CG Development - 2022

Corporate Governance
Development
1
Why corporate governance?
• Corporate failures/scandals
Examples: Enron and WorldCom (2001); Parmalat (2003); Lehman
Brothers (2008); Olympus (2011); LIBOR Scandal (2012);Volkswagon
(2015); Carillion (2018); Wirecard (2020), Luckin Coffee (2020),etc.
• A corporation with good corporate governance

indicates that such corporation is well managed
• A corporation that practiced good corporate
governance can achieve business sustainability in the
long term
2
Developing definition
‘If management is about running business,

governance is about seeing that it is run properly.
All companies need governing as well as managing’.
(Bob Tricker 1984)
3
 Cadbury Report (CR) issued in UK in 1992 defines
corporate governance as ‘the system by which companies
are directed and controlled’.
 As per CR, ‘Boards of directors are responsible for

the governance of their companies. The shareholders’
role in governance is to appoint directors and the
auditors and to satisfy themselves that an appropriate
governance structure is in place. The responsibilities
of the board include setting the company’s strategic
aims, providing the leadership to put them into effect,
supervising the management of the business and
reporting to shareholders on their stewardship. The
board’s actions are subject to laws, regulations and the
shareholders in general meeting.’
4
 Andrei Shleifer and Robert Vishny (1997) define
corporate governance as “the ways in which
suppliers of finance assure themselves of getting a
return on their investment”. This means that the
main objective of a corporation is to maximise
shareholder value.
5
 Marc Goergen and Luc Renneboog’s (2006) CG

definition suggests that the main objective of corporations of
different countries may differ:
 “A corporate governance system is the combination of

mechanisms which ensure that the management (i.e.
agent) runs the firm for the benefit of one or several
stakeholders (principals). Such stakeholders may cover
shareholders, creditors, suppliers, clients, employees and other
parties with whom the firm conducts its business.”
6
 Anglo-American corporations in UK + USA
pursue shareholder value maximisation, while
corporations in e.g. countries in Continental Europe
and Japan etc. pursue stakeholder value.
 UK Company Law 2006 – ‘Directors should also

recognise…..the company’s need to foster
relationships with the employees, customers
and suppliers, its need to maintain its business
reputation, and its need to consider the company’s
impact on the community and the working
environment’.
7
• The UK Corporate Governance Code 2016
• Stated ‘the purpose of corporate governance is to facilitate
effective, entrepreneurial and prudent management that can
deliver the long-term success of the company’.
• ‘Corporate governance is therefore about what the board of a
company does and how it sets the values of the company. It is
to be distinguished from the day to day operational
management of the company by full-time executives’.
• The UK Corporate Governance Code 2018

• Expands the definition ‘To succeed in the long-term, directors
and the companies they lead need to build and maintain
successful relationships with a wide range of stakeholders.’
8
• King IV Report on CG for South Africa 2016
defined CG as ‘ The exercise of ethical and effective
leadership by the governing body towards
achievement of the following governance outcomes:
• Ethical culture
• Good performance
• Effective control
• legitimacy
9
The Organisation for Economic Co-operation and
Development (OECD) published Corporate Governance
Principles in 1999 (revised in 2004)
 CG involves ‘a set of relationships between a company’s
management, its board, its shareholders and other
stakeholders….and provides the structure through which the
objectives of the company are set, and the means of attaining those
objectives and monitoring performance are determined.’
OECD in 2015 in a new set of CG principles states
that
 CG practices should ‘help build an environment of trust,
transparency and accountability necessary for fostering
long-term investment, financial stability and business
integrity, thereby supporting stronger growth and more
inclusive society’.
10
Corporate Governance Theory
Shareholder primacy theory

