.3.4 Minority Shareholder Watchdog Group (MSWG)

The Minority Shareholder Watchdog Group (MSWG) was established as a
government initiative in the year 2000 as part of a broader capital market
framework to protect the interests of minority shareholders through shareholder
activism. It is one avenue of market discipline which encourages good
governance among public listed companies with the objective of raising
shareholder value over time.
According to the MSWG website, over the years, MSWG has evolved into an
independent research organisation on corporate governance matters. MSWG
provides a platform and a collective voice to both retail and institutional minority
shareholders, and it advises on voting at general meetings of public listed
companies. This has been the first step towards encouraging shareholder
activism without recourse to the courts.
MSWG's objectives are set out in a Charter under its Memorandum and Articles
of Association. The objectives of the MSWG are to:
(a) Become the forum on minority shareholdersÊ experiences in the context of
the Malaysian Code on Corporate Governance, the Securities CommissionÊs
Disclosure-Based Regulations, and the Capital Markets Master Plans.
(b) Become the Think-Tank and Resource Centre for minority interest and
corporate governance matters in Malaysia.
(c) Develop and disseminate the educational aspects of corporate governance.
(d) Become the platform to initiate collective shareholder activism on
questionable practices by management of public listed companies.
(e) Influence the decision-making process in public listed companies as the
leader for minority shareholdersÊ legitimate rights and interests.
(f) Monitor for breaches and non-compliance in corporate governance
practices by public listed companies.
(g) Initiate, where appropriate, reports to regulatory authorities and
transforming MSWG into an effective deterrent of such events or activities
that can be against the interest of the minority shareholders.

MSWG has five founding organisations which are Employees Provident Fund
(Kumpulan Wang Simpanan Pekerja), Armed Forces Fund Board (Lembaga
Tabung Angkatan Tentera), National Equity Corporation (Permodalan Nasional
Berhad), Social Security Organisation (Pertubuhan Keselamatan Sosial) and
Pilgrimage Board (Lembaga Tabung Haji). These founding organisations
provided funding for MSWG's start-up and establishment. Currently, MSWG is
substantially funded by the Capital Market Development Fund initiative as well
as through sales of its own products and services.
The activities of MSWG are as follows:

(a) Monitoring AGM and EGM meeting of companies monitored by MSWG.
(b) Organising regular investor education programme seminars. These
seminars are open to the general public and cover a wide range of topics of
interest to both investors and those dealing with investors.
(c) Speaking engagement at various events related to its mission and vision.
(d) Organising periodic dialogues with various groups to obtain views and
feedback on issues affecting minority shareholders as well as how to
further improve MSWG's products and services.
(e) Participating in regional and international events as a means of sharing
information on minority shareholder rights and corporate governance
issues in ASEAN and the world.
(f) Producing MCG index.
SELF-CHECK 9.2
1. What are the governing bodies of corporate governance in

Malaysia?
2. What are the functions of the governing bodies of corporate

governance in Malaysia?
3. How do the governing bodies strengthen the practice of

corporate governance in Malaysia?

9.4 CORPORATE GOVERNANCE ISSUES AND

CHALLENGES IN MALAYSIA
There are many issues and challenges related to corporate governance. One of
the most important issues is about the role and responsibility of the board of
directors who are expected to effectively monitor management activities and
whether these are aligned with the shareholderÊs interest. In a modern business,
the shareholder has no right to access company information. Hence, the
shareholder relies greatly on the audited financial statements, which can be
considered as the only medium for the shareholder to gather such information.
However, normally, what is being reported in the audited financial statement can
be considered as historical information and sometimes, it is too late for corrective
action to be taken towards the performance or survival of company. In fact, this
is not a new issue. It has been long proposed by agency theorists such as Jensen
and Meckling (1976) and Fama and Jensen (1983) in their earlier work of
corporate governance. The crucial role and responsibility of the board is
reminded by the regulators as shown in the revised MCCG (2007) and MCCG
(2012).
In addition, the relationship between corporate governance, transparency and

