Chapter 5 - Governance Factors Flashcards
Corporate Governance
Process and structure of overseeing the business and management of a company.
Key Points for Company’s Governance
(8 Points)
- shareholder rights
- success of intended company strategy, effectiveness of leadership to deliver it
- executive pay
- audit practices
- board independence and expertise
- transparency or accountability
- related-party transactions
- dual-class share structures
Accountability in Corporate Governance
(5 Points)
People need to be:
* given authority and responsibility to make decisions
* held accountable for consequences of decisions and effectiveness of work they deliver
Accountability of the accounts for financial and business performance of directors.
Diversified skill sets of directors to facilitate meaningful discussion and debate.
Engagement helps to ensure that board directors are accountable for actions.
Issues from combined Board Chair and CEO
(5 Issues)
Combined Board Chair and CEO hampers ability to:
* exercise their oversight responsibilities
* challenge and debate performance and strategic plans
* set the agenda, for both board meetings and company as a whole
* influence succession planning
* debate executive remuneration
Alignment in Corporate Governance
(7 Points)
Executive pay structure to align interest of management with interest of owners and avoid agency problem.
Agency Problem:
* professional managers (agents) may have different interest than the owners of the business (shareholders)
* through incentives and appropriate chains of accountability, corporate governance attempts alignment of interest between agents and owners
Alignment between Majority and Minority Shareholders:
* may demand additional disclosures or shareholder votes for major transactions by listed companies
* pre-emption rights - rights for existing shareholders to maintain position by buying new issued shares
* dual-class shares - multiple votes, usually for founders (common for technology businesses)
3 Key Board Committees
- Nominations Committee: ensures that board is overall balanced, effective and management is accountable
- Audit Committee: oversees financial reporting and audit to ensure accountability in accounts. Also oversees internal audits and risk (if no Risk Committee). Meet minimum twice a year.
- Remuneration Committee: seeks to deliver proper alignment of interests through executive pay
Cadbury Report
(5 Points)
- Issued by Cardbury Committee, which was formed in May 1991, after the Caparo and Polly Peck scandals
- Issued in 1992 in UK
- World’s first corporate governance code
- Recommendations which companies should “Comply or Explain”
- Many recommendations are still best practice today
Board Structures in different Countries
(2 Structures, 4 Points)
Two-Tier Boards:
* non-executive supervisory board overseeing management boards (e.g. Germany, Netherlands)
Single-Tier Boards:
* dominated by executive directors (e.g. Japan)
* combined CEO and Chair (e.g. USA, France)
* between above 2 models (e.g. UK)
Country with no official Corporate Governance Code
USA, due to coporate law being set at the individual states level.
“Comply or Explain”
Adherence to relevant standards or issuance of thoughtful and intelligent discussion how board deliver on underlying principle.
Greenbury Report
(3 Points)
(UK)
* following shocks around pay levels at newly privatized utilities
* revised UK Coporate Governance Code in 1995
* increased remuneration structure visibility, KPI-performance pay transparency and time horizons over which pay is released (min. 3 years for long-term schemes)
Sarbanes-Oxley Act
(3 Points)
(US)
* from 2002, following Enron, Tyco and WorldCom scandals
* lifted expectations for greater integrity in financial reporting
* created Public Company Accounting Oversight Board (PCAOB) as country’s audit standard setter and inspector
Impact of Ahold and Parmalat Failure
(3 Points)
- 2003 in Europe
- heightened standards of corporate governance
- led to board and auditor independence across Europe
Impacts of 2008 Financial Crisis
(3 Points)
- renewed focus on corporate culture and executive pay, and questions around audit
- creation of stewardship codes
- led to 2010 Dodd-Frank Act in USA (tightened standards for banks)
Dodd-Frank Act
(3 Points)
- following 2008 Financial Crisis
- established 2010 in USA
- tightened standards for Banks
Impacts of Olympus Scandal
(3 Points)
- 2011 in Japan
- US$ 1,5bn in losses were hidden
- together with Toshiba Scandal, helped fuel rapid advancements of Japanese Governance Standards
Current UK Corporate Governance Code
(6 Points)
Published in 2018.
18 Principles under 5 Themes:
* board leadership and company purpose
* devision of responsibilities
* composition, succession and evaluation
* audit, risk and internal control
* remuneration
Audit and Remuneration Committee Structure
Will be populated soley by independent non-executive directors.
Nominations Committee Structure
Should be formed by majority of independent non-executive directors.
Board Structure, Diversity, Effectiveness and Independence
(3 Points)
- ideally, board membership should have a right mix of people with diversified and relevant skills, and right board culture to allow board members to contribute effectively
- training for board members and board appraisals can help to address areas with lack of competency
- board independence - board independent from management team, and operates with independence of thought so it can challenge management and previous decision-making
ICGN’s Global Governance Principles
(6 Principles)
Independance Criteria suggesting questions to an Individual who:
* had been executive at the company or a subsidiary, or an advisor to the company, without appropriate gap between employment and joining the board
* receives, or has received, incentive pay from the company, or receives fees additional to director fees
* has close family ties with any of the company’s advisers, directors or senior management
* hold cross-directorships or has significant links with other directors through involvement in other companies or bodies
* is a significant shareholder in the company, or is an officer of, or otherwise associated with, a significant shareholder, or is a nominee or formal representative of a shareholder or the state
* has been a director of the company for a long enough period that their independence may have become compromised (norm 8-12 years)
Typical Executive Remuneration
- fixed salary, usually increased annually
- benefits, including pension scheme
- annual bonus, often linked to achievment of KPIs, including ESG factors
- share-linked incentives, linked to long-term performance (e.g. over 3 years)
Corporate Governance Reporting and Transparency
(3 Points)
- board should present a fair, balanced and understandable assessment of the company’s position and prospects
- companies may mask weakening performance through “alternative performance metrics” (APMs)
- strong audit committee should strictly oversee the reporting process to ensure fair and balanced reporting. Strong and challenging auditor should intervene to prevent misleading of investors and highlight inconsistencies between financial statements and company reporting