Corporate Governance Lecture 5

International Corporate Governance Framework

• OECD Corporate Governance Framework
• US Corporate Governance Framework
• UK Corporate Governance Framework
• German Corporate Governance Framework
 OECD Corporate Governance Principles

 OECD Principles first developed in 1999, then revised in 2004 and

2015

 The OECD principles are not prescriptive or binding, but just a form of
recommendations that provides the broad framework of corporate
governance for countries to emulate taking into account their unique
culture, and regulatory and legislative systems.

 The OECD principles of corporate governance, which were originally

adopted by the thirty member countries of the OECD.

 The Principles have a proven record as an international reference

point and as an effective tool for implementation

 The principles are broadly divided into 6 sections with detailed

guidelines for effective corporate governance.
OECD Corporate Governance Principles

I.Ensuring the Basis for an Effective Corporate Governance

Framework

 The corporate governance framework should promote transparent

and fair markets and the efficient allocation of resources.

 focuses on the quality and consistency of the different elements of

regulations that influence corporate governance practices and the
division of responsibilities between authorities.

 new emphasis is placed on the quality of supervision and

enforcement.

 New principle on the role of stock markets in supporting good

corporate governance
 OECD Corporate Governance Principles

II. The rights and equitable treatment of shareholders and key ownership
functions

 The corporate governance framework should protect and facilitate the

exercise of shareholders’ rights and ensure the equitable treatment of all
shareholders, including minority and foreign shareholders.

 All shareholders should have the opportunity to obtain effective redress for
violation of their rights.

 Focuses on basic shareholder rights, including the right to information and

participation through the shareholder meeting in key company decisions.

 Also deals with disclosure of control structures, such as different voting rights.

 New issues in include the use of information technology at shareholder

meetings, the procedures for approval of related party transactions and
shareholder participation in decisions on executive remuneration.
 OECD Corporate Governance Principles

III. Institutional investors, stock markets, and other intermediaries

 The corporate governance framework should provide sound incentives
throughout the investment chain and provide for stock markets to
function in a way that contributes to good corporate governance.

 New principle with a particular focus on institutional investors acting in

a fiduciary capacity.

 Highlights the need to disclose and minimize conflicts of interest that

may compromise the integrity of proxy advisors, analysts, brokers,
rating agencies and others that provide analysis and advice that is
relevant to investors.

 New principles with respect to cross border listings and the importance
of fair and effective price discovery in stock markets.
OECD Corporate Governance Principles

IV. The role of stakeholders in corporate governance

 The corporate governance framework should recognise the rights of
stakeholders established by law or through mutual agreements and

 encourage active co-operation between corporations and

stakeholders in creating wealth, jobs, and the sustainability of
financially sound enterprises.
• Supports stakeholders’ access to information on a timely and regular
basis and their rights to obtain redress for violations of their rights.
OECD Corporate Governance Principles

V. Disclosure and transparency

• The corporate governance framework should ensure that
timely and accurate disclosure is made on all material
matters regarding the corporation, including the financial
situation, performance, ownership, and governance of the
company.
• Key areas of disclosures include such as the financial and
operating results, company objectives, major share
ownership, remuneration, related party transactions, risk
factors, board members, etc.
• New areas include the recognition of recent trends with respect to
items of non-financial information that companies on a voluntary
basis may include, for example in their management reports.
 OECD Corporate Governance Principles

VI. The responsibilities of the board

• The corporate governance framework should ensure the strategic
guidance of the company, the effective monitoring of management
by the board, and the board’s accountability to the company and
the shareholders.
• Includes guidance with respect to key functions of the board of directors,
including the review of corporate strategy, selecting and compensating
management, overseeing major corporate acquisitions and divestitures,
and ensuring the integrity of the corporation’s accounting and financial
reporting systems.
• New issues include the role of the board of directors in risk management,
tax planning and internal audit.
• New principle recommending board training and evaluation and a
recommendation on considering the establishment of specialized board
committees in areas such as remuneration, audit and risk management
 UK Corporate Governance Framework – Brief Overview

• The UK corporate governance system is guided by statutory

legislation, common law, code of practices and market guidance.

