Definitions and Issues in Corporate Governance Flashcards
What is meant by Corporate Governance?
“The system by which companies are directed and controlled” - The Cadbury Committee 1992
“To succeed in the long-term, directors and the companies they lead need to build an maintain successful relationships with a wide range of stakeholders” - UK Corporate Governance Code 2018
What are the main theories of corporate governance that form the basis of corporate governance practices?
- Shareholder Primacy Theory
- Agency Theory
- Stakeholder Theory
What is the Shareholder Primacy Theory?
This theory focuses on maximising the value to shareholders before considering other stakeholders such as employees, customers, suppliers and society as a whole.
What are the negatives of Shareholder Primacy Theory?
- Could lead to inappropriate Stewardship- where no single investor has a large enough stake in the company to act as a responsible owner, checking the performance and behaviour of the board and management of the company.
- Could lead to short termism -
Explain the agency theory and the 4 agency conflicts.
The agency theory is concerned with the separation of ownership and control of a company and the relationship and alignment between the shareholders as the owners and the managers running the company.
Conflicts:
1. Moral hazard - a manager has interest I receiving benefits from their position
2. Level of effort - managers may work less hard than they would if they were owners
3. Earnings retention- remuneration of managers is often related to the size of the company, leading to managers seeking to reinvest profits
4. Time horizon - managers may be more interested in short term results
What are the 4 theoretical approaches to corporate governance?
- Shareholder value approach - the directors should govern their company in the best interests of its owners
- Stakeholder approach (pluralist approach) - achieving a balance between economic goals and social goals
- The inclusive stakeholder approach - pursue the interests of shareholders in an enlightened and inclusive way
- The enlightened shareholder value approach - consideration of the interests of all stakeholders on the basis that this is in the best interest of the company.
What is stakeholder capitalism?
Stakeholder capitalism seeks to create shareholder returns by creating value for society as a whole, I.e. customers, employees, suppliers, communities and the environment.
What are the 4 principles of good corporate governance?
- Responsibility- those given authorities should accept full responsibility for the powers that they have been given and the authority they exercise. They should carry them out ethically with honesty, probity and integrity.
- Accountability- this refers to the requirement for a person or group of people in a position of responsibility to account for the exercise (or not) of the authority they have been given. They should provide honest information and not manipulate facts.
- Transparency- this refers to the ease with which an outsider is able to make a meaningful analysis of an organisation and its actions.
- Fairness - this refers to the principle that all key stakeholders should be treated fairly when decisions are made or actions taken by the organisation.
What are 5 benefits of a company having a good reputation?
- Improving relations with shareholders
- Creating a more favourable environment for investment and access to capital
- Recruiting and retaining the best employees
- Attracting the best business partners, suppliers and customers
- Reducing barriers to development in new markets
- Securing premium prices for products, and/or services
- Minimising threats of litigation and of more stringent regulation
- Reducing the potential for crises
- Reinforcing the organisation’s credibility and trust for stakeholders.
Explain the difference between ‘comply or explain’ and ‘apply and explain’ and give examples of the codes using these approaches.
Comply or explain - where the company believes 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 e.g. UK Corporate Governance Code
Apply and explain - avoids tick box mentality and focuses organisation to apply principle and explain how e.g. Wates Principles
What are 5 benefits to adopting good corporate governance practices?
- Long-term sustainability
- Improved access to external financing
- Lower cost of capital
- Improved operational performance
- Increased Firm valuation
- Improved share performance
- Reduced risk of corporate crisis and scandals
- Effective decision making
- Improved oversight, monitoring and evaluation
- Succession planning
- Ethical behaviour- an anti-corruption tool
What are the potential consequences of weak governance practices, providing examples?
- Corporate failure e.g. accounting fraud, lack of knowledge skills and experience on the board (e.g. Barings Bank), dominant personalities (e.g. Maxwell), failure to understand and manage risk (e.g. global financial crisis, Carillion).
- Reputational problems e.g. unethical business practices (e.g.volkswagon dieselgate), lack of transparency and disclosure (e.g. Olympus), poor relationship between the board and shareholders (e.g. sports direct), inappropriate remuneration and reward systems for directors and senior executive (e.g. Enron, Carillion).
- Excessive regulation - new laws/regulations are usually introduced in response to scandals that resulted from weak governance practices.
- Lack of investment- evidence shows investors place importance on good governance practices.
- The development of shareholder representative bodies e.g. the Investment Association- for monitoring the corporate governance practices of the companies they invest in.
- A focus on regulating and disclosing senior executive pay
- The establishment of powerful regulators such as the US securities and exchange commission (SEC).
What does a corporate governance framework typically consist of?
- Applicable laws, regulations, standards and codes - Companies Act, UK Corporate Governance Code 2018, principles based approach
- Organisation’s constitution - articles of association
- Structures - matters reserved for the board, audit committee, risk Committee, nomination Committee, remuneration Committee, role of Chair, CEO and NEDs
- Policies - Code of ethics, ABC policy, conflict of interests, related party transactions, whistleblowing, insider trading, IT policy, remuneration policy, etc.
- Procedures - strategic planning, business continuity, risk management and internal controls, computer data and security, health and safety, procurement and recruitment.
