3. Corporate Governance Flashcards
What is corporate governance, and why is it so important?
Corporate governance is defined as the system by which companies are directed and controlled.
Its important because of agency risk and used to improve companies’ accountability to shareholders and other stakeholders so that agency risk (the risk of directors acting in their own self-interest) is reduced.
What happens when companies fail to implement effective corporate governance?
Lead to management:
- Risk-taking behaviour,
- Financial mismanagement
- Ethical issues
How has the UK Corporate Governance Code developed over time?
Cadbury Code 1992, Greenery code 1995 reviewed by Hampel Report 1998 on ‘Stakeholder needs’:
led to the Combined Code 1998 Internal Controls
Turnball Report 1999, Smith report 2003 on Audit committees and Higgs Report 2003 on Non-Exec Directors:
led to the Combined Code 2003, 2006, 2008
After the financial crisis the code was updated to:
The UK Corporate Governance Code 2010, 2012
Final Update to:
The UK Corporate Governance Code 2016, 2018.
What are the 5 main sections of underlying principles of the UK Corporate Governance Code 2018?
- Board leadership and company purpose
- Division of responsibilities
- Composition, succession and evaluation
- Audit, risk and internal control
- Remuneration
Explain the main principles within Section 1 - Board leadership and company purpose of The UK Corporate Governance Code 2018
A – The need for an effective board.
B – The role of the board in setting the company’s values, and ensuring these are aligned with its culture.
C – The role of the board in establishing effective controls to manage risk.
D – The importance of effective engagement with stakeholders, including shareholders.
E – The need to implement workplace policies/practices which are consistent with the company values.
Explain the main principles within Section 2 - Division of responsibilities of The UK Corporate Governance Code 2018
F – The chairperson is responsible for leading the board and should be independent.
G – The board should have a mixture of executive and non-executive directors, and at least half the board should be non-executive directors. There should be a clear distinction between those directors running the business, and those running the board.
H – Non-executive directors should be able to dedicate sufficient time to their role, and should hold management to account by providing constructive challenge of board decisions.
I – The board should ensure it has the necessary time, information and resources required to be effective
Explain the main principles within Section 3 - Composition, succession and evaluation of The UK Corporate Governance Code 2018
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 members and senior management.
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. Directors should be re-elected every year.
L – Annual evaluation of the board should consider its composition, diversity and how effectively members work together to achieve objectives.
Explain the main principles within Section 4 - Audit, risk and internal control of The UK Corporate Governance Code 2018
M – The board should have policies and procedures to ensure the independence and effectiveness of both internal and external
audit functions.
N – The board should present a fair, balanced and understandable assessment of the company’s position and prospects. This includes the annual financial statements, plus other information provided within the annual report.
O – The board should set up effective internal controls, which should be reviewed at least annually. In addition, the board should continue to monitor emerging and key risks, to ensure that controls can be implemented/amended when required.
Explain the main principles within Section 5 - Remuneration of The UK Corporate Governance Code 2018
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.
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.
R – Directors should exercise independent judgement and discretion when authorising remuneration outcomes, taking account of company and individual performance, and wider circumstances.
What does ‘comply or explain’ mean in relation to the UK Corporate Governance Code?
(Applicable to premium listed companies only)
If these premium listed companies dont comply with the code, they need to explain why they haven’t. (E.g. more relevant to do another thing etc)
What is the role of the board of directors?
A number of executive and non-executive directors will sit on the board, and together will make decisions about the strategic direction of the company.
What is the role of the nomination committee?
- Appointment of new members to the board
- Annual review of existing members
- Diversity and inclusion
What is the role of the non-executive director (NED)?
Constructively challenge and contribute to the strategic decisions of the business and should scrutinise the performance of the executive directors and management.
What is board diversity and why is it important?
the distribution of different attributes and characteristics among a group of directors and the variations in the way boards are composed.
e.g. women, poc, ned’s, experience
What is the role of the directors in risk management?
(& what controls should have been put in place?)
The board of directors has ultimate responsibility for internal control and risk management, including controls around the preparation of financial statements.
Controls:
Provision 28 - requires companies to confirm that they have conducted a robust assessment of their emerging and principal risks in the annual report, and to describe what procedures are in place to identify and manage or mitigate those risks.
Provision 29 - of the Code also asks the board to monitor the company’s risk management and internal control systems and, at least annually, carry out a review of their effectiveness and report on that review in the annual report. The monitoring and review should cover all material controls, including financial, operational and compliance controls.
What is the role of the audit committee?
