3. Impact of Corporate Governance on Strategy

Question 1

What is the definition of corporate governance?

Answer 1

A system by which organisations are directed and controlled. Its ensures the best interests of the company are serviced in the most efficient and effective manner.

‘A set of relationships between a company’s directors, its shareholders
and other stakeholders. It also provides astructure throughwhich the objectives of the company are set,and the means ofobtaining these objectivesandmonitoring performance are determined.’

Question 2

What are the benefits of organisations applying a corporate governance framework?

Answer 2

• Improved risk management. The reduction of downside risk will reduce business losses.
• Overall business performance is enhanced by focusing attention on areas of critical importance.
• Defines clear accountability for executive decision making.
• It provides an appropriate and adequate system of internal control, which applies to the organisation from top to bottom.
• Best practice guidelines are applied by management, who therefore strive to improve their performance.
• Encourages ethical behaviour and corporate social responsibility.
• Safeguards the firm from misuse of business assets, both tangible and intangible.
• Can attract new investment, particularly in developing countries.

Question 3

What are the 11 underlying principles of good corporate governance?

Answer 3

Decision-Based Qualities

• Integrity
• Fairness
• Judgement
• Independence
• Scepticism

Disclosure Based Qualities

• Transparency
• Probity
• Responsibility
• Accountability
• Innovation

- REPUTATION!!

Question 4

What are the 5 OECD Principles surrounding corporate governance?

Answer 4

1. Rights of shareholders
2. Fair treatment of shareholders
3. Role of stakeholders
4. Disclosure & transparency
5. Responsibilities of the Board

Question 5

What are the principles on the role of corporate bodies? (ICGN)

Answer 5

1. Responsibility of Board to shareholders
2. Leadership and independence separation of the board and executive leadership.
3. Composition & appointment of a diverse, experienced Board
4. Corporate Culture supporting ethical behaviour
5. Risk Management (internal audit)
6. Remuneration is clear and aligned to act in s/h interest.
7. Reporting and audits are robust, effective and independent.
8. General meetings follow procedure.
9. Shareholder rights are protected.

Question 6

What is the main difference between the principles-based approach and the rules-based approach?

Answer 6

Principles-based: Comply or explain (i.e UK Corp. Gov. Code)

Rules-based: Comply or ‘face sanctions’ (i.e USA S-Ox)

Question 7

What are the advantages & disadvantages of the principles-based approach?

Answer 7

Adv:

• greater flexibility
• Potential cost savings on implementation
• Can be applied across multiple jurisdictions, which make corp. gov in MNE’s more effective.
• Forces both S/Hs and board to think about corp. gov arrangements

Disadv:

• principles can be vague and ambiguous
• investors can’t be sure of consistency in approach
• incorrectly viewed as voluntary

Question 8

What are the advantages & disadvantages of the rules-based approach?

Answer 8

Adv:

• Clear rules to follow easier to comply with and can be evidenced
• Provides a consistent minimum standard for investor confidence

Disadv:

• Can lead to a tick box approach and no consideration of the principle
• no deviation irrespective of how illogical the situation is
• Can be soft on some issues
• enforcement is difficult for situations not explicitly covered by the rules.
• Needs to be regularly updated

Question 9

What specific provisions did sox create?

Answer 9

• establishment of PCAOB
• Auditors need to review internal controls
• Rotation lead or reviewing audit partner.
• Auditors cannot provide any other work.
• Audit Committee to a point auditors
• Audit Committee to be made up of entirely out of NEDs and at least 1 financial expert
• (s404) Listed companies required to ensure internal controls and properly documented and tested.
• CEO and CFO must certify the appropriateness of F.S
• lawyers must whistleblow on any wrongdoing uncovered in companies.

Question 10

What is the domestic and international impact of SOx?

Answer 10

Domestic Impacts

• listed companies, are required to ensure their internal controls are properly documented and tested
• accountancy firms, SOx has formally stripped of almost all non-audit revenue streams from their audit clients
• lawyers, SOx requires them to whistleblow on any wrongdoing, they uncover at client companies.

International Impacts

• non-US companies listed on US stock exchanges are covered by the provisions of S-Ox.
• As the US is a global power, it influences other countries to adopt a rules-based approach.

Question 11

What are the main criticisms of S-Ox?

Answer 11

1. Too weak on some issues but too strong on others.
2. Directors may not consult lawyers through fear that S-Ox overrides client-attorney privilege.
3. A S-Ox compliance industry has sprung up.
4. Companies are turning away from the US Stock market towards other markets.

Question 12

What are the key considerations for board membership?

Answer 12

• Size of the Board
• Inside/outside mix
• Diversity mix in terms of gender, ethnicity, backgrounds, experience

Question 13

What are the responsibilities of the board?

Answer 13

• Monitoring the chief executive officer
• Overseeing strategy
• Monitoring risks, control systems and governance
• Monitoring the human capital aspects of the company, eg succession, morale, training, remuneration etc
• Managing potential conflicts of interest
• Ensuring that there is effective communication of its strategic plans, both internally and externally

Question 14

How should each director be individually appraised?

