Chapter 1a - Approaches to Corporate Governance Flashcards
What are the 4 Main Approaches to Corporate Governance?
The 4 main approaches to Corporate Governance are:
- The shareholder approach – Directors should govern the company in the best interest of its shareholders
- The stakeholder approach – achieving a balance between economic goals and social goals
- The enlightened approach – Pursues the interest of shareholders in an enlighten and inclusive way. 172 CA 2006
- The integrated approach – consideration of the interests of all stakeholders on the basis that this is in the best interest of the company.
The first 2 are theoretical frameworks.
What is meant by Shareholder value approach?
States that the board of directors should govern their company in the best interest of its owners, the shareholders.
The main objective is to maximise the wealth of a company’s shareholders through share price growth and dividend payments, whilst confirming to the rules of society as embedded in laws and customs.
Argued that pure shareholder value approach is not sustainable in the long run as companies are not islands and have to interact with different stakeholder groups, the interest of which they will have to consider if they are going to be successful and sustainable in the long run.
What is meant by Stakeholder approach?
Is a pluralist approach to corporate governance that states that companies should have regard to the views of all stakeholders, not just shareholders which includes the public at large.
When taking decisions, the board should try to balance the interests of all the company’s stakeholders.
It takes into account the social and financial interests of employees, creditors and consumers in their decision making. Therefore, there should be a balance between economic and social goals and between individual and communal goals.
Opponent of the stakeholder approach argue that if companies were to take into account all stakeholders’ conflicting views, the would never come to a decision.
What is meant by the Inclusive stakeholder approach? and
What is the integrated approach?
- The Board should consider the legitimate interests and expectations of all key stakeholders on the basis that this is in the best interest of the company.
- The inclusive stakeholder approach reflects African needs and culture. It incorporates the concepts of sustainability and ‘good citizenship’ (ethics and corporate social responsibility) into the definition of corporate governance as part of the fight against corruption, poverty and health issues such as TB, malaria and HIV/AIDS. The concepts of ethics and corporate social responsibility are often seen in the shareholder value approach as complementary disciplines
Integrated approach:
- The integrated approach – consideration of the interests of all stakeholders on the basis that this is in the best interest of the company.
What is the Enlightened Shareholder value approach?
Suggest that boards when considering actions to maximize shareholder value should look both to the short term and long term and consider the views of and impact on other stakeholders in the company, not just shareholders.
Introduced in the UK by the companies Act 2006 which imposes a statutory duty on directors to ‘promote the success of the company in the benefit of its members as a whole and in doing so have regard to:
a. A likely consequences of any decision in the long term
b. The interests of the companies employees
c. The need to foster the company’s business relationship with suppliers, customers and others, the impact of the company’s operations on the community and the environment
d. The desirability if the company maintain a reputation for high standards of business conduct
e. The need to act fairly as between members of the company creditors are not included in the list.
CA2006 specifically states that the duty imposed on directors to promote the success of the company overrides any laws or regulations requiring the director to act in the interests of creditors of the company.
What are the 2 main challenges to the Enlightened Shareholder Value Approach?
Challenges:
2 main challenges in practice with how the enlightened shareholder value approach has been adopted in the UK. Although directors now have a duty to consider the interests of a wider stakeholder group there is:
a. no provision in CA2006 to enforce the duty.
b. No guidance as to how directors should take other stakeholder interest into account, particularly conflicting ones.
The companies (miscellaneous reporting) regulations 2018 seeks to address these challenges by providing guidance and reporting requirements on how directors are taking into account their decision making the interests of employees and fostering relationships with customers, suppliers and others.
What is the Distinction between stakeholder (pluralist) & inclusive shareholder theory?
The distinction between stakeholder (pluralist) theory and the inclusive shareholder theory is that:
a. Stakeholder (pluralist) theory has all the interest of the stakeholders
b. Inclusive Shareholder theory has the best interest of the company
Refer to table and notes as the differences between the 2. Chapter 1, page 9.
What is the difference between the Enlighted shareholder value and the 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 considers the views of and impact on other stakeholders in the company, not just shareholders.
The views of stakeholders are only considered in the interests of when shareholders choose to do so.
This differs from the stakeholder and stakeholder inclusive approaches where boards balance the conflicting interests of stakeholders in the best interests of the company.
Which approaches 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 approach.
Which approaches put shareholders first?
The shareholder value and enhanced shareholder value approaches put shareholders first.
‘The agency theory of corporate governance states that the agent and principal may have conflicting interests. Explain these conflicting interests, using examples.’
