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CORPORATE GOVERNANCE PART 1

Learning Outcomes

By the end of these slides the student should be able to:

Define corporate governance and its aims

List the parties involved in corporate governance

Assess the importance of corporate governance

Explain “Carbery’s” recommendations of good governance

Describe the Agency Problem

Evaluate what constitutes good corporate governance

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  • Good business ethics is a prerequisite for good strategic management

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The Emergence of Corporate Social Responsibility (CSR)

Companies have responded to increasing expectations by advocating what is now a common term in business: Corporate Social Responsibility (CSR)

Most large companies now feature CSR reports, managers, departments, and the subject is increasingly promoted as a core area of management - next to marketing & accounting

Crane, Matten & Spence (2008)

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Who determines a good business ethics or CSR Agenda?

Government: the law makers?

Business ethics begins where the law ends

The ‘strategists’: CEO, CSO, CFO, managers

Core values, beliefs ‘embedded’ in organization

Business ‘code of ethics’ (Banking, Media, Food Industry)

Board of Directors

Corporate Governance

Duties & Responsibilities

Stakeholders

Consumers/pressure groups/local community/Media

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Who is Responsible for Ethics / CSR?

Leadership & Management Issues

CEO / Strategists

Code of business ethics:

  • Provides basis on which policies can be devised to guide daily behavior and decisions in the workplace

  • CEO & Management responsible for implementation

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Who else is responsible for Ethics / CSR? Governance Issues

Board of Directors Roles & Responsibilities

  • Control & oversight over management
  • Adherence to legal prescriptions
  • Consideration of stakeholder interests
  • Advancement of stockholder rights

Is ‘being ethical’ good for business?

Is it possible to be both profitable and responsible?

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For CSR we need good Corporate Governance.

Corporate Governance Definitions…

  • The way in which organizations are directed and controlled

Cadbury (1992)

  • The process by which corporations are made responsive to the rights and wishes of stakeholders

Demb and Neubauer (1992)

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Definition of Corporate governance

  • “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders ..also the structure through which objectives of the company are set, and the means of achieving those objectives and monitoring performance are determined.”
  • Focused on preventing corporate collapses such as Enron collapse.
  • https://www.youtube.com/watch?v=e5qC1YGRMKI&list=PL3_x0CVc7rFnu_PEXAizujCZyDnyaiLhr

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Corporate governance

Corporate Governance aims :

Define relationships between a company’s management, its board, shareholders and other stakeholders.

Provide a structure through which the company’s objectives are set, and how they are achieved and monitored.

Recognize the value of business ethics and corporate awareness of society interests to reputation and long-term success.

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Why Corporate Governance?

Better access to external finance.

Lower costs of capital – interest rates on loans.

Improved company performance – sustainability.

Higher firm valuation and share performance.

Reduced risk of corporate crisis and scandals.

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Corporate Governance

  • Contemporary corporate governance started in 1992 with the Cadbury report in the UK.
  • Cadbury was the result of several high-profile company collapses.
  • Sir George Adrian Cadbury was a Director of the Bank of England from “1970–1994” and of IBM from “1975-1994”. He was Chairman of the UK Committee on the Financial Aspects of Corporate Governance which published its Report and Code of Best Practice ("Cadbury Report and Code") in December 1992.
  • https://www.youtube.com/watch?v=ZfC7ykLKy4M

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Cadbury Report 1992

  • The Cadbury Report: titled Financial Aspects of Corporate Governance, is a report of a committee chaired by Adrian Cadbury that sets out recommendations on the arrangement of company boards and accounting systems to lessen corporate governance risks and failures.
  • The report was published in 1992. The report's recommendations have been adopted in varying degree by the European Union, the United States, the World Bank, and others.

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Cadbury Report Recommendations

Wider use of independent directors.

Introduction of audit committee.

Separation between Chairman and CEO.

Loyalty to detailed code of best practices.

Protect rights of Shareholders.

Recognize the rights of Stakeholders.

Timely and accurate Disclosure.

Responsibility of the Board of directors.

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Corporate Governance Parties

Shareholders : those that own the company.

Directors : Guardians of the Company’s assets for the Shareholders.

Managers: who use the company’s assets.

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Who else is responsible for Ethics / CSR? Governance Issues

Board of Directors Roles & Responsibilities

  • Control & oversight over management
  • Adherence to legal prescriptions
  • Consideration of stakeholder interests
  • Advancement of stockholder rights

Is ‘being ethical’ good for business?

Is it possible to be both profitable and responsible?