• The UK Companies Act 2006 sets legal foundation for the functioning
of the companies, well augmented and supported by Listing Disclosure
and Transparency Rules of Financial Services Authority (FSA)

• The UK Corporate Governance Code (revised and renamed from

Combine Code, from May 28 2010) sets out the standard of good
practice for all listed companies

• Financial Reporting Council takes care of UK Corporate Governance

Code
 UK Corporate Governance Code 2018 Brief Overview

• The first version of the UK Corporate Governance Code (the Code)

was published in 1992 by the Cadbury Committee.

• Over the years the Code has been revised and expanded to take
account of the increasing demands on the UK’s corporate governance
framework.

• Nevertheless, the debate about the nature and extent of the framework
has intensified as a result of financial crises and high-profile examples
of inadequate governance and misconduct, which have led to poor
outcomes for a wide range of stakeholders.

• UK CG code revised in 2018 from an earlier 2016 version

 UK Corporate Governance Code 2018 Brief Overview
• At the heart of this Code is an updated set of Principles that emphasise the
value of good corporate governance to long-term sustainable success.

• By applying the Principles, following the more detailed Provisions and using
the associated guidance, companies can demonstrate throughout their
reporting how the governance of the company contributes to its long term
sustainable success and achieves wider objectives.

• These operate on a ‘comply or explain’ basis and companies should avoid a

‘tick-box approach’. An alternative to complying with a Provision may be
justified in particular circumstances based on a range of factors, including the
size, complexity, history and ownership structure of a company.

• The Code does not set out a rigid set of rules; instead it offers flexibility through
the application of Principles and through ‘comply or explain’ Provisions and
supporting guidance.

• It is the responsibility of boards to use this flexibility wisely and of investors and
their advisors to assess differing company approaches thoughtfully.
 UK Corporate Governance Code 2018 – Principles

1 BOARD LEADERSHIP AND COMPANY PURPOSE

A. A successful company is led by an effective and entrepreneurial board,

whose role is to promote the long-term sustainable success of the
company, generating value for shareholders and contributing to wider
society.

B. The board should establish the company’s purpose, values and

strategy, and satisfy itself that these and its culture are aligned.

All directors must act with integrity, lead by example and promote the
desired culture.
 UK Corporate Governance Code 2018 – Principles

1 BOARD LEADERSHIP AND COMPANY PURPOSE

C. The board should ensure that the necessary resources are in place for
the company to meet its objectives and measure performance against
them. The board should also establish a framework of prudent and
effective controls, which enable risk to be assessed and managed.

D. In order for the company to meet its responsibilities to shareholders

and stakeholders, the board should ensure effective engagement with,
and encourage participation from, these parties.

E. The board should ensure that workforce policies and practices are
consistent with the company’s values and support its long-term
sustainable success. The workforce should be able to raise any matters
of concern.
 UK Corporate Governance Code 2018 – Principles
2 DIVISION OF RESPONSIBILITIES

F. The chair leads the board and is responsible for its overall effectiveness
in directing the company.

They should demonstrate objective judgement throughout their tenure and

promote a culture of openness and debate. In addition, the chair facilitates
constructive board relations and the effective contribution of all non-
executive directors, and ensures that directors receive accurate, timely and
clear information.

G. The board should include an appropriate combination of executive and

non-executive (and, in particular, independent non-executive) directors,
such that no one individual or small group of individuals dominates the
board’s decision-making.

There should be a clear division of responsibilities between the leadership

of the board and the executive leadership of the company’s business.
 UK Corporate Governance Code 2018 – Principles

2 DIVISION OF RESPONSIBILITIES

H. Non-executive directors should have sufficient time to meet their board

responsibilities.

They should provide constructive challenge, strategic guidance, offer

specialist advice and hold management to account.

I. The board, supported by the company secretary, should ensure that it

has the policies, processes, information, time and resources it needs in
order to function effectively and efficiently.
 UK Corporate Governance Code 2018 – Principles

3 COMPOSITION, SUCCESSION AND EVALUATION

J. Appointments to the board should be subject to a formal, rigorous and
transparent procedure, and an effective succession plan should be maintained
for board and senior management.
Both appointments and succession plans should be based on merit and objective
criteria and, within this context, should promote diversity of gender, social and
ethnic backgrounds, cognitive and personal strengths.
K. The board and its committees should have a combination of skills, experience
and knowledge.
Consideration should be given to the length of service of the board as a whole and
membership regularly refreshed.
L. Annual evaluation of the board should consider its composition, diversity and
how effectively members work together to achieve objectives. Individual
evaluation should demonstrate whether each director continues to contribute
effectively.
 UK Corporate Governance Code 2018 – Principles

4 AUDIT, RISK AND INTERNAL CONTROL

M. The board should establish formal and transparent policies and

procedures to ensure the independence and effectiveness of internal and
external audit functions and satisfy itself on the integrity of financial and
narrative statements.