financial disclosure is important as well. The MCCG (2012) emphasises that
boards and management must be mindful of their duty to direct their efforts and
resources towards the best interest of the company and its shareholders while
ensuring that the interests of other stakeholders are not compromised. Disclosure
and transparency are essential for informed decision making. The timely
availability of quality and accurate information including the reporting of
financial performance are key facets of investor protection and market
confidence. A company that is honest and direct with its shareowners inspires
their confidence. By building such trust, companies can be assured of the
continued support of their investors.
In contrast, the shareholders do not trust companies that engage in non-

transparent or related-party transactions or do not disclose market-sensitive
information promptly. Such companies will, therefore, not be valued as highly as
their more transparent rivals, and they will find it harder to raise additional
funds while opening themselves to hostile takeovers. A key feature of disclosure
is a genuinely independent audit of a companyÊs accounts. Repeated experience
in developed economies shows loss of investor confidence in the company when
the accounts are unexpectedly restated. For example in the case of Enron,
auditors decided to change the way they had classified certain related-party
transactions. As a result of these changes, investors lost confidence in the
company to such a degree that Enron collapsed into bankruptcy.
Furthermore, the structure of ownership of companies in Malaysia is different as

compared to that of the UK and the US. The UK and the US ownerships are
widely dispersed compared to East Asian countries including Malaysia, which
are more concentrated among family members (for example, Shleifer & Vishny,
1997, La Porta et al., 1999, Claessens et al., 1999a & b; 2000a & b). Furthermore,
studies by Claessens et al. (1999a & b), Claessens, Djankov, and Lang (2000a),
Claessens, Djankov and Lang, (2000b), Lemmon and Lins (2003) and Zuaini
(2004) show that families control half of Malaysian companies and, in turn, are
part of the management team of the companies. Without doubt, if this is the case,
ownership structure will influence board decisions. For that reason, to what
extent can the board effectively monitor the activities of executives in managing
the company?
In addition, how independent are subcommittees such as audit committees,

nomination committees and remuneration committees from the executiveÊs
influence although its members are independent non-executive directors? In
addition, Claessens et al. (1999b) find that when large shareholders effectively
control corporations, their policies might result in the expropriation of minority
shareholders. They also point out that the conflicts of interest between large and
small shareholders can be numerous, including controlling shareholders who
enrich themselves by not paying out dividends, through excessive remuneration
or transferring of profits to other companies they control.
In addition, Shleifer and Vishny (1997) underline that the benefits from
concentrated ownership may be relatively larger in countries that are generally
less developed, where property rights are not well defined and/or protected and
enforced by judicial systems. Hart (1995) states that large shareholders would
still under-perform monitoring and intervention activities since they do not
receive 100 per cent of the gains. The shareholder may use his power to improve
his own position at the expense of other shareholders.
ACTIVITY 9.3
1. What are the issues and challenges of corporate governance
practices in Malaysia? Discuss.
2. What is your opinion of handling the issues and challenges of

corporate governance practices in Malaysia?

TOPIC 9 CORPORATE GOVERNANCE IN MALAYSIA  165
 Corporate governance is recognised as an important element in fulfilling the

interest of business communities.
 Corporate governance plays a role as an umbrella that covers the way in

which companies are directed and controlled.
 The introduction of corporate governance codes has generally been

motivated by a desire for more transparency and accountability and to
increase investor confidence in the stock market.
 The Cadbury Report has turned out to be a great influence on the

development of many corporate governance codes globally.
 Good governance demands high commitment from the board of directors

and the management itself.
 The role and responsibility of the board of directors and the management
itself in running the company is not a new issue, it has been long proposed by
agency theorists.
Board of director Malaysian Code of Corporate

Governance
Corporate governance
Transparency and disclosure
Governing bodies
ASX Corporate Governance Council. (2002). Retrieved from http://www.

asxgroup.com.au

Claessens, S., Djankov, S., & Lang, L. H. P. (1999a). Who controls East Asian
corporations? World Bank Working Paper: 2054.
Claessens, S., Djankov, S., & Lang, L. H. P. (2000a). East Asian corporations,
heroes or villains? World Bank Working Paper: 409.
Claessens, S., Djankov, S., & Lang, L. H. P. (2000b). The separation of ownership
and control in East Asian corporations. Journal of Financial Economics, 58,
81-112.
Claessens, S., Djankov, S., Fan, J. P. H., & Lang, L. H. P. S. (1999b). Expropriation
of minority shareholders: Evidence from East Asia. World Bank Working
Paper: 2088.
Fama, E. F., & Jensen, M. C. (1983). Separation of ownership and control. Journal
of Law and Economics, 26(2), 301-325.
Hampel, R. (1998). Committee on corporate governance: Final report: The final

report (Hampel Report). London, England: Gee & Co.
Hart, O. (1995). Corporate governance: some theory and implications. The