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Managing the Relationship Between Shareholders, Board and Management

Shareholders

Board of Directors

Management

Companies Act and other rules and regulations

Contract

Corporate Governance

The Growth of Modern Corporations

The ‘Agency Problem’

  • The agency problem arises because of the separation between ownership of an organization and its control

  • The agency problem is inherent in the relationship between the providers of capital, referred to as the ‘principal’, and those who employ that capital referred to as the ‘agent’.

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Corporate Governance
(Jensen & Meckling 1976)

The ‘Agency Problem’

  • Agency problems occur because no contract, however precisely drawn, can possibly take account of every conceivable action that an agent may engage in

  • How do you ensure that the agent will always act in the best interest of the principal?

  • ‘Agency costs’ occur where there is a divergence between these interests

Hence original purpose of Board of Directors

How are such issues addressed?

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Directors Roles & Responsibilities
BusinessWeek’s ‘Principles of Good Governance’

  • No more than 2 directors are current or former company executives
  • No directors do business with the company
  • Each director owns a large equity stake in the company
  • At least one outside director with extensive experience
  • Each director attends at least 75% of all meetings
  • Board is frugal on executive pay, diligent in CEO succession, and prompt to act when trouble arises
  • CEO is not also the chairperson of the board
  • Shareholders have considerable power and information to
    choose & replace directors

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Four Principals of Corporate Governance

Accountability.

Fairness.

Transparency.

Independence.

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1. Accountability

  • Ensure that management is accountable to the Board of Directors.

  • Ensure that the Board of Directors is accountable to shareholders.

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2. Fairness

  • Protect Shareholders rights.

  • Treat all shareholders including minorities, equitably.

  • Provide effective redress for violations.

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3. Transparency

Ensure timely, accurate disclosure on all material matters, including the financial situation, performance, ownership and corporate governance.

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4. Independence

  • Independent Directors and Advisers i.e. free from the influence of others.

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Elements of Corporate Governance

Good Board practices.

Control Environment.

Transparent Disclosure.

Well-defined shareholder rights.

Board Commitment.

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1. Good Board Practices

Clearly defined roles and authorities.

Duties and responsibilities of Directors understood.

Board is well structured.

Appropriate work and mix of skills.

Appropriate Board procedures.

Director compensation in line with best practice.

Board self-evaluation and training conducted.

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2. Control Environment

Internal control procedures.

Risk management framework present.

Disaster recovery systems in place.

Media management techniques in use.

Business stability procedures in place.

Independent external auditor conducts audits.

Independent audit committee established.

Internal Audit Function.

Management Information systems established.

Compliance Function established.

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3. Transparent Disclosure

Financial Information disclosed.

Non-Financial Information disclosed.

Financials prepared according to International Financial Reporting Standards (IFRS).

Companies Registry filings up to date.

High-Quality annual report published.

Web-based disclosure.

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4. Well-Defined Shareholder Rights

Minority shareholder rights formalized.

Well-organized shareholder meetings conducted.

Policy on related party transactions.

Policy on extraordinary transactions.

Clearly defined and explicit dividend policy.

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5. Board Commitment

The Board discusses corporate governance issues and has created a corporate governance committee.

The company has a corporate governance champion.

Appropriate resources are committed to corporate governance initiatives.

Policies and procedures have been formalized and distributed to relevant staff.

A corporate governance code has been developed.

The company is recognized as a corporate governance leader.

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Corporate Governance & CSR?

The Purpose of Corporations?

To maximise shareholder value

‘In a free enterprise, private property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible…’

Milton Friedman (1970)

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Corporate Governance & CSR

The Purpose of Corporations?

To meet the needs of stakeholders

Stakeholders are individuals or groups that affect or are affected by the achievement of an organization’s objectives

Edward Freeman (1984)

eg., shareholders, customers, suppliers, employees, government, local community, media…

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Evaluating Corporate Responsibility

The Pyramid of CSR

Archie Carroll (1991)

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Organisations and Ethical Choice

Key question…

Should a business prioritise shareholder value or stakeholder needs?

Shareholders own the business

Primarily for financial gain

Stakeholders are affected by the decisions and operational activities of the business

Financial, non-financial and personal benefits

The social contract between business and society is constantly evolving... (Waddock 2010)

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The CSR Debate..

CSR imposes political functions of government on corporate executives

CSR has failed to create the good society – expecting too much from business

Close adherence to CSR agenda leads to falling profits

Difficulty in allocating rights responsibilities and enforcing them – who decides?

Stakeholder theory the way forward – CA through building superior relationships.

Good CSR manages the paradox of profitability & responsibility

Jury is still out – you decide!

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Recall Learning Outcomes

By the end of these slides the student should now be able to:

Define corporate governance and its aims

List the parties involved in corporate governance

Assess the importance of corporate governance

Explain “Carbery’s” recommendations of good governance

Describe the Agency Problem

Evaluate what constitutes good corporate governance

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