Chapter 4 - Governance Risk Flashcards

1
Q

What is corporate governance?

A

Corporate governance = system by which org’s are directed and controlled – ensure org’s are run for benefit of shareholders and stakeholders

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2
Q

Organisation for Economic Co-operation and Development (OECD)

A
  • Assist governments
  • Provide guidance for stock exchanges, investors and companies
  • Deals mainly with problems that result from separation of ownership and management
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3
Q

The G20/ OECD Principles:

A
  • 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
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4
Q

International Corporate Governance Network (ICGN)

A
  • 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
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5
Q

The agency problem:

A
  • 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
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6
Q

The agency solution:

A
  • 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
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7
Q

Corporate Governance Disclosures:

A
  1. G20/ OECD:
    * Framework should ensure timely & accurate disclosure of all material matters regarding:
    Corporation, financial situation, performance, ownership and governance
  2. 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
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8
Q

Principles-based approach

A
  1. Features
    * Broad principles
    * Comply/ explain basis
    * Allows investors to decide if they agree that departure from the code is appropriate
  2. 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
  3. 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
  4. Where you find them
    * Legal jurisdictions where governing bodies of stock markets have prime role in setting standards
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9
Q

Rules-based approach:

A
  1. Features:
    * Comply with detailed rigid code
    * Non-compliance cannot be justified
    * Investors rely on third party to penalise non-compliance
  2. Benefits:
    * Allows easier compliance – rules are unambiguous and can be evidenced
    * Provides consistent minimum standard
  3. Drawbacks:
    * Allows no leeway or deviation
    * Enforcement can be difficult for situations not covered by rules
  4. Where you find them:
    * Legal jurisdictions that lay great emphasis on obeying the letter of the law
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10
Q

Responsibilities of the chair of the board and CEO:

A

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

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11
Q

Focus of the board:

A
  • Boards should meet regularly and frequently

* Members should take sufficient time to fulfil responsibilities

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12
Q

Membership of board - considerations of membership:

A
  • 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
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13
Q

Continual professional development:

A
* 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
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14
Q

Board performance appraisal:

A
* Directors should be individually appraised
Criteria to be included in appraisal:
* Independent and innovative
* Industry familiarity
* Active participation
* Positive and enthusiastic
* Business development
* CPD
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15
Q

Who is the company secretary:

A

Important figure in ensuring compliance with legal and other regulatory frameworks

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16
Q

Duties of secretary:

A
  • 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
17
Q

Board structures:

A
  1. Single board structure:
    * Referred to as unitary board
  2. 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
  3. Three tiers of boards:
    * Policy (strategic), functional (operational) and monocratic (symbolic for PR purposes)
18
Q

What are non-executive directors?

A
  • No executive (managerial) responsibilities or power

* Primary function is to consider and safeguard interest of stakeholders

19
Q

Roles of NEDs:

A
  • 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
20
Q

Specific roles of NEDs:

A
  • 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
21
Q

Advantages of having NEDs on board:

A
  • External expertise and experience
  • Wider perspective
  • Independent and objective view
  • Assurance to and confidence for third parties
22
Q

Key problems with NEDs:

A
  • Lack of true independence

* Lack of effectiveness

23
Q

Nomination committee:

A
  • 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
24
Q

Audit committee:

A
  • 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
25
Q

Arguments in favour of having a separate risk committee:

A
  • 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
26
Q

Directors’ remuneration should be sufficient to:

A
  • Attract and retain individuals

* Motivate them to achieve performance levels

27
Q

Factors that make up executive remuneration:

A
  • Fixed and variable elements
  • Immediate and deferred elements
  • Long-term and short-term elements
  • Cash and non-cash elements
28
Q

Remuneration committee:

A
  • 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
29
Q

Factors to consider for executive remuneration:

A
  • 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
30
Q

Remuneration disclosures:

A
  • 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
31
Q

Other examples of poor corporate governance

A
  • 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