Role: Monitoring the integrity of the financial statements of the company.
Responsibilities:
- Providing advice to the board on whether the financial statements/annual report are fair, balanced and understandable, and provide the necessary information for shareholders to assess the company’s position and performance.
- Reviewing the company’s internal financial controls and internal control and risk management systems.
- Monitoring and reviewing the effectiveness of the company’s internal audit function or, where there is not one, considering annually whether there is a need for one and making a recommendation to the board.
- Reviewing and monitoring the external auditor’s independence and objectivity.
- Reviewing the effectiveness of the external audit process, taking into consideration relevant UK professional and regulatory requirements.
- Developing and implementing policy on the relationship with the external auditor, including any non-audit services, and ensuring there is prior approval of these, considering the impact this may have on independence.
- Reporting to the board on how it has discharged its responsibilities
How is directors’ remuneration determined and governed?
Determined by remuneration committee, and thus BOD and shareholders.
Governed by:
- FRC requiring remuneration to be strategic and sustainable, transparent and impartial, appropriate and not excessive.
- CA 2006 - Obligations to prepare and produce a directions remuneration report.
- UK Corporate Governance Code 2018 - develop directors remuneration policy.
What is the role of the remuneration committee?
- The setting of remuneration for directors and senior management
- Ensure non-executive directors are only paid in reflection of their time commitment and responsibilities (no performance-related elements).
What are the 3 things that a directors’ remuneration report contain?
- A statement by the chair of the remuneration committee.
- The company’s policy on directors’ remuneration (we will refer to this as the ‘remuneration policy’).
- Information on how the remuneration policy was implemented in the financial year being reported on (we will call this the ‘implementation report’). This is the annual report on remuneration.
What is the role of shareholders in corporate governance?
- Elect board members
- Request changes to the company’s internal documents
- Approve any extraordinary transactions that the company may need to undertake
Why is good stakeholder engagement so important for corporate governance?
Stakeholder engagement is important in CG because it fosters greater
transparency and accountability in business operations and ensures that diverse perspectives are considered in the decision-making process.
The UK Corporate Governance Code (2018) requires companies to disclose how companies engage with their stakeholders.
What are disclosures, and what kinds of disclosures might a company make?
Disclosures are what a listed company has to do as compelled by the UK Corporate Governance Code 2018 or explain why they haven’t complied.
Examples of disclosures include:
- How the company has applied the principles set out in the UK Corporate
Governance Code.
- A statement as to whether the listed company has:
a) Complied throughout the accounting period with all relevant provisions set out in the UK Corporate Governance Code, or
b) Not complied throughout the accounting period with all relevant provisions set out in the UK Corporate Governance Code and, if so, setting out:
− Those provisions, if any, it has not complied with
− In the case of provisions whose requirements are of a continuing nature, the
period within which, if any, it did not comply with some or all of those
provisions
− The company’s reasons for non-compliance
What disclosures do the Organisation for Economic Co-operation and Development (OECD) recommend?
- The financial and operating results of the company
- Company objective and sustainability-related information
- Major share ownership, including beneficial owners, and voting rights
- Information about board members
- Remuneration of members of the board and key executives
- Related party transactions
- Foreseeable risk factors
- Governance structure and policies
What weaknesses were identified by the FRC’s 2022 Review of Corporate Governance Reporting?
- The lack of disclosure in relation to the outcomes and impacts of governance policies and practices.
- Explanations as to why a departure from a provision was necessary lacked clarity and transparency.
- Reporting on wider stakeholder engagement, often insufficient narrative on the outcomes fromthe engagement
- Engaging with the workforce , most disclosures were limited to flexible working matters,
- Diversity targets, this progress had yet to translate into senior roles. Lack of transparency in relation to diversity policies and targets
- Did not explain how they assessed the effectiveness of internal control systems to justify the
results of their assessment. - Minimal disclosure on board engagement with major shareholders
- Divide between the statements provided within the annual report and voting at company AGMs on both the policy and the outcomes from the policy.
How important is sustainability reporting in corporate governance?
Very as sustainability reporting now informs their corporate strategy.
How have sustainability reporting and governance evolved in recent years?
Recent years have seen changes in stakeholder and investor priorities, with a strong emphasis on the importance of environmental, social and governance (ESG) matters, particularly for the workforce and stakeholders.
e.g. Issues such as climate change, wellbeing, flexible working and working constructively with stakeholders.
What would cause a NED to be impaired?
- Material business relationship with the company in the past 3 years.
- Employee of company or group within the last 5 years.
