A - Chapter 1 - Definitions and issues in corporate governance

Question 1

What is the definition of Corporate Governance?

Answer 1

There is no one definition of corporate governance. The UK Corporate Governance Code of 2016 states that the “the purpose of Corporate Governance is to facilitate effective , entrepreneurial and prudent management that can deliver the long-term success of the company”.

Question 2

What are the two main theories of corporate governance?

Answer 2

1. The Shareholder primacy theory
2. The Stakeholder theory

Question 3

What are the four main approaches to Corporate Governance?

Answer 3

1. Shareholder value approach
2. Stakeholder (or pluralist) approach
3. Inclusive stakeholder approach
4. Enlightened shareholder value approach

Question 4

Summarise the shareholder value approach

Answer 4

Directors should govern their company in the interest of its owners - the shareholders.
Main objective is to maximise the wealth of shareholders through share price growth and dividend payments however they should maintain the rules of society and laws and customs.
Directors are only accountable to shareholders who can remove or appoint them into office.
It is argued that pure shareholder value approach is not sustainable in the long term as companies are not islands and have to act with different stakeholder groups.

Question 5

Summarise the stakeholder (or pluralist) approach

Answer 5

Companies should have regards to the views of all stakeholders, not just shareholders. This incudes the public at large. Decisions should be made balancing the views of all stakeholders.
Mainly applies in countries who adopt civil law such as France, Germany, Japan and China.
Opponents of the stakeholder approach argue that if companies were to take into account all stakeholders’ views they would never reach a decision.

Question 6

Summarise the inclusive stakeholder approach

Answer 6

Approach differs from the shareholder value and stakeholder approach in that its supporters believe that the directors should consider LEGITIMATE interests and expectations of KEY stakeholders on the basis that is in the best interest of the company.
These should be considered on a case by case basis but in the best interest of the company.
Shareholders do not have predetermined precedence over other stakeholders. They should maximise shareholder value but within the parameters of the company as a sustainable enterprise and the company as a corporate citizen.

Question 7

Enlightened shareholder value approach

Answer 7

Proposes that boards when considering the actions to maximise shareholder value should look to the long term as well as the short term and consider the views and impact in other stakeholder, not just shareholders. The views of other stakeholders are considered in so far as it would be in the interests if shareholders to do so.
Introduced by the UK CA2006 by imposing a stat. duty on directors to “promote the success if the company for the benefit of its members as a whole, and in doing so have……”
Main challenges are that there is no provision to enforce the duty. Provisions would be through alternative aspects of law such as employment law or members can raise a derivative action. Also, no guidance as to how directors should take other stakeholder interests into account especially conflicting one therefore focus in reality is shareholder interests only.
In 2018, the publication of The Companies (Misc. Reporting) regulations seek to address these challenges,

Question 8

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Function of the company?

Answer 8

Shareholder Primacy Approach - Maximise wealth for shareholders
vs.
Company (stakeholder) Approach - Provides goods and services; provides employment; creates opportunities for investment; drives innovation

Question 9

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Purpose of the company

Answer 9

Shareholder Primacy Approach - Maximise wealth for shareholders
vs.
Company (stakeholder) Approach - Business purpose set by the particular company’s board

Question 10

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Responsibilities to society

Answer 10

Shareholder Primacy Approach - None
vs.
Company (stakeholder) Approach - Fulfil business purpose and act as a good corporate citizen

Question 11

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Ethical standards

Answer 11

Shareholder Primacy Approach - Whatever shareholders want or obey the law and avoid fraud and collusion
vs.
Company (stakeholder) Approach - Obey the law and follow ethical standards generally accepted in society in which it operates

Question 12

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Role of shareholders

Answer 12

Shareholder Primacy Approach - Owners of the company with authority over its business
vs.
Company (stakeholder) Approach - Owners of shares; suppliers of capital with defined rights and responsibilities

Question 13

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Nature of shareholders

Answer 13

Shareholder Primacy Approach - Undifferentiated, self-interested wealth maximisers
vs.
Company (stakeholder) Approach - Diverse, with differing objectives, incentives, time horizon and preferences

Question 14

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Role of directors

Answer 14

Shareholder Primacy Approach - Shareholders’ agents, delegates, or representatives
vs.
Company (stakeholder) Approach - Fiduciaries for the company and its shareholders