Economic Journal, 105, 678-689.
Jensen, M. C., & Meckling, W. (1976). The theory of the firm: Managerial
behavior, agency costs and ownership structure. Journal of Financial
Economics, 3, 305-360.
La Porta, R., Lopez De-Silanes, F., & Shleifer, A. (1999). Corporate ownership
around the world. Journal of Finance, LIV, 2, 471-517.
Lemmon, M. L., & Lins, K. V. (2003). Ownership structure, corporate governance,

and firm value: evidence from the East Asian financial crisis. The Journal of
Finance, LVIII, 4, 1445-1468.
Malaysian Institute of Corporate Governance (MICG). Retrieved from

http://www.micg.org.my/
Minority Shareholder Watchdog Group (MSWG). Retrieved from http://www.

mswg.org.my/web/
OECD Principles of Corporate Governance. Retrieved from http://www.

oecd.org/corporate/
Securities and Exchange Commission. Retrieved from http://www.sc.com.my/
Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. The

Journal of Finance, 52, 737-783.

The Bursa Malaysia Listing Requirement. Retrieved from http://www.

bursamalaysia.com/market/
The Malaysian Code on Corporate Governance (The MCCG). (2000, 2007 & 2012).
Finance Committee on Corporate Governance. Retrieved from
http://www.sc.com.my/.
The Sarbanes-Oxley Act of 2002. Retrieved from http://www.soxlaw.com/

Topic X Implementing
10 Corporate
Governance
LEARNING OUTCOMES
1. Describe the basic model for implementing corporate governance;
2. Discuss how to activate the basic model of corporate governance; and
3. Explain how to integrate the corporate governance model.
X INTRODUCTION
In previous topics, a comprehensive discussion on corporate governance issues
has been provided. It includes developments in corporate governance, owners
and stakeholders, as well as directors and board structure.
This topic will provide some discussion on how to implement corporate

governance. Specifically, this topic will discuss the corporate governance model
and how to implement and integrate the model.
10.1 A BASIC MODEL FOR IMPLEMENTING

Corporate governance structure varies from one country to another. The
differences are mainly due to different legal and regulatory frameworks; and also
the parties involved in corporate governance. Based on past research, three
models of corporate governance were identified. These are the:
(a) Anglo-US Model;
(b) Japanese Model; and
(c) German Model.

TOPIC 10 IMPLEMENTING CORPORATE GOVERNANCE W 169
These models are characterised by their:

(i) Key players;
(ii) Share ownership pattern;
(iii) Composition of board of directors;
(iv) Regulatory framework;
(v) Disclosure requirement for public-listed companies;
(vi) Power of shareholders; and
(vii) Interaction among key players.
Each characteristic for each model is summarised in Table 10.1.
Table 10.1: Characteristics of the Models of Corporate Governance
Models of Corporate Governance

Characteristic The Anglo-US The Japanese The German Model
Model Model
Key players • Management, • Main bank, • German banks,
directors and keiretsu, corporations are also
shareholders management shareholders
and
government
Share ownership • Institutional • Institutional • German banks and
pattern and individual and individual corporations are
investors investors dominants
shareholders
Composition of • Insider • Almost • Two-tiered board
board of directors (executive) and insiders structure consists of:
outsider (non- (executive − Supervisory
executive) managers) board (employee
directors with average and shareholders
50 members representatives);
and
− Management
board (insiders).

