Chapter 4 - Governance Risk Flashcards
What is corporate governance?
Corporate governance = system by which org’s are directed and controlled – ensure org’s are run for benefit of shareholders and stakeholders
Organisation for Economic Co-operation and Development (OECD)
- Assist governments
- Provide guidance for stock exchanges, investors and companies
- Deals mainly with problems that result from separation of ownership and management
The G20/ OECD Principles:
- Ensuring basis for effective corporate governance framework
- Rights and equitable treatment of shareholders and key ownership functions
- Institutional investors, stock markets and other intermediaries
- Role of stakeholders in corporate governance
- Disclosure and transparency
- Responsibilities of the board
International Corporate Governance Network (ICGN)
- Guidance for corporate boards
1. Board role and responsibilities
2. Leadership + independence
3. Composition and appointment
4. Corporate culture
5. Risk oversight
6. Remuneration
7. Reporting and audit
8. Shareholder rights
The agency problem:
- Principal = shareholders Agent = Directors, managers, employees
- Agency theory assumes that agent and principal act in their own self-interest which may conflict
- Agency problem derives from the principals not being able to run the org and therefore having to rely on agents to do so for them
- Separation of ownership can cause issues if there is a breach of trust by directors either by intentional action, omission, neglect or incompetence
The agency solution:
- Remove directors from office – undesirable due to inevitable fallout
- Exercise control – incur agency costs (consultants and external auditors), can be time consuming and difficult due to info asymmetry
Corporate Governance Disclosures:
- G20/ OECD:
* Framework should ensure timely & accurate disclosure of all material matters regarding:
Corporation, financial situation, performance, ownership and governance - ICGN:
* Oversee timely and high quality disclosures for investors and other stakeholders relating to:
Financial statements, strategic and operational performance, corporate governance and material environmental and social factors
Principles-based approach
- Features
* Broad principles
* Comply/ explain basis
* Allows investors to decide if they agree that departure from the code is appropriate - Benefits
* Greater flexibility and potential cost savings
* Applies across different legal jurisdictions (more effective for multinationals)
* Forces boards and shareholders to think about consequences of governance arrangements - Drawbacks
* So broad that it offers very little use as guide to best practice
* Investors cannot be confident of consistency in approach
* Incorrectly viewed as optional - Where you find them
* Legal jurisdictions where governing bodies of stock markets have prime role in setting standards
Rules-based approach:
- Features:
* Comply with detailed rigid code
* Non-compliance cannot be justified
* Investors rely on third party to penalise non-compliance - Benefits:
* Allows easier compliance – rules are unambiguous and can be evidenced
* Provides consistent minimum standard - Drawbacks:
* Allows no leeway or deviation
* Enforcement can be difficult for situations not covered by rules - Where you find them:
* Legal jurisdictions that lay great emphasis on obeying the letter of the law
Responsibilities of the chair of the board and CEO:
Chair of the board:
* Providing leadership to the board
* Ensuring board receives adequate and timely info
* Ensuring effective communication with shareholders
* Facilitating effective contribution from NEDs
* Taking lead in providing induction for new directors and board development
* Meeting with NEDs without executives
* Facilitating board appraisal
* Encouraging active engagement by all members of board
CEO:
* Providing leadership to organisation
* Providing accurate + timely info
* Communicating effectively with stakeholders
* Facilitating effective implementation of board decisions
* Co-operating in induction and development of board members
* Co-operating by providing any necessary resources + info
* Co-operating in board appraisal
* Co-operating with all members of board
Focus of the board:
- Boards should meet regularly and frequently
* Members should take sufficient time to fulfil responsibilities
Membership of board - considerations of membership:
- Size – requires balance between benefits of varied views and opinions and need for coherence of decision making
- Inside/outside mix – split between executive decision-making directors and NEDs
- Diversity mix – gender, ethnicity, backgrounds and experience
Continual professional development:
* CPD procedures ensure that directors are adequately prepared for their roles CPD covers: * Strategic planning * Financial management * Human resource issues * Risk management * Legal and regulatory issues * Audit practice and procedures
Board performance appraisal:
* Directors should be individually appraised Criteria to be included in appraisal: * Independent and innovative * Industry familiarity * Active participation * Positive and enthusiastic * Business development * CPD
Who is the company secretary:
Important figure in ensuring compliance with legal and other regulatory frameworks
Duties of secretary:
- Arranging meetings of shareholders and board of directors – also included communicating decisions to the staff or outsiders
- Signing, authenticating and maintaining documents and registers
- General administrative duties = maintaining accounting records, corresponding with legal advisers, tax authorities, trade associations and administering the head office
Board structures:
- Single board structure:
* Referred to as unitary board - Dual board structure:
* Supervisory board = overall responsibility for comp’s governance and strategic issues, independent board and should have broad stakeholder representation
* Management board = daily running of comp - Three tiers of boards:
* Policy (strategic), functional (operational) and monocratic (symbolic for PR purposes)
What are non-executive directors?