(5 marks)
Q1, June 2022
The agency theory of corporate governance is that an agent-principal relationship exists in a company where there is a separation of ownership and control, with the shareholders being the principal and the directors or managers being the agent.
The director or manager (manager), as agent, is expected, to promote value for the shareholders, as principal, above their own interests, but this gives rise to conflicts because the managers (that is the agent) and the shareholders (that is the principal) can have differing interests.
Examples of these conflicting interests are:
- Shareholders are likely to be focusing on the long-term growth in the value of the company, and on the value of their shareholding. In contrast, the managers may be focused on their short term remuneration and may not stay with the company for more than a few years.
- There is a moral hazard because a manager’s incentive to maximise the benefits that come from their role is higher when they have no, or only a few, shares in the company.
- Managers may work less hard than they would if they were the owners of the company which could result in smaller profits for the company.
- The remuneration of managers is often related to the size of the company rather than its profits. This gives managers an incentive to increase the size of the company, rather than to increase the returns to the company’s shareholders.
Explain how the enlightened shareholder value approach, in section 172 of the Companies Act 2006, attempts to reconcile the shareholder value and stakeholder approaches to corporate governance.
(5 marks)
- The shareholder value approach to corporate governance is the view that the Board of directors of a company should govern the company in the best interests of its shareholders
-The stakeholder value approach requires the Board of directors to have regard to the views and interests of all of the company’s stakeholders, including for example its employees and the local community, and not just its shareholders.
-The enlightened shareholder value approach in section 172 of the Companies Act 2006 combines these two approaches by imposing a duty on directors to act in the way they consider would be most likely to promote the success of the company for the benefit of its members/shareholders as a whole and, when doing so, to have regard to the matters listed in that section.
-The matters listed include the likely consequences of any decision in the long-term and the impact of the decision on a range of stakeholders, including for example employees, customers and the community.
-The enlightened shareholder approach does not require the directors to act for the benefit of any other stakeholders, or to balance the interests of different stakeholders, but requires them to determine, having taken into account those stakeholder interests, what action would best promote the success of the company for the benefit of the shareholders as a whole.
Accountability and transparency are core principles of corporate governance. Explain why transparency is one of the core principles and how it can aid accountability. (5 marks)
Q1, Nov2020
- Transparency is a core principle of corporate governance because:
Transparency is needed in order for shareholders to be able to assess a company’s Board and how it operates. - Transparency and openness helps to create trust between the company and its shareholders and other stakeholders.
- Transparency can drive better behaviour by companies because they are being judged by the behaviours that are disclosed.
- Timely and accurate disclosure is needed in order for a fair market to operate in the securities of traded companies.
Transparency can aid accountability because:
1) The provision of information can help stakeholders to hold companies to account.
2) It requires companies to set out who is accountable for what so that stakeholders are clear who should be held responsible.
Explain the differences between the governance of a company and the management of a company. (5 marks)
1) Governance means ensuring that the business of a company is conducted properly , whereas management means running the business.
2) The governance of an organisation includes establishing its structures, policies and procedures.
3) Corporate governance can be defined as the system by which a company is directed and controlled.
4) The management of a company relates to how it operates its business and includes the day-to-day operational management of the business.
5) It is the Board of directors who are responsible for the governance of a company and they cannot delegate that responsibility.
6) The Board of directors normally include non-executive directors, who are not employees of the company and so, although they are responsible for its governance, they do not manage the company.
7) In contrast, the management of a company is led by the executive directors and can be delegated to a management team.
Principle B of the UK Corporate Governance Code requires the Board of a company to establish
the company’s purpose. Explain why a company’s purpose is important
- A company’s purpose means the reason that it is in business.
- Everything a company does should stem from its organisation’s purpose because its purpose sits at the top of its corporate governance framework.
- The company’s purpose should help the Board to make decisions about its strategic goals and its consideration of risk.
- Setting out a company’s purpose helps to ensure that the company can focus its efforts on
being successful in the long-term, taking into account all of its stakeholders. (1)
It also helps to set the organisation’s governance framework of policies and procedures. - It gives clarity of purpose for the Board, management, employees and investors. (1)
The company’s culture needs to align with its purpose, as stated in Principle B of the UK Corporate Governance Code. - This is supported by Provision 2 of the Code which states that if the Board is not satisfied
that the company’s policy, practices or behaviours are not aligned with its purpose, it should ensure that corrective action is taken by management. - The UK Corporate Governance Code also states, in Principle P and Provision 40, that
executive remuneration should be aligned to the company’s purpose and values, and
should drive behaviours which are consistent with them. (1)