N. The board should present a fair, balanced and understandable

assessment of the company’s position and prospects.

O. The board should establish procedures to manage risk, oversee the

internal control framework, and determine the nature and extent of the
principal risks the company is willing to take in order to achieve its long-
term strategic objectives.
 UK Corporate Governance Code 2018 – Principles

5 REMUNERATION

P. Remuneration policies and practices should be designed to support strategy

and promote long-term sustainable success.

Executive remuneration should be aligned to company purpose and values, and

be clearly linked to the successful delivery of the company’s long-term strategy.

Q. A formal and transparent procedure for developing policy on executive

remuneration and determining director and senior management remuneration
should be established.

No director should be involved in deciding their own remuneration outcome.

R. Directors should exercise independent judgement and discretion when

authorising remuneration outcomes, taking account of company and individual
performance, and wider circumstances..
 Key Provisions of the Code

• Position of Chairman and Chief Executive officer (CEO) should be held by

different persons, and with clear demarcation of responsibilities between these
two positions;
• Chairman to be an independent director;
• Balance of executive and non –executive directors on the board; at least half
the board, excluding the chairman, comprised non-executive to be independent
directors.
• A smaller company to have at least two independent non-executive directors;
• A designated senior independent director to provide a sounding board for the
Chairman, and to serve as an intermediary for the other directors when
necessary;
• Full-time executive directors should not take on more than one non-executive
directorship in a FTSE 100 company or other significant appointment.
 Key Provisions of the Code

• Separate executive sessions of non-executive directors;

• Annual evaluation of Board, its committees and individual directors;
• A nomination committee with a majority of independent directors and
independent chair to assure transparency in the board appointment process;
• An independent remuneration committee to look after compensation of both
executive and non-executive directors;
• An independent audit committee to look after audit process, liaison with
auditors and ensuring integrity of financial reports
 Key Changes in UK Code After 2008 Crisis

• New provisions on board diversity, which encourages companies to

make appointments to the Board, based on merit, against objective
criteria and with due regard for the benefits of diversity on the board,
including gender;
• More responsibility to the chairman of the board- made responsible for
ensuring that the directors receive accurate, timely and clear
information. The chairman should ensure effective communication with
shareholders;
• Non-executive director also made responsible to provide for
constructive challenge, with commitment on time expectation;
• Board evaluation of FTSE 350 Companies should be externally
facilitated
 Key Changes in UK Code After 2008 Crisis

• Board evaluation of FTSE 350 Companies should be externally

facilitated at least once every three years;
• All the directors of FTSE 350 should be subject to annual re-election;

• The business model of the company should be explained in the annual

report, and the board should be responsible for determining the nature
of the risk it is willing to take in pursuit of its strategy.
• The performance-related executive directors’ remuneration should be
stretched and designed to promote the long-term success of the
company, commensurate with its risk policy.
 US Corporate Governance Framework - Brief Overview

• The corporate governance in the US is guided by the state corporate law

(predominately , Delaware State Laws, the state in which most of the US
companies are registered), the Securities Act 1933, the Securities Exchange
Act 1934, provisions of the SEC, and the stock exchange listing rules,
particularly that of the NYSE and NASDAQ.
• The state law creates enabling statues that establish minimum conditions for the
functioning of the corporations, and enforces the fiduciary responsibility of the
directors and management and rights of shareholders of the company.
• The SEC (a centralized regulatory agency-) has full authority in regulating
securities law and regulations.
• institutional investors like CalPERS, TIAA-CREF (the Teachers Insurance and
Annuity Association College Retirement Equities Fund) and the Council of
Institutional Shareholders also significantly influence the corporate governance of
the companies, in which they invest.
 US Corporate Governance Framework - Brief Overview

The listed companies in the US are guided by listing requirements of the NYSE
and NASDAQ. The major highlights of listing requirements include :
• Boards of company to have a majority of independent directors;
• Stringent norms for director independence;
• Regular executive session of independent directors without the presence of
management directors;
• Regular board and Committee evaluation;
• Nominating/ governance committee, compensation committee and audit
committee to publish charter, detailing the responsibilities performed by them;
• CEO certification of compliance with corporate governance standards;
• Annual publication and certification of code of ethics by CEO;
• Disclosure requirements in the annual reports with compliance with corporate
governance requirements.
 The Sarbanes–Oxley (SOX) Act of 2002

