Chapter 1 - Test yourself Q&A's - Definitions and issues in corporate governance Flashcards
What is the main difference between the agency and stakeholder theories?
Agency theory deals with the relationship between shareholders and directors where there is separation between ownership: the shareholders playing the part of the principal and the directors and managers playing the part of the agent.
Challenges associated with the agent - principal relationship occur. These relate to conflicts of interest and the costs associated with avoiding and managing those conflicts.
The stakeholder theory, in direct contrast to the agency theory, states that the purpose of corporate governance should be to meet the objectives of everyone that has an interest in the company.
How does agency / stakeholder theories affect the objectives of the companies?
A company whose governance is based on the agency theory, will be focusing on reacting and maintaining shareholder value through managing conflicts of interest and the costs associated with avoiding / managing those conflicts. This is usually reflected in a focus on financial objectives such as return on investment, sales and profit targets. Objectives also tend to be short term.
In contrast, stakeholder theory requires boards to balance the interests of the different stakeholder groups when making decisions, deciding on a case by case basis which interests should take priority in a particular circumstance. This means that non-financial objectives, such as employee relations or limiting environmental impact would be considered. Objectives tend to be longer term.
How can a company manage conflicts of interest between shareholders and directors and managers?
Agency theory says that companies should use corporate governance practices to avoid or manage these conflicts. Examples of how companies can achieve this are:
- The use of long term incentive share award or stock option schemes based on total shareholder return to align the interests of shareholders and management
- Adoption of conflict of interest and related party transaction policies
What is the difference between the enlightened shareholder value and inclusive stakeholder approaches to corporate governance?
The enlightened shareholder value approach proposes that boards, when considering actions to maximise shareholder value, should look to the long term as well as the short term and consider the views of and impact on other stakeholders in the company, not just shareholders. The views of other stakeholders are, however, only considered in so far as it would be in the interest of shareholders to do so.
This differs from the stakeholder inclusive approaches where boards balance the conflicting interests of stakeholders in the best interests of the company.
Which approach see boards taking a longer term view in decision making?
Enhanced shareholder value, stakeholder, and inclusive stakeholder approaches tend to take a longer - term view than the shareholder value approach.
Which approach puts shareholders first?
The shareholder value and enhanced shareholder value approaches put shareholders first.
What are the pros and cons of a rules based approach versus a principles based approach to corporate governance?
Critics of the rules-based approach argue that it only works:
- Where the challenges faced by companies under the purview of the regulation are substantially similar, justifying a common approach to common problems and
- If the rules and their enforcement efficiently and effectively direct, modify or preclude the behaviours they are aimed at affecting.
The benefits of such a system is that it sends a message out to owners, potential investors and other stakeholders that the country take seriously their protection from nefarious practices by those who managing and overseeing the organisation’s they are investing in or dealing with, In reality, it is the enforcement of the riles that achieves this and in many countries, enforcement is weak.
What is the comply or explain rule for listed companies?
Comply or explain refers to the system whereby a company is asked to comply with voluntary principles-based code of best practices. 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.
The company’s shareholders and shareholder representative bodies are then expected to assess whether the explanation is acceptable or not. The UK corporate governance code works on the premise of a ‘comply or explain’ code.
How do “comply and explain” and “apply and explain” differ?
The term ‘apply and explain’ was adopted in the South African King Code for two main reasons.
- The code for the first time, applied to all types on entities regardless of their form of establishment or incorporation. These entities under a ‘comply or explain’ regime would only have had the option of complying or not. As many of the entities were not listed companies, which the corporate governance practices had originally been designed for, it was felt that the regime would put off many entities from adopting good corporate governance. Asking them how they were ‘applying’ the principles within the code was a less harsh way of reporting on what they were doing as they did not have to give a yes or no answer, they could tell a story of how corporate governance was being adopted in their organisations.
- To avoid a mindless response, to corporate governance recommendations within the code. There was a feeling amongst many stakeholders that the ‘comply or explain; regime was leading to companies adopting a tick-box approach to corporate governance, adopting the provisions without considering whether they were suitable for their companies or not.
Why is knowing your purpose important for an organisation?
Knowing the organisation’s purpose is very important as everything stems for it: the organisation’s vision, mission, strategic goals and governance framework, including risk management. It is only through knowing the purpose of the organisation and focusing efforts and resources achieving that purpose that organisations can be successful in the long run.
If an organisation has clarity of purpose then its employees know what they are working towards, investors know what they are investing in and boards and management know how to focus their resources and manage their risks.
For the company secretary, knowing the organisation’s purpose helps set up the organisations governance frameworks of structures, policies and procedures.
What is the difference between compliance and governance?
Compliance answers ‘what is required’. It leads to an organisation adopting the appropriate structures, policies and procedures. On its own, it is a purely box-ticking exercise.
Governance answers ‘how do we make this effective.’ The company secretary needs to ensure that the infrastructure is appropriate for the organisation, 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, sustainable organisation. If the infrastructure is not appropriate for the organisation, then the anticipated ‘cultures’ will not be developed. Those within the organisation will develop their own cultures which, as they are not being managed, often led to bad practices such as failure to follow policies, the misuse of resources, breakdown of important relationships etc. This in turn threatens the performance and long term sustainability of the organisation.