170 X TOPIC 10 IMPLEMENTING CORPORATE GOVERNANCE
Regulatory • Securities and • Industrial • Federal and state law

framework Exchange policy (Stock Corporation
Commission, governed by Law, Stock Exchange
Stock Exchange government Law, Commercial
ministries, Law)
Securities
Bureau of the
Ministry of
Finance, and
the Securities
Exchange
Surveillance
Committee
Disclosure • Corporate • Relatively • Corporate financial
requirement for financial data, stringent, data, data on capital
public-listed a breakdown disclosure of structure, limited
companies of the corporate information on each
corporationÊs financial data, nominee to the BOD,
capital corporationÊs aggregate
structure, capital compensation paid
substantial structure, to executive officers,
background background shareholding more
information on information on than five per cent of
each nominee each nominee total share capital,
to the BOD, to the BOD, information of
compensation compensation proposed mergers
paid to paid to and restructuring,
executive executive proposed
officers, officers, amendments to the
shareholding information of articles of
more than five proposed association, name of
per cent of mergers and proposed auditors
total share restructuring,
capital, proposed
information of amendments
proposed to the articles
mergers and of association,
restructuring, name of
proposed proposed
amendments auditors
to the articles
of association,
name of
proposed
auditors

Power of • Elections of • Approval of • Approval of

shareholders directors and shareholders allocation of net
appointment of on payment of income, ratification
auditors; dividends and of the acts of the
establishment allocation of management board
or amendment reserves; for the previous
of stock option election of fiscal year,
plans, mergers directors; and ratification of the
and takeovers, appointment acts of the
restructurings, of auditors supervisory board
amendments • Others include for previous fiscal
of articles of capital year, election of
association authorisation, supervisory board,
amendments appointment of
to the article of auditors
association,
payment of
retirement
bonuses to
directors and
auditors
Interaction • Shareholders • Strong • Include the interests
among key may exercise relationship of labour,
players their voting between key corporations, banks
power by players, while and shareholders in
proxy; outside the corporate
institutional shareholders governance system,
investors play minimum with some scope for
monitor role participation by
corporation • Shareholders minority
performance may attend shareholders
through AGM, vote by
variety of proxy or by
specialised mail
investment
funds, rating
agencies,
auditors

ACTIVITY 10.1
1. Discuss the main differences in characteristics between the Anglo-

US, Japanese and German corporate governance models.
2. What are the factors that may lead to these differences? Explain.
10.2 ACTIVATING BASIC MODEL OF

There are several elements that are crucial in implementing the corporate
governance model. These elements are shown in Figure 10.1:
Figure 10.1: Elements in implementing corporate governance model
10.2.1 Shareholders
Shareholders are the main capital contributors for a company. As a return for
their investments, shareholders will usually receive profit sharing and dividends.
Based on the three corporate governance models, they can be classified as
institutional and individual shareholders. In some models, the shares are
dominated by banks.

Because they are the main contributors of capital, their influence on the
companiesÊ policies, operations and decisions is significant. One of the channels
to use their power is voting rights. Thus, to implement good corporate
governance practices, rational and active shareholders are crucial in demanding
their rights. When the shareholders are demanding, the board of directors and
the management team will work for the best interest of the shareholders and
other stakeholders.
10.2.2 Board of Directors

A board of directors plays a fiduciary role in the company on behalf of other
interested parties. They are the main push factor in order for a company to have
a good corporate governance environment. Their power is significant in setting
the companyÊs policies. They can be viewed as an intermediary party between
the insiders (management) and outsiders (stakeholders) of a company.
Based on the corporate governance models, a board of directors can be appointed

from the inside and outside of a company. It can also be formed as a two-tiered
structure. An active board of directors is important so that a company would
have good care of corporate governance matters.
10.2.3 Regulatory Bodies

Regulatory bodies are crucial in implementing good corporate governance. These
bodies are formed to shape and govern the implementation of corporate
governance for a company from the legal perspective. Based on the corporate
governance models, the regulatory bodies can be organisations that govern
securities and stock market, corporations and industries.
Good regulatory bodies will indirectly lead to good corporate governance

implementation. Regulatory bodies are formed to ensure companies adhere to
the rules and regulations, hence creating a good business and corporate
governance environment.
10.2.4 Other Stakeholders

Other stakeholders such as creditors, government agencies and other interested
parties are also important in implementing corporate governance. These
interested parties also have their concern about the operations of a company. For
example, creditors are concerned about the ability of a company to pay back their

debt, while government agencies like the Inland Revenue Board is concerned
about taxes which need to be paid by the company.
Thus, to ensure a company is able to fulfil other stakeholdersÊ demands, one of

the critical factors is having good corporate governance practices. These groups
may use their influence and power to motivate companies to practise better
corporate governance.
10.3 INTEGRATING THE CORPORATE