• Establishment of the Public Company Accounting Oversight Board

(PCAOB) to govern and enforce the accounting standards, and
monitor the activities of “auditing firms”.
• SOX section 301 mandates that all public corporations must have an
audit committee comprised exclusively of independent directors;
• Section 201 forbids accounting companies from providing a number of
non-audit services to public corporations they audit;
• Section 402(a) prohibits loans by corporations to their executives;
• Sections 302 and 906 require the chief executive officer (CEO) and
chief financial officer (CFO) to certify their firm’s SEC filings;
• Section 409 requires the monitoring of operational risk and the real-
time reporting of material events;
 The Sarbanes–Oxley (SOX) Act of 2002

• Sections 802 and 906, important, both introduce significant legal

sanctions for non-compliance (the ‘do or die’ aspect of the US
corporate governance framework);
• Section 806 is also important in its own aspect as it gives, protection
for ‘whistle-blowers’.
• Section 404 (a) requires the issuer of financial statements to include
internal controls in their annual reports,
• Section 404 (b) requires an auditor to confirm and report on
management assessment made under section 404 (a) as a part of the
audit
• Section 404 tremendously increased compliance costs for all the
companies without giving due consideration to smaller companies.
Corporate Governance Provisions of Dodd-Frank Act

• Board Leadership Structure (Section 972) - Companies in their annual to

disclose whether the same person, or different persons, holds the positions of
CEO and chairman. In both cases, companies have to disclose reasons for
adopting such leadership structure.
• Proxy Access rule (Section 971) - Permits the SEC to adopt proxy access
(which SEC adopted on August 25, 2010). Under new rule 14a-11 of the SEC,
limited only to large companies, shareholders are empowered to nominate
candidate for board positions in the companies. Shareholders who own at least
3 % of the company’s shares and have done so continuously for at least the
prior three years may put forward their claim on one nominee position or up to
25 % of the company’s board of directors, whichever is greater.
• Independent Compensation Committees (Section 952) - Mandates
changes in the listing standards requirement of self-regulatory organizations
(SROs) through SEC requiring, each member of the compensation committee
to be independent and enabling the committee to seek the services of outside
compensation consultants.
Corporate Governance Provisions of Dodd-Frank Act

• Clawback Policy on Executive (Section 954) - Mandates SEC

( through inclusion of new Section 10D to the Securities Exchange Act)
to adopt rules on claw-back of executive compensation in cases of the
financial restatements.
• Say-on-Pay (Section 951) - Mandates SEC (through new section 14A
of the Securities Exchange Act) to require companies to compulsory
conduct a shareholder advisory vote on specified executive
compensation not less frequently than every three years and at least
once every six years, shareholders must vote on how frequently to
hold such an advisory vote .
• Pay Disclosure (Section 953) - Companies in their annual proxy
statement to disclose the relationship between executive
compensation and financial performance. Further disclosure on the
internal pay equity (median of total compensation of all employees
excluding CEO, the compensation of the CEO and ratio of two)
German Corporate Governance Framework - Brief Overview

The German corporate governance regime relies both on the statutory laws and
non-binding corporate governance code to guide listed firms as a social entity
situated within consensus based social market economy
Relevant statutory laws in Germany that regulate corporate governance aspect of
listed entities
• Stock Corporation Act – entails mandatory framework for organization of
stock corporations. It also sets the rights and responsibilities of the corporate
bodies, the management board, the supervisory board and the shareholders
and provisions for conducting the shareholder meeting.
• Securities Trading Act – contains rules regarding the disclosure of affecting
share price of corporations, and rules prohibiting insider trading.
• Commercial Code- among many other things contains accounting rule
applicable to corporations.
• Co-determination and One-Third Participation Act- granting employee right
to sit on the Supervisory Board of companies.
 German Corporate Governance Code

• The German Corporate Governance Code presents both statutory regulation

and standards of corporate governance for all the listed companies.
• The code is based on the “comply or explain” principle, similar to that of the UK
system, where listed companies have to explain if do not follow some specific
recommendations.
• Different from the other voluntary system in the sense that the statement of
compliance with the Code in Section161 of the German Stock Corporation Act,
gives it a statutory recognition.
• It sets statutory responsibility on the Supervisory Board and Management
Board of all listed German corporations to state whether they have complied
the code or to provide an explanation in case of non-compliance.
• This declaration is required on the annual basis and made available to the
shareholders at all times.
German Corporate Governance Code

