1.4 Corporate governance

Question 1

Corporate governance has become a major bus issue driven by:

Answer 1

• a succession of public scandal
• which led to the formation of UK Corporate Governance Code
• collapse of London Stock Exchange / liquidation of BCCI (Bank of Credit and Commerce International)

Question 2

The need for corporate governance arises because

Answer 2

• in all but the smallest of org, there is a separation of ownership and control

Question 3

The separation of ownership and control refers to

Answer 3

• the situation in an org where the people who own the company (shareholders) are not necessarily the people who run the company (board of directors)
• can be beneficial eg. specialist managers can run the org more efficiently than owners

Question 4

The agency problem arises as a result of

Answer 4

• directors controlling the company while shareholders own the company
• the risk is that the directors may act in their own best interest and not in the shareholders or other stakeholders best interests

Question 5

Corporate governance is the set of:

Answer 5

• processes and policies which direct, administer and control the org.
• it covers the appropriate role of the board of directors and the auditors of the org.
• CG is concerned with the overall control and direction of org so that the objectives of the org are achieved in a way that is acceptable to all stakeholders.

Question 6

The following symptoms can indicate poor CG:

Answer 6

• Board dominated by single individual or group
• No involvement by the board, eg: meeting irregularly, failing to systematically consider activities & risks, basing decisions on inadequate info.
• Inadequate control function, eg: no internal audit, lack of adequate knowledge in key roles, rapid turnover of staff
• Lack of supervision of employees
• Lack of independent scrutiny by internal & external auditors
• Lack of contact with shareholders
• Emphasis on short-term profitability - can lead to concealing problems or manipulating info to meet desired results
• Misleading financial statements and info

Question 7

One of the main debates around CG regulation is whether it should be:

Answer 7

• A set of best practice guidelines - UK has principles based approach which requires bus to adhere to the spirit rather than the letter of the law
• A legal requirement - US has appropriate penalties for transgression.

Question 8

In the UK, company law sets out many of the rules on CG, especially with regards to:

Answer 8

• The board of directors
• Director’s powers and duties
• The relationship of the company with directors, ie. loans to directors and interests of directors in company contracts
• Accountability for stewardship and financial reporting via financial statements
• Rules on meetings and resolutions

Question 9

The Financial Reporting Council (FRC) is responsible for

Answer 9

• promoting high standards of CG in UK
• all companies listed on London Stock Exchange are required to apply principles of UK Corporate Governance Code
• and must produce a disclosure statement confirming compliance and explaining any departures.

Question 10

UK CG Code provides guidance on the following:

Answer 10

• AGM
• The board
• Chairman and CEO
• Non-executive directors
• Nomination committees
• Remuneration committees
• Audit committees

Question 11

Code Guidance regarding use of AGM:

Answer 11

• The AGM (annual general meeting) should be used to construct a dialogue with shareholders

Question 12

Code Guidance regarding the Board:

Answer 12

• Org should have a effective board, with balance of skills, experience, independence and knowledge, that meets regularly.
• The annual report should identify the Chairman, Deputy Chairman, Chief Executive Officer, senior independent directors and the members and chairs of the board committee
• and it should disclose the number of meetings held and attendance
• revised code emphasizes positive relationships between org, shareholders and stakeholders (eg: board is responsible for workforce policies and practices that reinforce a healthy culture)

Question 13

Code Guidance regarding Chairman and CEO:

Answer 13

• The positions of Chairman ( responsible for leadership and board effectiveness) and CEO (in charge of running the company) should be separate.
• This ensures no one individual has too much power

Question 14

Code Guidance on Non-executive directors (NEDs)

Answer 14

• Executive directors (EDs) are involved in the execution of day to day management decisions
• NED’s primarily only attend board meetings, no day to day operating responsibilities
• NED’s should as much as possible be independent so that their oversight role can be performed effectively and responsibly
• NEDs should be paid fees that reflect their time commitment and the responsibilities of the role (eg. fixed daily rate when they work for org)

Question 15

NEDs must not:

Answer 15

• have been an employee of the company in last five years
• have had a direct or indirect material business interest in the org in last three years
• participate in the org share options, performance-related pay scheme or pension schemes
• have close family ties with directors or senior employees
• serve as a NED for same org for more than nine years
• hold cross-directorship (two or more directors sit on the board of the same third party company) or have significant link with other directors through involvement in other org.

Question 16

Typical recommendation for NEDs include:

Answer 16

• At least half of the board (excluding Chairman) should be independent NEDs. A smaller org should have at least two independent NEDs.
• One of the NEDs should be appointed the senior independent director. Shareholders can contact them to raise matters outside the normal executive channels of communication.

Question 17

Code guidance for Nomination Committees:

Answer 17

• Appointments to the board should be made via a nominations committee
• Over 50% of this committee should be made up of NEDs
• This is to provide independence from current board members and to ensure that appointments are based on merit and suitability and composition of board is balanced.
• The revised code states that the committee is responsible for effective succession planning when developing a more diverse board and that the gender balance of senior management and their direct reports should be reported.

Question 18

Code guidance on Remuneration Committee:

Answer 18

• This is a committee made up of NED’s responsible for determining the pay and incentives offered to executive directors
• The Chairman can be a member but cannot Chair the committee
• The Chair must have been a member for at least 12 months
• An important principle of CG is that a director may not be involved in determining their level of remuneration.
• Remuneration should be enough to attract, retain and motivate quality directors but shouldn’t be more than necessary, and significant portion should be performance related.
• Revised code states that there should be clear reporting on remuneration and how it helps the org to achieve it’s strategy and long-term success and it’s alignment to workforce remuneration.

Question 19

Advantages of remuneration committee:

Answer 19

• It avoids the agency problem of directors determining their own remuneration
• It leaves the board free to make strategic decisions about the future

Question 20

Disadvantages of remuneration committee:

Answer 20

• There is a danger that NEDs recommend high remuneration for executive directors in the hope that they will recommend high remuneration for NEDs.
• The cost of preparing and holding meetings.

Question 21

Code guidelines on Audit Committees:

Answer 21

• consists only of NEDs who are responsible for monitoring and reviewing the org financial controls and integrity of financial statements.
• the board should review the effectiveness of risk management and internal controls at least annually and report to shareholders
• acts as interface between board of directors and internal and external auditors
• they should be the first point of contact for auditors, improving the independence and overall quality of audit functions.

Question 22

Responsibilities of the audit committee include:

Answer 22

• Review accounting policies and financial statements as a whole to make sure that they are appropriate and balanced
• Review systems of internal controls and risk management within org.
• agreement of the work agenda for internal audit dep. and review the results of internal audit work.
• Liase with external auditors, monitor their independence and objectivity, deal with problems in the audit and the appointment and removal of external auditors.