 Developed in 1960s by e.g. Milton Friedman
 Focus on maximizing the value to shareholders
before considering other stakeholder, e.g. employees,
customers, suppliers, society, etc.
Stakeholder theory
 Companies should consider the impact of their
activities on the society and the environment
 Companies should be accountable to the society
11
 “It is in the interest of every man to live as much at his ease as he can;
and if his emoluments are to be precisely the same, whether he does,
or does not perform some laborious duty, it is certainly his interest, at
least as interest is vulgarly understood, either to neglect it altogether,
or, if he is subject to some authority which will not suffer him to do
this, to perform it in as careless and slovenly a manner as that
authority will permit.”
 As per Adam Smith, conflict of interests may exist

between an agent and agent’s principal.
Smith, A. (1776), An Inquiry into the Nature and Causes of the Wealth of
Nations, reprinted in K. Sutherland (ed.) (1993), World’s Classics, Oxford:
Oxford University Press.
12
Michael Jensen and William Meckling formalised

the conflict of interests in their principal–agent
theory.
 When the principal asks the agent to carry out a

specific duty, the agent may not act in the best
interest of the principal once the agent has been
appointed by the principal. The agent rather acts in
his own interest. This is moral hazard.
13
 Asymmetric information is the cause of moral

hazard.
 Asymmetric information refers to situations where one
party, typically the agent, has more information than
the other party, the principal. If both parties had access
to the same information at all times, then there would be
no moral hazard problem.
 Moral hazard exists because the principal cannot
keep track of the agent’s actions all the time.
 Jensen and Meckling’s principal–agent model also
assumes that there is a separation of ownership and
control.
14
Adolf Berle and Gardiner Means were the first to point
out this separation in their 1932 book The Modern Corporation
and Private Property.
 ‘No conflict of interests when an entrepreneur owns and manage his own
corporation. When corporation grows, the entrepreneur may raise funds and
sell his business. The company would then be run by professional managers
on behalf of shareholders. In this regard, there is a clear division of labour
in the modern corporation with:
◦ the manager (agent), who has the expertise to run
the firm, but not the funds to finance the corporation
and
◦ the shareholders (principal(s)), who has the required
funds, but not the skills to run the corporation.
 In practice, managers, who has the control, run the day-

to-day operations of the corporation on behalf of the
shareholders. This is separation of ownership and
control.
15
 The agent may manage the corporation in his own interests
rather than those of the principal. So, this is principal–
agent problem (or agency problem).
 The main consequence of this problem is agency costs,

which comprise of:
◦ monitoring expenses incurred by the principal;
◦ bonding costs accruing to the agents; and
◦ residual loss.
16
 Monitoring expenses  principal observes agent, keeps

track of agent’s behaviour and restrict agent’s behaviour in
various ways.
 Bonding costs  costs incurred by agent to signal

credible way to principal that the agent will act in the
interest of the principal.
 Residual loss  loss incurred by principal since the

agent (who acts for his own interest) may not make
decisions to maximise the firm’s value.
17
Agency problems
Two main types of agency problems are perquisites and
empire building.
◦ Perquisites or perks : Benefits enjoyed by managers,

but the costs are borne by shareholders. Examples of
perks include expensive managerial offices, corporate
jets and yachts, and CEO mansions financed by the
corporation, etc.
◦ Empire building: Managers pursue growth rather

than shareholder-value maximisation. They benefit from
increasing the size of their firm. Such benefits include
increased power and social status.
18
Expropriation of minority shareholders
 The principal–agent model is based on the Berle-

Means’ assumption. They assume that, if corporations
grow, ownership eventually separates from control.
This only applies to the Anglo-American system of
corporate governance. But in other parts of the world,
the large shareholders exert significant control over the
corporations. So, the conflict of interests is between
the large shareholder(s) and the minority
shareholders.
19
 Minority shareholders are expropriated by large

shareholder(s) through tunnelling, transfer pricing,
nepotism and infighting.
 Tunnelling: the large shareholder transfers the firm’s

assets or profits into his own pockets.
 Transfer pricing: large shareholder overcharges the

corporation for services or assets provided.
20
Expropriation of the minority shareholders by the large shareholder
Large shareholder
51% 100%
Firm A Firm B
• Large shareholder dominates decision making in Firm A and he is able to steal assets from Firm
A.
• If he steals one dollar of Firm A’s assets by transferring assets to Firm B, the gross gain will be 1
dollar, while the net gain will be $1 - $0.51  $0.49 or 49 cents.
• Transfer assets/profits from Firm A to large shareholder’s firm (i.e. Firm B)  expropriate Firm
A’s minority shareholders  refers as Tunnelling. The cost to minority shareholders is 49
cents. Therefore, large shareholder ends up in stealing 49 cents from Firm A’s minority
shareholders.
Source: Extract from Goergen, International Corporate Governance, 1st Edition © Pearson Education Limited 2012
Leveraging control and increasing the potential for expropriation
Large shareholder
100%
51%
Holding Firm B
Co.
51%
Firm A
• Large shareholder is the controlling shareholder in Firm A via an intermediary, a Holding