• The German Corporate Governance Code features both

“recommendations” and “suggestions”, and sets aside the clear
distinction between them.
• While recommendations are marked by the usage of the word “shall”,
suggestions of the code include words such as “should” or “can”.
• Companies can deviate from the recommendations of the code, but
with the obligation of disclosure of such deviation.
• Suggestions included in the code are not obligatory for companies,
and as such require no disclosure.
• Any other feature of the German Corporate Governance Code, not
marked by “recommendations” or “ suggestions” are mandatory for all
the listed companies under the given statutory law.
German Corporate Governance – Board Structure

• A two tier board structure is stipulated for stock corporations that

consist of the Management Board and the Supervisory Board.
• The Management Board is directly responsible for managing the
enterprise and its Chairman coordinates the work of the Management
Board.
• The Supervisory Board appoints, supervises and advises the members
of the Management Board, and has responsibility for taking decisions
that are of fundamental importance to the enterprise.
• The members of the Supervisory Board are elected by the
shareholders at the Annual General Meeting.
German Corporate Governance – Board Structure

• In Germany, employee co-determination on Supervisory Board is

permitted under the statutory law mentioned above.
• For corporations with more than 500 employees, the One-Third,
Participation Act provides that at least one-third of members of the
Supervisory Board must be employee representatives.
• In companies with more than 2000 employees, half of the Supervisory
Board must be comprised of employee representatives under the
stipulation of the Co - Determination Act.
• The Chairman of the Supervisory Board (for companies having more
than 2000 employees) is essentially selected for shareholders, and
only can cast vote in case of split resolution.
• Both shareholder and employee representatives on the Supervisory
Board are equally obliged to fulfill their responsibilities in the
corporation’s best interest.
German Corporate Governance Code

German Corporate Governance Code are presented, which are classified

into six sections, namely :
Shareholder and the General Meeting, Cooperation between
Management Board and Supervisory Board, Management Board,
Supervisory Board, Transparency, Reporting and Audit of the
Financial Statements

• The Chairman of the Supervisory Board should not be Chairman of the

Audit Committee, and should act as the first point of contact with the
Management Board.
• Supervisory Board to contain an adequate number of independent
directors to permit independent advice to the Management Board.
German Corporate Governance Code

• An Audit Committee with responsibility on issues of accounting, risk

management and compliance, auditor independence, audit mandate, and
auditor fees. Chairman to have specialist knowledge of accounting principles
and internal control controls
• A nomination committee comprised only of shareholder representatives for
selection of the candidates to the supervisory board
• Compensation of the management board includes both fixed and variable
components and is approved by the Supervisory board
• Immediate disclosure of insider information and change in the shareholding of
an individual owning company share (as per specified limit). Disclosure of
share ownership by Management and Supervisory Board, if it exceeds 1% of
shares issued by the company
• Disclosure of information on stock options and other incentive-based systems
in the corporate governance reports
• Disclosure of related parties in the consolidated financial statements
Developments after 2008 Crisis

The German Bundestag in June 2009 promulgated a new law, “Appropriateness

of the Executive Compensation” that has hosted significant changes for
governance of the listed companies.
• Members of the management board can only be appointed to the supervisory
board after two years of their retirement from the management board
• Full supervisory board to be responsible for the remuneration of the CEO, and
not just the remuneration committee
• Exercise of the stock option only after four years
• Restriction on the usage of “ Directors and Officers Liability Insurance”
• Non-binding shareholder advisory on the executive compensation
• Authorization to the supervisory board to link executive compensation with
company financial performance
Developments after 2008 Crisis

• The German Corporate Governance Code has also undergone several

changes.
• The obligation of the Management Board and the Supervisory Board to ensure
the continued existence of enterprise and its sustainable of value in conformity
with the principles of the social market economy (interest of the enterprise)”
• New law weights on aligning remuneration practices with wider stakeholder
interests with a view to the long-term sustainability of the company.
 Focus on board diversity of management board including
consideration of women;
 Composition of the supervisory board in line with the concrete objective of
the company (taking into account company activities, conflict of interest,
age limit and diversity – female representation). Disclosure of this is
required in the corporate governance report;
 Executive compensation norms