Answer 14

All directors should also be individually appraised.

• Independence and Innovative
• Industry Familiarity
• Active Participation
• Positive and enthusiastic
• Business development
• CPD

Question 15

What are the responsibilities of the Chairman and the CEO?

Answer 15

Chairman’s Responsibilities

• Provide Leadership to the board
• Ensure the board receives accurate and timely information
• Effective communication with shareholders and express their views
• Facilitate Effective Contribution of NEDs
• Lead on providing an induction program to new directors
• Meet with NEDs without Executives
• Encourage active management by all the members of the board
• Facilitating board appraisal

CEO Responsibilities

• Provide Leadership to the Business
• Provide accurate and timely information
• Communicating effectively with key stakeholders
• Facilitate the effective implementation of board decisions
• Co-operate in induction and development
• Co-operate by providing any necessary resources
• Co-operate with all members of the board
• Co-operate in board appraisal

Question 16

Why should the Chairman and the CEO role be separated?

Answer 16

• The CEO can then run the company, while the chairman can run the board. Separation of the roles allows them both to be given suitable focus.
• Having two different people in the role brings two different perspectives, two sets of experience and skills and therefore improves decision making.
• Time Considerations, both roles are very demanding and by splitting the roles, the CEO and Chairman can focus on their respective roles.
• Reduces conflicts of interest in CEO decision making, if the CEO’s remuneration contains performance-related bonuses it could lead to unacceptable risk-taking or worse dishonest and fraudulent practices. The chairman can take action to prevent this.
• The board cannot truly keep the CEO accountable to shareholders if they also have to report the same person as a chairman.
• NEDs can have effective and open conversations with the Chairman in private.

Question 17

What is a unitary board? and the pro’s and con’s?

Answer 17

The single-board structure with sub-committees is known as a unitary structure

Advantages of Unitary

• All Participants have legal responsibility for the management of the company
• Single Board promotes easier co-operation
• Presence of NEDs should lead to better decisions
• Independent NEDs are less likely to be excluded from decisions or given restricted information

Disadvantages of Unitary

• A NED can not be expected to both manage and monitor.
• Time-requirements on NEDs is more demanding
• No Specific provision for employees to be represented on the management board
• Emphasis the divide between the shareholders and the directors

Question 18

What is a two-tier board? And the Pros and Cons of this?

Answer 18

• *Supervisory board** with no executive function. It reviews the company’s direction and strategy and is responsible for safeguarding stakeholders’ interests.
• *Management or executive board** composed entirely of executive directors/managers. It is responsible for the running of the business. The supervisory board appoints the management board.

Advantages of two-tier boards

• The clear and formal separation of duties
• The Supervisory board has the capacity to be an effective guard to mismanagement. E.g. inefficient management or worse fraud
• The supervisory board should take account of the needs of stakeholders other than shareholders, specifically staff.
• Actively encourages transparency within the company.

Disadvantages of two-tier boards

• Confusion over authority and lack of accountability.
• The management board may restrict the information passed on to the supervisory board
• The supervisory board may not be as independent as wished.
• members of the supervisory board can be shareholder representatives, this could detract from legal requirements that shareholders do not instruct directors how to manage.

Question 19

How can you leave the board?

Answer 19

• Resignation
• Not Offering themselves for re-election
• Failing to be re-elected
• Death in service
• Retirement
• Removed
• Dissolution of the company
• Prolonged absence
• Disqualified
• Agreed departure

Question 20

Name the 4 main board subcommittees?

Answer 20

• -Audit Committee
• -Remuneration Committee
• -Nominations Committee
• -Risk Committee

Question 21

What is the role of NEDs

Answer 21

• Strategy – Contribute and challenge the director on strategy
• Risk – NEDs should satisfy themselves that financial and risk management processes are in place.
• Scrutiny – NEDs should scrutinise performance and ensure agency issues do not arise.
• People - NEDs are responsible for appropriate remuneration and appointment of senior managers.
• Increase the objectivity and independence of decision making

Question 22

What are the advantages and disadvantages of Neds?

and

How can you overcome the disadvantages of Neds?

Answer 22

Advantages of NEDS

• Bring external Expertise
• Independent and objective view
• Demonstrate compliance with virtually every Corp Gov guides
• NEDs will provide assurance, confidence for many stakeholders

Disadvantages of NEDS

• Lack of independence, as length of service increase, NEDs become more aligned with the company, conflicts of interest are likely to increase. Rewards schemes could also create conflicts of interest
• Lack of Effectiveness, this comes from not having the right calibre or experience. Unfortunately, organisations who need NEDs the most cannot afford them.

What can be done to overcome disadvantages

• Independence issues can be overcome by following best practice guidelines on length of service contracts
• Full disclosure of NED remuneration, to help reduce conflict of interest appear under the radar
• Training and induction to organisation to help will effectiveness
• Market rates of pay can help with both independence and effectiveness

Question 23

What is the objective of directors remuneration package?

And

What are the 4 elements, the 3 considerations and the length of service contracts when setting remuneration packages?