Question 15

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Role of management

Answer 15

Shareholder Primacy Approach -Shareholder’s agents
vs.
Company (stakeholder) Approach - Leaders of the organisation; fiduciaries for the company and its shareholders

Question 16

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Management’s objectives

Answer 16

Shareholder Primacy Approach -Maximise returns to shareholders
vs.
Company (stakeholder) Approach - Sustain the performance of the company

Question 17

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Management’s timeframe

Answer 17

Shareholder Primacy Approach -Present / near term
Company (stakeholder) Approach - Established by the board; potentially indefinite, requiring attention to the near, medium and long-term

Question 18

What are the main differences in approach between Shareholder Primacy and Company (stakeholder) approach in relation to:
Management performance metrics

Answer 18

Shareholder Primacy Approach -Returns to shareholders
Company (stakeholder) Approach - Multiple: among them, company value, achievement of strategic goals, quality of goods and services, employee well-being, returns to shareholders

Question 19

What is stakeholder capitalism?

Answer 19

Stakeholder capitalism seeks to create value for society as a whole i.e. customers, employees, suppliers, communities and the environment.
It’s about aligning their interest to grow the pie for the benefit of all.
Concept was introduced globally at the WEF in 2020.

According to the WEF, the technological, environmental, geopolitical and socioeconomic transformations over the last 20 years are driving a re-examination of the traditional models of corporate governance.
The focus of the 2021 Davos meeting was also Stakeholder Capitalism.

Not everyone is in agreement. Countries have been adopting their own forms of stakeholder governance for many years and these are still preferred as they are embedded in how organisations in those countries do business.

Question 20

What are the 4 principles of corporate governance?

Answer 20

Responsibility, Accountability, Fairness and Transparency

Question 21

Summarise the principle of responsibility

Answer 21

People need to understand what their responsibilities are and should carry them out with honesty, probity and integrity.
Organisations should ensure that procedures and structures are un place so that people know that they are responsible for and thus liable to account for.
This helps people avoid conflicts of interest that could arise.

Question 22

Summarise the principle of accountability

Answer 22

This refers to the requirement for people with a position of responsibility to account for the exercise (or non exercise) of the authority they have been given.
Accountability should be to the person or group of people from whom the authority is derived.
Those providing accountability should provide ‘honest’ information and no manipulate facts or ‘spin’ them to their own or their organisations advantage.

Corporate Governance best practice requires and organisation to set out clearly who is accountable for what and over what time period so that an organisations stakeholders are clear whom they should hold responsible for what.

Question 23

Summarise the principal of transparency

Answer 23

The ease to which and outsider is able to make meaningful analysis of an organisation and its actions, both financial and non-financial.
It also refers to the clarity of process in making decisions and carrying them out.
Transparency builds trust between the organisation and its stakeholders.
Organisations should have policies in place about transparency and the disclosure of information.

Question 24

Summarise the principal fairness

Answer 24

All key stakeholders should be treated fairly when decisions are made or actions taken by the organisation.
The organisation should provide effective redress for violations, for example to minority shareholders when they have been unfairly treated.
Organisations should have policies , structures and procedures in place to ensure that the organisation and the people within consider key stakeholders views with justice and avoidance of bias or vested interests.

Question 25

Is reputational management important in CG?

Answer 25

Yes - in the UK, directors now have a statutory duty to consider this via the CA2006.
S172 states A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—
the desirability of the company maintaining a reputation for high standards of business conduct

Question 26

What did Judy Larkin in 2002 identify as the benefits to companies of good reputational management?

Answer 26

1. Improving relations with shareholders
2. Creating a more favourable environment for investment and access to capital
3. Recruiting and retaining the best employees
4. Attracting the best business partners, suppliers and customers
5. Reducing barriers to development in new markets
6. Securing premium prices for products and / or services
7. Minimising threat of litigation and of more stringent regulation
8. Reducing the potential for crises
9. Reinforcing the organisations credibility and trust for stakeholders

Question 27

What 5 things should make up a corporate governance framework?