company.
• Majority control in Firm A is 26.01% (i.e. 51% of 51%)
• If he steals one dollar of Firm A’s assets by transferring assets to Firm B, the gross gain will be
one dollar, but at a cost of only 26.01 cents.
• Both Firm A and the Holding company have minority shareholders
• Total cost or loss to minority shareholders  73.99 cents (cost of 49 cents for minority
shareholders of Firm A and cost of 24.99 cents for minority shareholders of Holding company),
generated by their 49% stake in the Holding company’s 51% stake in Firm A.
Source: Extract from Goergen, International Corporate Governance, 1st Edition © Pearson Education Limited 2012
 Nepotism: the large family shareholder appoints family

members to top management positions rather than the
most suitable candidates on the job market.
 Infighting: may not be a form of expropriating the

corporation’s minority shareholders, but it is likely in
deflecting management time as well as other firm
resources.
23
Corporate Governance Theories
 Stewardship Theory
 Shareholders appoint directors (agents) to run the corporation’s
businesses. Directors owe fiduciary duties towards shareholders.
 Being directors of a corporation, they act as stewards for their

shareholders’ interests.
 Stewardship theory assumes that directors do not act/make

decisions solely for their own benefits, they will act independently
with integrity and accountable to shareholders when carry out
their duties.
 The theory emphasize board’s responsibility to maximize

shareholder value in achieving corporate sustainability.
24
Corporate Governance Theories
 Enlightened Shareholder Theory

 Boards should satisfy shareholders’ needs and
interests  crucial to corporations’ success and
creation of long-term wealth.
 Corporations could then make profits and enhance

shareholder wealth by satisfying stakeholders’
needs and interests.
25
Corporate Governance Approaches
Shareholder value approach
Board of directors maximises the company’s wealth through price
growth and dividend payments and govern the company in the best
interests of shareholders  accountable to shareholders only.
Stakeholder value approach

Board of directors has a wider vision beyond profit maximisation for
shareholders and obliges them to act in the interests of a wider group of
constituents with a stake or interest in the company and its business.
Inclusive stakeholder approach

The best interest of the company not in terms of maximising shareholder
value, but ‘within the parameters of the company as a sustainable
enterprise and the company as a corporate citizen’ (as defined by the
Institute of Directors for South Africa, King Code of Governance for
South Africa 2009, King IV).
26
Corporate Governance Approaches
Enlightened shareholder value approach

Board of directors, when considering actions to maximise shareholder
value, must consider the views of and impact on other stakeholders and
not just shareholders. The views and interests of other stakeholders are
only considered in so far as it would be in the interests of shareholders
to do so. The enlightened shareholder value approach is still in essence a
shareholder value approach. The views of other stakeholders are only
considered in so far as it would be in the interests of shareholders to do
so.
27
Principles of Corporate Governance
 Responsibility
 Accountability
 Transparency
 Fairness
28
 What is corporate governance?

 Cadbury Report (1992): ‘the system by which
companies are directed and controlled’.
 CG is a system of rules, processes, practices by which

a company is directed and controlled.
 It sets out the relationship between the board of

directors, senior management, shareholders and
stakeholders.
29
Corporate Governance framework
Legislation + Common Law

Regulations Shareholders
Board of Directors
Corporate Governance framework
Stakeholders Shareholders
Regulators
Auditors
Board of Directors
Audit committee
Company
B. Ethics
secretary
CSR Other Remuneration + Nomination
committees committees
Corporate Governance Framework
Legislation
 Companies Ordinance
 Securities and Futures Ordinance
 Other Ordinances
Common Law
Regulations & Codes
 The Listing Rules
 Corporate Governance Code (Appendix 14)
 Company’s own code
 The Hong Kong Code on Takeovers & Mergers
 The Hong Kong Code on Share Buy-backs
32
Rule-based approach to corporate governance