- No executive (managerial) responsibilities or power
* Primary function is to consider and safeguard interest of stakeholders
Roles of NEDs:
- Strategy = contributing to and challenging direction of strategy
- Scrutiny = scrutinise performance of management
- Risk = need to satisfy themselves that financial info is accurate and financial controls and systems of risk management is robust
- People = determine appropriate levels of remuneration for executives and appointing/ removing senior managers
Specific roles of NEDs:
- Father confessor = someone with experience in whom chair and other directors can confide
- Oilcan = intervening in cases of stalemate to make board run more effectively
- High sheriff = taking steps to remove chair, CEO or other directors who have gone rogue
Advantages of having NEDs on board:
- External expertise and experience
- Wider perspective
- Independent and objective view
- Assurance to and confidence for third parties
Key problems with NEDs:
- Lack of true independence
* Lack of effectiveness
Nomination committee:
- Responsible for recommending appointments of new directors
- Majority of members should be independent NEDs
- Should consider balance between NEDs and executives on the board, skills and knowledge possessed and desirable size
- Appointments should be made on merit using objective criteria
Audit committee:
- Members should be independent NEDs and they should be financially literate
- At least one member should be financial expert
- Responsible for liaising with external audit, supervising internal audit and reviewing annual accounts and internal controls
Arguments in favour of having a separate risk committee:
- Risk committee can be staffed by executive directors, audit committees must be staffed by NEDs
- Audit committee will focus mainly on financial risk whereas risk committee will consider wider range of risks
- Risk committee will promote awareness and drive changes in practice whereas audit committee will have a purely monitoring role
- Risk committee can carry out specific investigations whereas audit committee is more likely to investigate accounting systems
Directors’ remuneration should be sufficient to:
- Attract and retain individuals
* Motivate them to achieve performance levels
Factors that make up executive remuneration:
- Fixed and variable elements
- Immediate and deferred elements
- Long-term and short-term elements
- Cash and non-cash elements
Remuneration committee:
- Determines general policy on remuneration of executive directors, the chair and senior management
- Amounts paid to NEDs are agreed by the board
- Should consist of NEDs
- Remuneration should be connected to performance, be best practice and based on market factors
Factors to consider for executive remuneration:
- Clarity – transparent and fair
- Simplicity – easy to understand
- Risk – avoiding remuneration that affects the comp’s reputation
- Predictability – no surprises
- Proportionality – link between reward, strategy and company performance
- Culture – aligned to the values and strategy of the company
- Service contracts greater than 12 months need to be carefully considered and should ideally be avoided
Remuneration disclosures:
- Remuneration policy and how it fits into comp strategy
- Detailed arrangements for individual directors
- Performance conditions attached to remuneration packages
- Duration of contracts, notice periods and termination payments
- Level of engagement with shareholders and rest of comp’s staff regarding executive remuneration
Other examples of poor corporate governance
- Dominance of the org by one individual
- Ignoring rules and formal controls in place
- Org’s run for benefit of management not shareholders or other stakeholders
- Excessive pay and benefits
- Lack of effective scrutiny by auditors and stakeholders
