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CORPORATE

GOVERNANCE

CHAPTER 1

What is Corporate Governance?


2

Deals with the problems arising fro


m the separation of ownership and
control.

Separation of Ownership and Control


3

The thousands, or more, investors who own


public limited corporations could not collect
ively make the daily decisions needed to op
erate a business. Therefore:
The shareholders are owners of the firm
The shareholders elect directors to act as their
agents in supervising the firm
The directors appoint officers (or executives) to
actually run the firm on a day-to-day basis

Separation of Ownership and C


ontrol
Ownership

Shareholders

Board

Control

Managemen
t
Employees

Focus of Corporate Governance


5

Shareholders elect directors who represent them.


Directors vote on key matters and adopt the majority decision
s.
Decisions are made in a transparent manner so that sharehold
ers and others can hold directors accountable.
Company adopts accounting standards to generate the inform
ation necessary for directors, investors and other stakeholders
to make decisions.

Principal-Agent Problem
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Principal-agent problem represents the confli


ct of interest between the principal and the a
gent.

Primary principal-agent problem in corporatio


ns: Principal = Shareholders
Age
nt = Officers
If shareholders cannot effectively monitor the o
fficers behavior, then officers may be tempted t
o use firms assets for their own personal use.

Solutions to Principal-agent problem


7

Incentivesaligning executive incentives with


shareholder desires.
Monitoringsetting up mechanisms for moni
toring the behavior of managers.

Can Shareholders Influence Managers?


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Shareholders do not directly hire/fire manage


rs so they cant vote to replace them
Shareholders can influence managers indirect
ly through the board of directors
Changing board members can be difficult as
management controls the process and some i
nactive shareholders will go along with whate
ver management wants.
Some active shareholders are large enough
to try and influence management or change t
he board, but they are often met with defeat.

Monitors
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Monitors are called for because managers


may not act in the shareholders best inter
est.
Figure 1.1 shows that monitors exist:

inside the corporate structure


Board of directors

outside the structure


Auditors, analysts, bankers, credit rating agencies, and attorneys

in government
SECP, FBR

Figure 1.1
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Inside monitors-Board of direct


ors

Oversee management and are supposed to re


present shareholders interests.
Evaluates management and design compensa
tion contracts to tie managements salaries to
the firms performance.

Outside monitors
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Interact with the firm and monitor manager a


ctivities

Auditors
Analysts
Bankers
Credit rating agencies
Attorneys

Government monitors
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The SECP regulates public firms for the protec


tion of public investors
The SECP also makes policy and prosecutes vi
olators in civil courts.

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Governance is more than just Boar


d Processes and Procedures

It involves the full set of Relationship between

a companys management
Its Board
Its Shareholders
Its other stakeholders

One size doesnt fit all. The Board Objectives and Proce
dures may be the same to all societies but when it com
es to applying them to individual countries we have to r
eckon the peculiar, socio-cultural characteristics, the hi
story of its people, their value systems, their economic
system, etc.

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Corporate Governance Guidelin


es

Most worldwide organizations have strongly p


romoted good corporate governance by appli
cation of the following corporate governance
guidelines:

1. Rights of shareholders
2. Equitable treatment of shareholders
3. Role of stakeholders in corporate governance
4. Disclosure and transparency
5. Responsibilities of the board

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Corporate Governance Guidelin


es

1. Rights of shareholders

All shareholders must be given their due rights i.


e. They all should have
Secured

ownership of their shares


Voting rights
Right to full disclosure of information
participation on decisions on sale or change in corpo
rate assets or new share issues
Capital structure must be disclosed
All transactions should be at transparent prices and u
nder fair conditions

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Corporate Governance Guidelin


es

2. Equitable treatment of shareholders


All

shareholders should have equal opportunity for r


edressal of the violation of their rights
Insider trading should be prohibited

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Corporate Governance Guidelin


es

3. Role of stakeholders in corporate governan


ce

Corporate governance framework apart from the


rights of shareholders allow
Employees

representation on BOD
Profit sharing
Creditors involvement in insolvency proceedings

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Corporate Governance Guidelin


es

4. Disclosure and transparency

Financial details, operating results, policies, gove


rnance structure should be disclosed
Annual audits should be performed by independ
ent auditors

When in

oubt
isclose

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Corporate Governance Guidelin


es

5. Responsibilities of the board

Board is responsible for


Protecting

the company, its shareholders and other s


takeholders
Making policies, strategies
Monitoring effectiveness

McKinseys Two-Version Governance Chain


Models
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Model 1: Market Model


In Market Model governance chain, there are
efficient, well-developed equity markets and
dispersed ownership.
Model 2: Control Model

In Control Model governance chain is represented by


underdeveloped equity markets, concentrated(famil
y) ownership, less shareholder transparency and ina
dequate protection of minority and foreign sharehol
ders.