Answer 23

Objectives:-

1. Attract and retain sufficient calibre of staff
2. Motivate them to achieve performance levels

Factors to consider when setting remuneration packages:

1. Fixed and Variable elements
2. Cash and non-cash elements
3. Immediate and deferred elements
4. Long-term and Short-term element

Considerations

• Connected to performance – Significant proportion of rewards being related to measurable business performance, while being alert to the risk that remuneration levels rise with no business improvement
• Best Practice – Needs to consider regulatory factors and the need to be sensitive to pay conditions of the company
• Market Factors – Needs to consider labour market factors, using consultants and benchmarking across the sector, setting the rate according to demand and supply.

Also, a key issue is the length of service contracts ( guidelines suggest 1 year) with a short notice period should be appropriate, so in the event of bad performance and termination of the contract, it does not seem directors are being rewarded for poor performance.

Question 24

What role does the remuneration committee play when engaging shareholders? and the types of disclosures that need to be made?

Answer 24

Role

• Engage key shareholder regarding remuneration packages, discuss concerns and seek approval on key elements on the package.
• Ensure Remuneration is aligned with shareholder interests the whole time.
• Submit the Remuneration Policy to a binding vote of shareholders.

Disclosures and annual reporting.

• Remuneration policy report.
• Detailed arrangements for individual directors.
• Performance conditions attached to remuneration packages.
• The duration of contracts with directors, and notice periods and termination payments under such contracts.

Question 25

What are the 2 main models of ownership?

Answer 25

1. Insider System: Occurs when most companies listed on local stock exchange are owned by a few dominant shareholders. Usually made up of family-owned and run organisations, along with banks other companies or V.Cs The reason for the concentration of share ownership is the legal system of the company.
2. Outsider system: Occurs where is shareholding is widely dispersed for e.g Stock Market shareholders. There is a manager-ownership separation, shareholders can be varied.

Question 26

What are the benefits and disadvantages of an insider system?

Answer 26

Advantages

• It is easier to establish ties between owners and managers, reduced agency problems
• It is easier to influence management and strategy
• Smaller base of shareholders may be more willing to take a long-term strategic view
• Owner-managed organisations, develop systems that grow over time and are cultural, as opposed to companies where this is no continuity

Disadvantages

• May be discrimination against minority shareholders.
• Insider systems tend to have less formal governance structures
• Maybe be reluctant to employ outsiders or NEDs
• More prone to opaque financial transactions or misuse of funds
• Many Large shareholders such as institutional investors tend to avoid share like this and prefer to invest in “blue-ship”

Question 27

What are the benefits and disadvantages of Outsider systems?

Answer 27

Advantages

• More robust legal and governance regimes to protect shareholders
• Shareholders have voting rights
• Hostile takeovers are far more frequent, the threat of these acts are higher to discipline bad company management and can deter bad performers.

Disadvantages

• More likely to have agency problems and associated agency costs
• Larger shareholders tend to have short-term priorities.

Question 28

What is an institutional investor? and what are the benefits and disadvantages of them?

Answer 28

Tend to have large amounts of money to invest, less protected because they are knowledgeable and able to protect themselves. They are now the biggest investors in any stock market. Tend to be: -

• Pension Funds
• Insurance Companies
• Investment and unit trusts
• Venture capital organisations

Advantages

• Makes investments such as pensions available that are separate to an employer
• Access to big markets for smaller investors

Disadvantages

• Dominance can influence economy unduly and lead to anti-competitive behaviour
• Play to safe
• Can be to short-termist in investment decisions
• Investors can not influence the fund managers but are encouraged to engage with directors if the believe poor governance practices are present

Question 29

How do institutional Investors flex there influence? and reasons why they may intervene more actively?

Answer 29

• One-to-one meetings - To discuss strategy, objectives, performance and quality of management. But no single investor can seek further information that what is already available to the public.
• Voting - Generally institutional investors prefer to work behind the scenes and to avoid voting against the board. Normally state their intention in advance. Most corporate governance reports emphasise their importance of exercising their vote regularly and responsibly.
• Focus Lists
• Contributing to corporate governance rating systems

Reasons to actively intervene.

• Fundamental concerns about the strategy being pursued in terms of products, markets and investments
• Poor operational performance,
• Management is dominated by a small group of executive directors, with the non-executive directors failing to hold management to account
• Major failures in internal controls, particularly in sensitive areas such as health and safety, pollution and quality
• Failure to comply with laws and regulations or governance codes
• Excessive levels of directors’ remuneration
• Poor attitudes towards corporate social responsibility

Question 30

What types of Disclosures corporate governance guides tend to request?

Answer 30

Annual reports should disclose whether the organisation has complied with government regulations and codes. In the UK, for example, this can be a statement explaining how a company has either complied or not complied with the UK Code.

Disclosure reports generally focus on:-

• The Board
• Relations with shareholders
• Operations
• Review of internal controls
• Relations with auditors
• Committee reports
• A statement of the business going concern status

Question 31

describe, compare and contrast in the governance of Public and third sector organisations?

Answer 31