 Mandatory set of laws, regulations, standards, codes (e.g.
Sarbanes-Oxley Act 2002, USA)
 Non-compliance results in sanctions/fines on the company;
directors may be disqualified and end up in jail.
Principle-based approach to corporate governance

 Voluntary set of best practices as per CG code (e.g. The UK
CG Code 2018; HK CG Code 2022)
 The code, which is voluntary, adopts a ‘comply or explain’
approach.
 Companies/shareholders may choose the principles/practices that
are appropriate to their companies. Example : CLP Holdings
Limited developed their own CG Code.
33
Company’s constitution (e.g. Articles of Association)
Corporate structure (e.g. BOD; board committees)
Policies (e.g. code of conduct or ethics; bribery; conflict of
interests; whistleblowing; insider trading; risks; IT policies;
sexual harassment; gifts and entertainment, etc.)
Procedures (e.g. strategic planning; business continuity;
risk management and internal controls; computer data and
security; health and safety; procurement and recruitment)
Regulatory bodies
 The Companies Registry
 The Stock Exchange
 The Securities and Futures Commission
 Hong Kong Monetary Authority
 Courts and Tribunals
34
Corporate Governance reports/codes
 U.S.A. - in 1980’s - corporate takeover activities

◦ directors’ protective practices
◦ shareholders i.e. public pension funds
◦ legal requirements Imposed on corporate
pension funds “ to manage their assets”
 U.K. - corporate failures

◦ e.g. Polly Peck, Coloroll + BCCI
 Agency problem
35
Cadbury Report
 Background
 Common features of successful companies that fail
◦ dominant leader - combined roles
◦ limited presence of non-executive directors
◦ over-riding internal controls by chief executive

officer
◦ Irregular board meetings
◦ inadequate management information systems

36
Cadbury Report
 Cadbury Committee - Sir Adrian Cadbury
 The Committee issued the Report on Financial

Aspects of Corporate Governance and Code of
Best Practice.
 The Committee’s work initially limited to financial fraud

as a reaction to financial scandals, but subsequently
extended beyond financial aspects.
 CG - a system by which companies are directed +

controlled
 Directors are responsible for governance of a corporation

37
Cadbury Report
Recommendations
 Comply with the Code of Best Practice
 Directors
◦ More accountable to shareholders
◦ 3 years’ service contract
◦ 3 non-executive directors
 Full access to information and independent professional advice by
independent non-executive directors
 Audit, remuneration and nomination committees
 Separation of roles of Chairman +CEO
 Decision at full board level on certain matters
 Auditors
◦ Independence of auditors - audit committee
◦ Free access to audit committee + voice concern over management
◦ Report on internal control system; business as a going concern
◦ Include in Directors’ Report directors’ responsibility for preparing accounts 38
Cadbury Report
Recommendations
 Internal control
◦ Establish proper internal control system
◦ Satisfactory internal control system ?
 directors’ statement
 auditors’ statement
 Disclosure
◦ Remuneration of chairman
◦ Highest paid director
◦ Basis of remuneration
 Role of shareholders
◦ Shareholder committee - direct link with board of directors
Corporate Governance is the system by which companies are
directed and controlled
Cadbury’s work focused on accountability
39
Greenbury Report
 Background
 Greenbury Committee - Sir Richard Greenbury
 Greenbury Report 1995 + Code of Best Practice
 Recommendations
◦ Directors’ service contracts
◦ Review of directors’ remuneration + recommendation to
shareholders remuneration committee - non-executive directors
only
◦ Remuneration committee report
◦ Inform shareholders re directors’ pay + benefits
 Greenbury Code -effective 1995

◦ Applicable to UK listed companies
 Greenbury’s work focused on accountability
40
Hampel Committee on Corporate Governance
 Hampel Committee - Sir Ronald Hampel

