F1-Corporate Governance

What is Corporate Governance?

Corporate governance is the system by which organisations are directed and controlled by
senior officers.

Although mostly discussed in relation to large quoted companies, governance is an issue for all
bodies corporate; commercial and not for profit.

Need of Corporate Governance

Corporate governance has become increasingly high profile in recent years due to a number of factors including:
(a) High-profile corporate scandals (e.g. Maxwell, Enron, WorldCom)
(b) Increasingly active and international shareholders
(c) Increasing media scrutiny
(d) Globalisation highlighting cultural differences
(e) Developments in financial reporting

Elements of corporate governance

There are a number of elements in corporate governance:

(a) The management and reduction of risk

(b) Overall performance enhanced by good supervision and management
within set best practice guidelines.
(c) Good governance provides a framework for an organisation to pursue its
strategy in an ethical and effective way.
(d) Good governance is not just about externally established codes, it also requires
a willingness to apply the spirit.
(e) Accountability

Key Definitions
Integrity: Integrity in business means dealing honestly with employees, customers and all business
contacts.

Accountability: Accountability means being the business being answerable for its actions.

Independence: Independence in this context means that there must be independent people within the
organisation checking that the business is complying with its code of governance.

Good management: Good management in business means setting best practice guidelines.

Perspectives on governance

In a small business the shareholders (ie owners) are likely to be the directors and so the owners
and the managers are the same and there are no issues. In larger businesses the shareholders (ie
owners) will not necessarily be involved in the day-to-day running and management of the
business. The owners and the managers will not be the same and so there may be a conflict of
interest.
Debates about the place of governance are founded on three differing views associated
with the ownership and management of organisations.

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Stewardship theory (managers are stewards of the assets)
Some approaches to good governance view the management of an organisation as the stewards of
its assets, charged with their employment and deployment in ways consistent with the overall
strategy of the organisation. With this approach, power is seen to be vested in the stewards, that is
the executive managers.
Other interest groups take little or no part in the running of the company and receive relevant
information via established reporting mechanisms; audited accounts, annual reports etc. Technically,
shareholders or member/owners have the right to dismiss their stewards if they are dissatisfied by
their stewardship, via a vote at an annual general meeting.

Agency theory (managers seek to look after their own interests)

Another approach to governance is enshrined in agency theory. The theory is that management seek
to service their own self-interest and only look after the performance of the company where its goals
are co-incident with their own. For example, management may run the business in a way that does not
benefit all stakeholders fairly by primarily managing their own interests.

Stakeholder theory (management has a duty of care to stake holders)

The stakeholder approach takes a much more 'organic' view of the organisation, imbuing it with a
'life' of its own, in keeping with the notion of a separate legal personage. Effectively stakeholder
theory is a development of the notion of stewardship, stating that management has a duty of care, not
just to the owners of the company in terms of maximising shareholder value, but also to the wider
community of interest, or stakeholders.

Governance principles
Most corporate governance codes are based on a set of principles founded upon ideas of what
corporate governance is meant to achieve. This list is based on a number of reports.
(a) To minimise risk via compliance
(b) To ensure adherence to and satisfaction of the strategic objectives
(c) To fulfil responsibilities to all stakeholders and to minimise potential
conflicts of interest between the owners, managers and stakeholder.
(d) To establish clear accountability at senior levels within an organisation.
(e) To maintain the independence
(f) To provide accurate and timely reporting of trustworthy/independent
financial and operational data to both the management and
owners/members of the organisation.
(g) To encourage more proactive involvement of owners/members in the
effective management of the organisation.
(h) To promote integrity, that is straightforward dealing and completeness.

Principle v Rule Based Codes

Codes on Corporate governance around the world could broadly be divided into:
Rule based corporate governance codes consist of a strict set of regulation which have to be
followed in any case. An example of such a code would be The one followed by listed companies in
America

Principle based corporate governance codes on The contrary, consist of basic guidelines that The
companies have to follow. Such codes are based on a "comply of explain" system, where companies
who fail to follow the principles stated in the code have to give valid reasons for doing so. The
combined code of corporate governance followed in the UK along with most other codes around the
world are principle based codes

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Features of poor corporate governance

The various risks and problems that can arise in organisations' systems of governance.
 Domination by a single individual
 Lack of involvement of board
 Lack of adequate control function
 Lack of internal audit.
 Lack of adequate technical knowledge in key roles
 Lack of supervision
 Lack of segregation of key roles
 Lack of independent scrutiny
 Lack of contact with shareholders
 Emphasis on short-term profitability
 Misleading accounts and information

Risks of poor corporate governance

Clearly the ultimate risk is of the organisation making such large losses that bankruptcy
becomes inevitable. The organisation may also be closed down as a result of serious
regulatory breaches, for example misapplying investors' monies.
Committees on Corporate Governance

The Role of theboard

A director is someone who works for a company and is charged with the conduct and management of its affairs. The directors
collectively are referred to as the Board of Directors, who are elected by the shareholders. The role that should be taken
by the Board has been much debated. The Cadbury report suggests that the Board should have a formal schedule of matters
on which it decides, which should include:
a) Mergers and acquisitions
b) Acquisitions and disposals of major assets
c) Investments
d) Capital projects
e) Bank and other borrowings

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1.2 Corporate governance codes have made a number of recommendations in relation to the Board,
including the following:
(a) Individual directors should have relevant expertise, which complements each other.
(b) The Board should receive appropriate information of sufficient quality in a timely manner, including
non-financial information.
(c) The performance of the Board and its members should be assessed annually
(d) The roles of chairman and chief executive should be separated. Companies are discouraged from
appointing an outgoing chief executive as chairman.

Non-executive directors
Non-executive directors have no executive (managerial) responsibilities.
Non-executive directors are not employees of the company but they do take part in decision making
at board meetings. They do not take part in the day-to-day running of the company.
Non-executive directors should provide a balancing influence, and play a key role in reducing
conflicts of interest between management (including executive directors) and shareholders. They
should provide reassurance to shareholders, particularly institutional shareholders, that management
is acting in the interests of the organisation.

Role of non-executive directors

The UK's Higgs report provides a useful summary of the role of non-executive directors:
(a) Strategy: non-executive directors should contribute to, and challenge the
direction of, strategy.
(b) Performance: non-executive directors should scrutinise the performance
of management in meeting goals and objectives, and monitor the reporting
of performance.
(c) Risk: non-executive directors should satisfy themselves that financial
information is accurate and that financial controls and systems of risk
management are robust.
(d) Directors and managers: non-executive directors are responsible
for determining appropriate levels of remuneration for executives, and are
key figures in the appointment and removal of senior managers and in
succession planning.

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Advantages of non-executive directors

Non-executive directors can bring a number of advantages to a board of directors.
(a) They may have external experience and knowledge which executive directors do not
possess.
(b) Non-executive directors can provide a wider perspective than executive
directors who may be more involved in detailed operations.
(c) Good non-executive directors are often a comfort factor for third parties
such as investors or suppliers.
(d) The most important advantage perhaps lies in the dual nature of the non-
executive director's role. Non-executive directors are full board members who
are expected to have the level of knowledge that full board membership implies.
At the same time they are meant to provide the so-called strong, independent
element on the board.
Problems with non-executive directors
Nevertheless there are a number of difficulties connected with the role of non-executive director.
(a) In many organisations, non-executive directors may lack independence. (For
example, potential non-executive directors are more likely to agree to serve if
they admire the company's Chair or its way of operating.)
(b) There may be a prejudice in certain companies against widening the
recruitment of non-executive directors to include people proposed other than by
the board or to include stakeholder representatives.
(c) Non-executive directors may have difficulty imposing their views upon the
board. It may be easy to dismiss the views of non-executive directors as
irrelevant to the company's needs.
(d) Perhaps the biggest problem which non-executive directors face is the limited
time they can devote to the role. If they are to contribute valuably, they are likely
to have time-consuming other commitments.

Number of non–executive directors

Most corporate governance reports acknowledge the importance of having a significant presence
of non-executive directors on the board. The question has been whether organisations should
follow the broad principles expressed in the Cadbury report:
'The board should include non-executive directors of sufficient character and number for
their views to carry significant weight.' or whether they should follow prescriptive
guidelines. New York Stock Exchange rules now require listed companies to have a majority
of non-executive directors.

Independence of non-executive directors

Various safeguards can be put in place to ensure that non-executive directors remain independent.
Those suggested by the corporate governance reports include:
(a) Non-executive directors should have no business, financial or other connection
with the company, apart from fees and shareholdings. Recent reports such as the
UK's Higgs report have widened the scope of business connections to include
anyone who has been an employee or had a material business relationship over
the last few years, or served on the board for more than ten years.
(b) They should not take part in share option schemes and their service should
not be pensionable, to maintain their independent status.
(c) Appointments should be for a specified term and reappointment should not be
automatic. The board as a whole should decide on their nomination and
selection.
(d) Procedures should exist whereby non-executive directors may take independent
advice, at the company's expense if necessary.

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Chairman
A chairman is an executive elected by a company's board of directors that is responsible for presiding
over board or committee meetings. The chairman ensures that the meetings run smoothly and remain
orderly, and works at achieving a consensus in board decisions.
The chairman of a company is the head of its board of directors. The board is elected by shareholders
and is responsible for protecting investors' interests, such as the company's profitability and stability.
The Chairman Guides the Board
The chairman of the board is a part-time leader who manages the board’s business and activities and
provides guidance and direction to other board members. The chairman, however, does not hold a
managerial position over other board members. All members are considered peers; therefore, board
decisions are not the sole responsibility of the chairman. The board, with the chairman at its head,
holds the highest level of decision-making authority for the company, above that of the CEO.

Chief Executive Officer (CEO)

A chief executive officer (CEO) is the highest-ranking executive in a company, and their primary
responsibilities include making major corporate decisions, managing the overall operations and
resources of a company, and acting as the main point of communication between the board of
directors and corporate operations.
The main difference if we see in term of power, Chairman is included in hiring or firing of
CEO/directors/presidents while vice versa is not happened. CEO is the primary face of an
organisation interacted with outer world as a representative of company.

The CEO Leads the Company

A CEO is a full-time leader and the company’s top decision maker. This leader establishes strategic
processes, oversees progress toward meeting corporate objectives and instructs other leaders to take
appropriate actions to keep business moving in the right direction. The CEO holds other executives
accountable when things don’t go the way they should. In turn, the CEO is held accountable by the
board of directors and is expected to follow board direction and implement board decisions.

Remuneration, nomination, audit and risk committees

Directors' remuneration should be set by a remuneration committee consisting of independent
non-executive directors.

Remuneration should be dependent upon organisation and individual performance.

Accounts should disclose remuneration policy and the packages of individual directors.

The Greenbury committee in the UK set out principles which are a good summary of what
remuneration policy should involve.
 Directors' remuneration should be set by independent members of the board
 Any form of bonus should be related to measurable performance or enhanced shareholder value
 There should be full transparency of directors' remuneration including pension rights in
the annual accounts

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Nomination committee
A nomination committee should be in place for selecting board members and making
recommendations to the board.

The nomination committee should consist of a majority of non-executive directors. The committee
should be responsible for finding suitable applicants to fill board vacancies and recommending them
to the board for approval.

Risk committee
The audit committee may be responsible for reviewing risk management or there may be a
separate risk committee. The risk committee should ensure that the systems in place identify,
assess, manage and monitor financial risks.

Reporting on corporategovernance
Companies listed on the London Stock Exchange are required to provide:
(a) A narrative statement of how the principles of the Combined Code have been applied
(b) A statement of compliance with the Code throughout the accounting period, or reasons for
non-compliance
(c) Information about the Board of Directors
(d) Reports of the Remuneration and Audit Committees
(e) A statement of effectiveness of internal controls
Corporate social responsibility

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Strategies for social responsibility

A strategy which a business follows where it is prepared to take full
responsibility for its actions. A company which discovers a fault in a product
and recalls the product without being forced to, before any injury or damage is
Proactive strategy caused, acts in a proactive way

Reactive strategy This involves allowing a situation to continue unresolved until the public,
government or consumer groups find out about it.

This involves minimising or attempting to avoid additional obligations arising

Defence strategy from a particular problem.

This approach involves taking responsibility for actions, probably when one of
Accommodation the following happens.
strategy
Encouragement from special interest groups
Perception that a failure to act will result in government intervention

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