GOVERNANCE MODEL
According to Davies (2006), the following issues are important in implementing
and integrating a good corporate governance model:
(a) Full continuous support from the board and its committees;
(b) The influence of senior executives to drive and control the corporate
governance system;
(c) Independent and regular advice on best practices in corporate governance;
(d) How to use corporate governance to gain competitive advantage;
(e) Intra and extra company communications channel to receive feedback;
(f) Holistic relationship between shareholders and company;
(g) Training staff and selected stakeholders on what is expected of the
companyÊs corporate governance system;
(h) Values need to be agreed, monitored and regularly reviewed;
(i) Full support of all involved or affected by the corporate governance system; and
(j) The system serves for long-term success of the company.
• There are three corporate governance models ă the Anglo-US, Japanese and
German models.
• These models share similarities, yet have differences in their characteristics.
• Shareholders, board of directors, regulatory bodies and other stakeholders

are crucial in implementing corporate governance.

Anglo-US model Regulatory bodies

Board of directors Shareholders
German model Stakeholders
Japanese model
Mallin, C. A. (2007). Corporate governance (2nd ed.). Oxford, England: Oxford

University Press.

sustainable success. Hants, England: Gower Publishing.
Three models of corporate governance from developed capital market. (2005).

EWMI/PFS Program/ Lectures on Corporate governance. Retrieved from
http://www.emergingmarketsesg.net/esg/wp-
content/uploads/2011/01/ Three-Models-of-Corporate-Governance-
January-2009.pdf

176 X REFERENCES
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Module Writers: Dr Noor Afza Amran

Moderator: Assoc Prof Dr Zuhairah Ariff Abd Ghadas

Developed by: Centre for Instructional Design and Technology

First Edition, August 2013

Copyright © Open University Malaysia (OUM), August 2015, BBCG3103

Copyright © Open University Malaysia (OUM)

Topic 1 Theoretical Aspects of Corporate Governance 1

Topic 2 Development of Corporate Governance Codes 19

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2.4.2 Principles for Enhancing Corporate Governance 29

Topic 3 Shareholders and Stakeholders 38

Topic 4 Family-owned Firms 57

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Topic 5 The Role of Institutional Investors in Corporate Governance 80

Topic 6 Socially Responsible Investment (SRI) 91

Topic 7 Directors and Board Structure 115

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Topic 8 DirectorsÊ Performance and Remuneration 136

Topic 9 Corporate Governance in Malaysia 150

Topic 10 Implementing Corporate Governance 168

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Copyright © Open University Malaysia (OUM)

COURSE GUIDE DESCRIPTION

As an open and distance learner, you should be acquainted with learning

Copyright © Open University Malaysia (OUM)

Table 1: Estimation of Time Accumulation of Study Hours

Topic 1 begins with the definition of corporate governance, why it is important to

Topic 2 discusses the development of corporate governance codes in the United

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Topic 4 discusses ownership structures around the world, family-owned firms

Topic 5 explains the role and influence of institutional investors in corporate

Topic 6 describes socially responsible investment in relation to corporate

Topic 8 discusses director performance and remuneration with stress on key

Topic 9 highlights the background, structure, governing bodies and regulations

Topic 10 deals with the implementation of the corporate governance model.

TEXT ARRANGEMENT GUIDE

Self-Check: This component of the module is inserted at strategic locations

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Activity: Like Self-Check, the Activity component is also placed at various

References: The References section is where a list of relevant and useful

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TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

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We have seen high-profile corporate collapses such as those of Barings Bank,

1.1 CORPORATE GOVERNANCE – DEFINITION

1.1.1 What is Corporate Governance?

The Cadbury Report (1992) defined corporate governance as „a whole system of

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In Western countries, companies are characterised as having diffused ownership

In concentrated ownerships, the concern is potential conflicts of interest between

In Malaysia, the Malaysian Code on Corporate Governance (MCCG) was first

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It is observed that the definitions of corporate governance mainly have to do with

1.1.2 Why is Corporate Governance Important?

The key to corporate governance is having effective monitoring mechanisms to

In the MCCG 2012, there were eight principles and 26 corresponding

(a) Principle 1 ă Establish Clear Roles and Responsibilities

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