Chapter 1. Definitions and issues in CG Flashcards
What is meant by the term ‘Corporate Governance’?
The system by which companies are directed and controlled’ Cadbury Committee 1992
Corporate governance is therefore about what the board of a company does and how it sets the values of the company (UK Corporate Governance Code 2016)
- ‘To succeed in the long-term, directors and the companies they lead need to build and maintain successful relationships with a wide range of stakeholders.’ (UK Corporate Governance Code 2018)
Explain the agency theory?
Concerned with the separation of ownership and control of a company
And the relationship and alignment between the shareholders as the owners and the managers running the company.
Explain the four agency conflicts
- Moral Hazard – A manager has interest in receiving benefits from their position
- Level of Effort – Managers may work less hard than they would if they were owners
- Earnings retention – Remuneration of managers is often related to the size of the company, leading to managers seeking to re invest profits
- Time horizon – Managers may be more interested in short term results
What are the 4 theoretical approaches to Corporate Governance?
- The Shareholder Value Approach
– ‘The board of directors should govern their company in the best interest of its owners’ - The Stakeholder Approach (pluralist approach)
– ‘achieving a balance between economic goals and social goals - The Enlightened Shareholder Approach
– Pursue the interests of shareholders in an enlightened and inclusive way - Inclusive Approach
– ‘consideration of the interests and expectations of all stakeholders on the basis that this is in the best interest of the company.’
What are theories of corporate governance?
Shareholder primacy theory (leading into agency theory)
- maximising the value to shareholders
Stakeholder theory
- purpose of corporate governance should be to meet the objectives of everyone that has an interest in the company.
- Non-financial objectives considered equal to financial objectives
What is stakeholder capitalism?
Seeks to create shareholder returns by creating value for society as a whole, i.e. customers, employees, suppliers, communities, and the environment.
What are the 4 principles of good corporate governance?
- Responsibility
– Those given authorities should accept full responsibility for the powers that they have been given and the authority they exercise. They should carry them out ethically with honesty, probity and integrity. - Accountability
– This refers to the requirement for a person or group of people in a position of responsibility to account for the exercise (or not) of the authority they have been given. They should provide ‘honest’ information and not manipulate facts. - Transparency
– This refers to the ease with which an outsider is able to make a meaningful analysis of an organisation and its actions. - Fairness
– This refers to the principle that all key stakeholders should be treated fairly when decisions are made or actions taken by the organisation.
What are 5 benefits of a company having a good reputation?
- Improving relations with shareholders
- Creating a more favourable environment for investment and access to capital
- Recruiting and retaining the best employees
- Attracting the best business partners, suppliers and customers;
- Reducing barriers to development in new markets
- Securing premium prices for products and/or services;
- Minimising threats of litigation and of more stringent regulation
- Reducing the potential for crises
- Reinforcing the organisation’s credibility and trust for stakeholders.
Explain the difference between ‘Comply or Explain’ and ‘Apply and explain’ and give examples of corporate governance codes using these approaches
- ‘Comply or explain’
– 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 they have not complied e.g. UKCG Code - ‘Apply and explain’
– Avoids ‘tick box’ mentality and focusses organization to apply principle and explain how. e.g. King IV, Wates
List 5 benefits to adopting good Corporate Governance practices?
- Long-term sustainability
- Improved access to external financing
- 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 – an anti-corruption tool
What are the potential consequences of weak governance practices, providing examples?
- Corporate failure
– Accounting fraud
– Lack of knowledge skills and experience on the board, e.g. Barings Bank
– Dominant personalities, e.g. Maxwell
– Failure to understand and manage risk, e.g. global financial crisis, Carillion - Reputational problems
– Unethical business practices, e.g. Volkswagen ‘Dieselgate
– Lack of transparency and disclosure, e.g. Olympus
– Poor relationship between the board and shareholders, e.g. Sports Direct
– Inappropriate remuneration and reward systems for directors and senior executive, e.g. Enron, Carillion
Brief explanation of Shareholder primacy theory
Theory of corporate governance focuses on maximising the value to shareholders before considering other stakeholders
Based on the premise that
shareholders own companies and that directors, managers and employees are engaged by the company for the purpose
of maximising shareholder wealth.
Criticism
Inappropriate stewardship
Changes from direct investment by individual to wealth invested under management (asset managers, pensions, insurance) = ownerless companies.
(No responsible owner checking performance of board and management)
Short termism
Tendency to under invest
Companies were not
allocating capital to tackle the major challenges faced by the UK in infrastructure and research and development.
Instead, paying their cash to shareholders by way of dividends or share buyback
programmes.
What is agency conflict?
Conflict arises in an agent–principal relationship when agents and principals have differing interests.
What are the main agency conflicts between shareholders and directors?
Shareholders
Want income and wealth to grow over long term
Directors/ Managers
Short term to annual increases in remuneration/ bonuses
What are agency costs?
Costs associated with maintaining the agent–principal relationship
Examples;
Bonding costs
Costs of monitoring the performance of the board and executive management