Answer 27

1. Applicable laws, regulations, standards and codes
2. Organisation’s constitution
3. Structures
4. Policies
5. Procedures

Question 28

What are the three main approaches in developing and adhering to laws, regulations, stds and codes?

Answer 28

1. Rules based approach - example Sarbanes - Oxley Act 2002 in US
2. Principles based approach - example UK Corporate Governance Code
3. Hybrid approach

Question 29

What do critics of the rules based code argue?

Answer 29

1. Companies need to be substantially similar under the purview of the regulation justifying a common approach to common problems for it to work.
2. The rules (and enforcement of the rules) need to be effective against the behaviours they are aimed at. In reality it is the enforcement of the rules which achieves this and in many countries, the enforcement is weak - leaving the approach weak.

Question 30

What is the benefit of a rules based approach?

Answer 30

Sends a message out to owners, potential investors and other stakeholders that the country takes very seriously their protection from nefarious practices by managing and overseeing the organisations they are investing in.

Question 31

Summarise the principles based approach.

Answer 31

The principle based approach are based on the presumption that shareholders of companies will self regulate the companies in which they invest.

It allows companies to choose which principles an practices they believe are appropriate for their company at that particular times.

It recgniosies the need for fliexbility due to the diversity of circumstance

Question 32

Summarise the principles based approach.

Answer 32

The principle based approach are based on the presumption that shareholders of companies will self regulate the companies in which they invest. It was hoped that this approach would restrict the regulatory burden on companies.

It allows companies to choose which principles an practices they believe are appropriate for their company at that particular times.

It recognises the need for flexibility due to the diversity of circumstances and experiences and the fact that non-compliance (at a particular time) may be in the companies best interests.

Question 33

What is the hybrid approach?

Answer 33

Many countries are now adopting a hybrid approach to corporate governance combining mandatory laws and regulations with voluntary principle based codes of best practises. The UK is an example of this.

Question 34

What is the concept comply or else?

Answer 34

The concept comply or else refers to a company’s obligation to abide with a mandatory rules based system of corporate governance. Failure to abide with the rules, as we saw above, usually results in some form of sanction for the company and or its directors.

Question 35

What the is concept comply or explain?

Answer 35

The concept comply or explain refers to a company’s obligation to comply with a voluntary principles - based code of best practice. Where the company believes that it is not in its best interests to ‘comply’ with a provision of the code, it is required to explain to shareholders why it has not complied.
The company’s shareholder rep. bodies are then expected to assess whether the explanation is acceptable or not.

In Feb 2021, the FRC issued guidance on ‘Improving the quality of comply or explain reporting’.

Question 36

What is the concept apply or explain?

Answer 36

The concept apply or explain asks companies (or different structures and sizes regardless of their form of establishment) to explain how they have applied a principal within a code. It was felt that this was a less harsh was reporting on what they were doing as they did not have to give a yes or no answer and could tell their story of how corporate governance was being adopted in their organisation.

An example of this in the UK is The Wates Corporate Governance Principles for Large Private Companies, published in Dec 2018.
Companies adopting the Wates Principals should apply each Principle by considering them individually within the context of the companies specific circumstance.

In Feb 2021, the FRC issued guidance on ‘Improving the quality of comply or explain reporting’.

Question 37

What is an organisations constitution otherwise known as and what types of things would it set out?

Answer 37

An organisations constitution is known by many names depending on what type of company it is and the country of incorporation.

The most common names are Articles of Association, bylaws, charters or trust deeds.

The constitution sets out how an organisation sets out how the company will organise itself in relation to laws, regulation, standards and codes.

It also usually covers shareholders’ rights, powers and duties or directors and CEO, board proceeding, appointments, powers and duties or the co. sec, matters to do with accounts and audits and provisions for winding up.

Question 38

What types of things should an organisation consider in relation to ‘structures’?

Answer 38

The type of organisation it is,

The laws and regulations applicable to the type of entity e.g. audit committees for banks,

The strategic objectives of the organisation,

The risks associated with the operations conducted by the organisation,

The people who work for the organisation.

Question 39

What are some examples of types of structures that may be put in place?

Answer 39

A board with a charter and statement of reserved powers or delegated authorities,

audit committee,

risk committee,

governance and nominations committee,

Role profiles for chair, chief executive, non executive directors,

Executive committee or senior management team,

Organisational structure including employee job descriptions.

Question 40

List some examples of policies that organisations may introduce to govern how they operate.

Answer 40

Code of conduct or ethics
Bribery
Conflict of interest
Related party transactions
Whistleblowing
Disclosure of information
Sexual harassment
Insider trading
Risk
IT policies
HR Inc. remuneration
Gifts, entertainment and gratuities
Fair competition and business practice

Question 41

List some examples of procedures and processes that organisations adopt.

Answer 41

Strategic planning
Business continuity
Risk management and internal controls
Computer data and security
Manging information
Health and safety
Procurement
Retirement

Question 42

What 3 things should a co. sec consider when implementing an appropriate governance framework for an organisation?

Answer 42

1. The organisation’s purpose
2. The assimilation of corporate governance practices
3. What constitutes success for their organisation

Question 43

Where should you find reference to the companies purpose?

Answer 43

In the object clause in the company’s memorandum of association or defined in the governance documents of the organisation.

Knowing the companies purpose is very important as everything stems from this - the vision, mission, strategic goals and governance framework.

For a co. sec, knowing the organisation’s purpose helps set up the organisation’s governance framework of structures, policies and procedures.

Question 44

What is the difference between compliance and governance?

Answer 44

Compliance answers the question “what is required”. It leads to an organisation adopting the appropriate structure, policies and procedures. On it’s own it is a box ticking exercise.

Governance answers the ‘how do we make this effective’ question. The co. sec, needs to ensure that the infrastructure is appropriate, that people are focused and work well together, resources are used effectively and information flows smoothly. Decisions are then made effectively and this all contributes to a successful and sustainable organisation. If the infrastructure is not appropriate, then the anticipated ‘cultures’ will not be developed and bad practices will follow.

Question 45

List some benefits of well governed companies.

Answer 45

Good corporate governance leads to:
Long term sustainability
Improved access to external financing, whether through listings or from banks
Lower cost of capital
Improved operational performance
Increased firm valuation
Improved share performance
Reduced risk of corporate crisis and scandals
Effective decision making
Improved oversight, monitoring and evaluation
Succession planning
Ethical behaviour - anti corruption tool.

Question 46

List some examples of studies showing the benefits of corporate governance.

Answer 46

The McKinsey Global Investor Opinion Survey 2002 shows that investors are prepared to pay a premium for companies exhibiting high governance standards. This is on average 20-25% in Europe.

The S&P / Hawkamah environmental, social and corporate governance pan arab index which monitors and ranks listed companies in MENA (middle east and north Africa) show that companies within the index had annualised returns which outperformed those in it’s benchmark over the past 10 years.

In 2007, Derwall and Verwijmeren found that US companies with better governance practices received a lower cost of equity.

Hermes Investment Management (a UK investment firm) is of the view that it is not just the governance structure of the organisations that lead to better performing companies but the active engagement by the ownership of those organisations with the boards and senior managers that matter. (shareholder relations)

Question 47

List some consequences of weak governance practices.

Answer 47

Failing companies
Corporate scandals
Fraud (Enron, Worldcom, Parmalat)
Lack of knowledge, skills and experience on the board (Barings Bank)
Dominant personalities (Polly Peck, Tesla)
Failure to understand and manage risk (Lehman Brothers)
Questionable business practises (BHS / Phillip Green)

Reputational problems
Unethical business practises (Volkswagen, Siemens)
Lack of transparency and disclosure (Olympus)
Poor relationships between boards and shareholders (Sports Direct)
Inappropriate remuneration and rewards systems for directors and senior exe. (Enron, Carillion)

Wider economic consequences
Excessive regulation
Lack of investment in capital markets
The development of shareholder representative bodies to monitor companies they invest in
A focus on regulating and disclosing senior exe. pay
The establishment of powerful regulators such as the US SEC.

Question 48

How does governance and management differentiate at board and executive team level?

Answer 48

The board is responsible for setting up the ‘governance’ of the organisation, the structure, policies and procedures within which the business of the organisation is conducted.

The powers to manage the day to day affairs are delegated, normally to the CEO and executive team. The CEO may be passed all authority with the power to sub-delegate or authority is passed to several members of the executive team depending on their responsibilities.