Market Model Governance Chai


n
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More common in US, UK, Canada & Australia

Shareholder environment

Institutional
Context

Dispersed
Sophisticatownership
ed
institution
al
ownership
Active
equity
market
Active
takeover
market

Capital Market Liquidity

Independence & Performance


Nonexecutive
Majority
Aligned
Boards
incentive
s
High
disclos
ure

Corporate
Context

Sharehold
er equality

Transparency & Accountability

Control Model Governance Cha


in
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More common in Asia, Latin America, parts of Europe

Shareholder environment

Institutional
Context

Concentrat
ed
Reliance
ownership
on family,
bank,
public
finance
Under
developed
new issue
Limited
market
takeover
market

Capital Market Liquidity

Independence & Performance

Incentives
aligned
with core
shareholde
rs
Limited
disclos
ure
Inadequat
e minority
protection

Insider
boards

Corporate
Context

Transparency & Accountability

Corporate Governance Concerns


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1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Management Accountability
Providing Adequate Incentives To Management
Disciplining & Replacement Of Bad Management
Enhancing Corporate Performance
Transparency
Shareholder activism
Enhancing Protection
Improving Access To Capital Markets
Promoting Long-Term Investment
Encouraging Innovation

Issues in Corporate Governanc


e

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Corporate Governance conveys different meanings to different people. But


to all, corporate governance is a mean to an end, the end being long-term s
hareholder value and more importantly stakeholder value. All authorities h
ave identified some governance issues being crucial and critical to achieve
these objectives. These are:
1.

Distinguishing the role of Board & Management

2.

Composition of Board & related issues

3.

Separation of the roles of CEO & chairperson

4.

Should the board have committees?

5.

Appointments to the board & directors re-election

6.

Directors and executives remuneration

7.

Disclosure & audit

8.
9.
10.

Protection of shareholders rights & their expectations


Dialogue with institutional shareholders
Should investors have a say in making a company socially responsible corporate
citizen

Issues in Corporate Governance


1. Distinguishing the role of Board & Management
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Board of the company has following functions:

Select, decide the remuneration & evaluate on regular basis and when necessary
change the CEO.

Oversee indirectly the conduct of companys business

Review and approve the companys financial objective if necessary

Render advice & counsel to the top management

Recommending candidates to the shareholders for electing them to BOD

Review the adequacy of systems to comply with all laws and regulations

All other functions required by law to be performed

Issues in Corporate Governance


2. Composition of Board & related issues
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BOD is a committee elected by shareholders. Sometimes, full-t


ime functional directors are appointed, each being responsible
for some particular branch of the firms work.

Issues in Corporate Governance


3. Separation of the roles of CEO & chairperson
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Combining the role of chairperson with that o


f the CEO leads to conflict in decision making
and too much concentration of power in one
person resulting in unhealthy consequences.
The role of CEO is to lead the senior manage
ment team in managing the enterprise, while
The role of chairperson is to lead the board to
evaluate the performance of senior executive
s including the CEO.

Issues in Corporate Governance


4. Should the board have committees?
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Following committees if made would lessen t


he burden of the board and enhance its effec
tiveness:

Nomination
Remuneration
Auditing

Issues in Corporate Governance


5. Appointments to the board & directors re-electi
on

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The board or its specially constituted committ


ee selects and appoints the prospective direct
or and gets the person formally elected by th
e shareholders at AGM.

Issues in Corporate Governance


6. Directors and executives remuneration
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Shareholders are entitled to a full and clear st


atement of Directors recent and future benef
its and how they have been determined.
Remuneration committee must be appointed
for this task.

Issues in Corporate Governance


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7. Disclosure & audit


8. Protection of shareholders rights & their exp
ectations
9. Dialogue with institutional shareholders
10. Should investors have a say in making a co
mpany socially responsible corporate citizen

Need & Importance for Corporate Governan


ce
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Corporate governance is needed to create a c


orporate culture of consciousness, transparen
cy and openness.
It refers to the combination of laws, rules, reg
ulations, procedures and voluntary practices t
o enable companies to maximize shareholder
s long-term value.
It should lead to increasing customer satisfact
ion, shareholder value and wealth

Governance & Corporate Performance


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There is a positive relationship between corpo


rate governance and corporate performance.
Improved corporate governance is linked with
improved corporate performance either in ter
ms of rise in share price or profitability.

Investors Preference for Good Govern


ance

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Majority of investors (institutional) consider g


overnance practices to be at least as importa
nt as financial performance, when they evalua
te companies for potential investment.
They are prepared to pay a premium for shar
es in a well-governed company as compared t
o a poorly governed one exhibiting similar fin
ancial performance.

Benefits of Good Corporate to a Corporation


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1. Creation & enhancement of a corporations compet


itive advantage
2. Enabling a corporation perform efficiently by preve
nting fraud & malpractices
3. Providing protection to shareholders interest
4. Enhancing the valuation of an enterprise
5. Ensuring compliance of laws and regulations (BCCI)

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