 Hampel Report - Jan. 1998
 Recommendations
◦ 1/3 of the board - non-executive directors
◦ Senior independent director
◦ Audit/remuneration/nomination committees
◦ Internal audit function
◦ Separation of Chairman and CEO
◦ Directors’ report on internal control
◦ Training of directors
41
The Combined Code
 June 1998 – “Committee on Corporate
Governance - The Combined Code” (Principles
of Good Governance and Code of Best Practice)
* combines the work of Cadbury, Greenbury and
Hampel Committees
 July 2003 – “The Combined Code on Corporate
Governance”
 June 2006 – revised Combined Code
 June 2008 – updated version
 June 2010 - The Combined Code was renamed as
“ The UK Corporate Governance Code ”
 July 2018 - Latest version
42
Other CG Reports/Codes/Guidance
 Myners report on role of institutional investors (2001)
 Higgs report - Review of the role and effectiveness of non-executive
directors (2003)
 Smith report - Audit Committees - Combined Code Guidance (2003)
 The Tyson report - Recruitment and development of Non-Executive
Directors (2003)
 Guidelines for Disclosure and Transparency in Private Equity (2007)
 Walker Report (2009)
 Davies Report (2011) – Women on Boards review
 Guidance on Risk Management, Internal Control and Related Financial and
Business Reporting (2014)
 The AIC Code of Corporate Governance Guide for Investment Companies
(2016)
 Audit Firm Governance Code (2016)
 Guidance on board effectiveness (2018)
 The UK Stewardship Code (2020)
43
Other governance
principles/recommendations/codes/guidelines/report
 Australia – ASX Principles & Recommendations 2019
 Belgium –Belgian Code on CG 2020
 Canada – CG Guideline 2018
 China – Code of CG for Listed Cos. in China 2019
 Denmark –Recommendations on CG 2017
 France – C G Code of Listed Corporations 2020
 Germany – German Corporate Governance Code 2022
 Malaysia – Malaysian Code on Corporate Governance 2021
 Netherlands – Dutch CG Code 2016
 Singapore – Code of Corporate Governance 2018; Guidelines on
Corporate Governance for Designated Financial Holding Companies, Banks,
Direct Insurers, Reinsurers and Captive Insurers which are incorporated in
Singapore 2021.
 South Africa – King Report on CG for SA 2016 (King IV Report);
Governance in SMEs 2017.
 USA – CG Principles for US Listed Companies 2017; Commonsense
Principles 2.0 2018. 44
OECD Corporate Governance Principles
 Organization for Economic Co-operation And
Development - 30.9.1961
◦ to achieve highest sustainable economic
growth + employment + rising standard of
living in member countries + contribute to
development of world economy;
◦ to contribute to sound economic expansion
in member + non-member countries in
economic development; and
◦ to contribute to the expansion of world
trade on multilateral +non-discriminatory
basis.
45
OECD Principles of Corporate Governance
 OECD Principles of Corporate Governance were issued
in 1999 and were last updated and renamed as
G20/OECD Principles of Corporate Governance
in 2015
◦ Ensuring the basis for an effective corporate
governance framework
◦ The rights and equitable treatment of shareholders and
key ownership functions
◦ Institutional investors, stock markets, and other
intermediaries
◦ The role of stakeholders in corporate governance
◦ Disclosure and transparency
◦ The responsibilities of the board
46
OECD Principles of Corporate Governance
 Initially aimed at Governments
◦ inter-governmental attempt to develop international

standards for corporate governance
 Provide guidelines on corporate requirements and

codes of conduct for :
◦ stock exchanges
◦ investors
◦ private corporations
◦ national commissions
47
Basel Corporate Governance Principles for Banks
 Principle 1 – Board’s overall responsibilities

 Principle 2 – Board qualifications and composition
 Principle 3 – Board’s own structure and practices
 Principle 4 – Senior management
 Principle 5 – Governance of group structures
 Principle 6 – Risk management function
 Principle 7 – Risk identification, monitoring and controlling
 Principle 8 – Risk communication
 Principle 9 – Compliance
 Principle 10 – Internal audit
 Principle 11 – Compensation
 Principle 12 – Disclosure and transparency
 Principle 13 – Role of supervisors
48
 General corporate governance literature
◦ direction, control+ ensure shareholders’ value
 Sir Ronald Hampel stated that:

◦ “ it is the board’s responsibility to ensure good governance and
to account to shareholders for their record in this regard”
◦ “the importance of corporate governance lies in its contribution
both to business prosperity and to accountability”
 Institute of Directors in Standards for the Board stated that:

◦ “the key purpose of the board is to ensure the company’s
prosperity by collectively directing its affairs and meeting the
legitimate interests of shareholders and other interested parties.”
49
 National Association of Pension Funds’ Report (UK)

1996 on good corporate governance
◦ board integrity
 ensure accounting + other statutory issues are

addressed
◦ enterprise
 encourage boards to drive businesses forward in

the long-term interests of the shareholders
50
Benefits of corporate governance practices
 Improved external financing
 Lower cost of capital
 Reduce the risks of crisis and scandals
 Improved oversight, monitoring and evaluation
 Anti-corruption tool  ethical behaviour
 Enhance operational performance, share performance

and firm valuation
 Effective decision-making
 Succession planning
51
References
 Goergen, M. International Corporate Governance, latest edition, England,
Pearson Education Limited.
 Tricker, B., Corporate Governance: Principles, Policies, and Practices, latest

edition, Oxford University Press.
 G20/OECD Principles of Corporate Governance
 Basel Corporate Governance Principles for Banks
 The UK Corporate Governance Code
 Code of Corporate Governance (Appendix 14), HK
 HKCGI module on Corporate Governance
 ICSA (now CGI) Study Text on Corporate Governance
 European Corporate Governance Institute (https://ecgi.global)

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Corporate Governance

• A corporation with good corporate governance

‘If management is about running business,

(Bob Tricker 1984)

 As per CR, ‘Boards of directors are responsible for

 Marc Goergen and Luc Renneboog’s (2006) CG

 “A corporate governance system is the combination of

 UK Company Law 2006 – ‘Directors should also

• The UK Corporate Governance Code 2018

Shareholder primacy theory

 As per Adam Smith, conflict of interests may exist

Michael Jensen and William Meckling formalised

 When the principal asks the agent to carry out a

 Asymmetric information is the cause of moral

 In practice, managers, who has the control, run the day-

 The main consequence of this problem is agency costs,

◦ monitoring expenses incurred by the principal;

◦ bonding costs accruing to the agents; and

 Monitoring expenses  principal observes agent, keeps

 Bonding costs  costs incurred by agent to signal

 Residual loss  loss incurred by principal since the

◦ Perquisites or perks : Benefits enjoyed by managers,

◦ Empire building: Managers pursue growth rather

 The principal–agent model is based on the Berle-

 Minority shareholders are expropriated by large

 Tunnelling: the large shareholder transfers the firm’s

 Transfer pricing: large shareholder overcharges the

• Large shareholder is the controlling shareholder in Firm A via an intermediary, a Holding

 Nepotism: the large family shareholder appoints family

 Infighting: may not be a form of expropriating the

 Being directors of a corporation, they act as stewards for their

 Stewardship theory assumes that directors do not act/make

 The theory emphasize board’s responsibility to maximize

 Enlightened Shareholder Theory

 Corporations could then make profits and enhance

Stakeholder value approach

Inclusive stakeholder approach

Enlightened shareholder value approach

only considered in so far as it would be in the interests of shareholders

to do so. The enlightened shareholder value approach is still in essence a

shareholder value approach. The views of other stakeholders are only

considered in so far as it would be in the interests of shareholders to do

 What is corporate governance?

 CG is a system of rules, processes, practices by which

 It sets out the relationship between the board of

Legislation + Common Law

Rule-based approach to corporate governance

Principle-based approach to corporate governance

 U.S.A. - in 1980’s - corporate takeover activities

 U.K. - corporate failures

 Common features of successful companies that fail

◦ dominant leader - combined roles

◦ limited presence of non-executive directors

◦ over-riding internal controls by chief executive

◦ Irregular board meetings

◦ inadequate management information systems

 The Committee issued the Report on Financial

 The Committee’s work initially limited to financial fraud

 CG - a system by which companies are directed +

 Directors are responsible for governance of a corporation

 Greenbury Code -effective 1995

 Hampel Committee - Sir Ronald Hampel

◦ inter-governmental attempt to develop international

 Provide guidelines on corporate requirements and

 Principle 1 – Board’s overall responsibilities

 Sir Ronald Hampel stated that: