Governance Factors Flashcards
issues address when considering company’s governance include but not limited to:
shareholder rights
the likely success of the intended company strategy, and the effectiveness of the leadership in place to deliver it
executive pay
audit practices
board independence and expertise
transparency or accountability
related-party transactions
-dual-class share structures
Corporate governance
- accountability
- alignment
- process by which a company is managed and overseen
- grows out of the legal system of the country in whcih the company is incorporated
- about people and processes
Good corporate governance should lead to strong business performance and long-term prosperity to the benefit of shareholders and the company’s other stakeholders
assessing the effectiveness of corp. governance systems within a firm gives investors insight into the accountability mechanisms and decision-making processes
support all critical decisions impacting the allocation of investors’ capital and the likely delivery of long-term value
Accountability
people need to:
- give authority and responsibility for decision-making
- held accountable for the consequences of their decision sand the effectiveness of the work they deliver
strong focus on board structure and independence of directors
chair and CEO the same person:
excessive concentration of powers and hamper the board’s ability to:
- exercise their oversight responsibilities
- challenge and debate performance and strategic plans
- set the agenda, both for board meetings and for the company as a whole
- influence succession planning
- debate execution remuneration
报酬
chain of accountability
beneficiaries asset owner fund manager corp. board management workforce
circle of accountability
mgmt beneficiaries/workforce asset owner fund manager corporate board - mgmt
Alignment comes down to the challenge of the agency problem
agency problem has been identified as
inevitable consequence of the separation of onwership and control
agency problem arises in that
the interests of these professional managers - the agents
may not always be wholly aligned with the interests of the owners of the business and so, the company may not be run in the way the owners wish.
corp. governance attempts to ensure that there’s greater alignment in the interests of the agents with the owners through incentives, but also through appropriate chains of accountability, to mitigate the potential negative consequences of the agency problem.
nominations committee
aims to ensure that the board overall is balanced and effective, ensuring that management is accountable
audit committee
oversees financial reporting and the audit, delivering accountability in the accounts.
The audit committee will also oversee internal audit, where this exists, and unless there is a separate risk committee will have responsibility for risk oversight.
Remuneration commitee
seeks to deliver a proper alignment through executive pay
at the most basis level - two tier boards with wholly non-executive supervisory boards overseeing management boards (Netherlands and Germany)
single- tier boards
some dominated by executive directors ( in japan)
a combined CEO and Chair (USA and Finance)
Cadbury Code model of recommendation
USA is the only country that does not have such a code
companies should comply or explain any n on-compliance has also been followed throughout much of the world.
Greenbury report
shocks around pay levels at newly-privatized utilities led to the greenbury report, which revised the corp. governance code in 1995.
increased the visibility of remuneration structures and pressed towards transparency over the KPIs that drive performance pay and the time horizons over which pay is released.
Sarbanes-Oxley Act 2002
Enron, Tyco and WorldCom scandals
lifted expectations for greater integrity in financial reporting and created the Public Company Accounting Oversight Board (PCABO) as the country’s audit standard setter and inspector, establishing a standard for auditor independence and challenge.
Shareholder engagement
active dialogue b/w companies and their investors, with the latter expressing clear views about areas of concern.
helps ensure that the bod are accountable for their actions, which hopefully in time helps to improve the quality of their decisio -making.
exploitation of minority shareholders
- they are not exploited by the dominant or controlling shareholders
class tests in UK listing regime: if
a transaction affects more than 5% of any of a company’s assets, profits, value or capital, there must be additional disclosures or
- it affects more than 25% of any of them then there must be a shareholder vote to approve the deal, based on detailed justifications
pre-emption先发制人
right for shareholder protection
-rights issue are cumbersome繁琐
if a company is issuing a relatively small # of shares, companies often seek authority at AGMs to issue relatively small proportion of shares (up to 5/to10%) non pre-emptively.
ensure that an investor has the ability to maintain its position in the company
soft pre-emption
an allocation equivalent to their existing shareholding but in a less formal, legalistic way
mechanism of dual-class shares
one of the classes is restricted to the founders of a company who receive multiple votes when compared to the class of shares that subsequent shareholders can invest in
Corp. Governance Code UK 2018
18 principles under 5 themes
- board leadership and company purpose
- division of responsibilities
- composition, succession and evaluation
- audit, risk and internal control
- remuneration
audit and remuneration committees
be populated solely by independent non-executive directors while such directors should form a majority of the nominations committee
Board independence as a key conerm
aim must be to have a board that is independent of the mgmt team and operates with independence of thought such that it can challenge both mgmt and previous decision-making at the company.
ICGN’s Global Governance Principles
set out an unusually complete investor persoective on independence criteria
2019 OECD corp. governance factbbok
diff. markets have varying expectations as to how long it takes for independence to erode.
Executive remuneration challenge
the directors’ obligation is to the success of the individual company
while shareholders in most cases have an eye to the broader market.
Executives pay structures:
- fixed salary
- benefits, including pension
- annual bonus
- share-linked incentive
reporting and transparency starts with oversight of audit committee
fair, balanced and understandable assessment of the company’s position and prospects.
- alternative performance metrics APMs
measures that are adj. forms of the accounting standard-approved measures of performance
inconsistency in reporting b/w narrative and financial reporting is
climate change
narrative reporting in response to TCFD TASK force on Climate-related Financial Disclosures
and other reporting std are not reflected in changes to the associated financial reporting.
IASB International Accounting Standard Board
sets the IFRs for most of the world
commented that the material climate issues should be reflected in financial reporting and the
PRI Principles for Responsible Investment have called on companies and their auditors to ensure this is delivered in practice.
European Securities and Markets Authority ESMA published a set of guidelines on the use of APMs in 2015
require consistency
IASB published Exposure Draft on Primary Financial Statement
allow the disclosure of a management-preferred measure of performance on the face of the income statement but alongside the permitted standard measures and with full reconciliation between them.
capital allocation is a function of history
a company retains a legacy business operation, even a sizeable operating business, when the opportunity for the company as a whole has in fact moved on.
capital structure is a crucial area of debate within the boardroom and between the board and its shareholders
Companies without debt on their balance sheets are often thought to be inefficient and failing to deliver the full extent of possible returns, maximizing return on equity,
Having a sustainable capital structure means
there must be some compromise b/w the extremes of maximizing returns on equity in the ST and making the company entirely robust from a downturn.
key financial resilience question which boards will need to answer is
how they strike the balance between full resilience and maximizing short-term returns.
US’s Foreign Corrupt Practices Act
UK’s Bribery Act
UK Act explicitly requires companies to maintain procedures to ensure that no bribery is carried out by agents or others on its behalf.
both are extraterritorial laws to prevent corruption
A ethical approach to business will encompass such issues as:
- corporate culture and having a set of expected behavioral standards for all staff , not tolerating inappropriate behaviors
- treating employees fairs, by upholding high standards in health and safety, human rights and avoiding modern slavery
- offering value to customers and avoiding discriminatory or other exploitative behavior, including avoiding collusion with rivals or other anti0competitive activity
- avoiding bribery and corruption, and fraudulent behavior
- paying suppliers appropriately and promptly, and not seeking unfair benefit from any dominants negotiating position
- developing appropriate relationships with local communities close to relevant business operations, and being ready to enter into dialogue on any key concerns they may have
- approaching any regulatory or political lobbying activity honestly and without seeking unfair advantage
- seeking to pay a fair and appropriate level of tax by approaching tax compliantly and recognizing that tax avoidance, not just evasion, can be inappropriate
- acknowledging that a company’s reputation is a valuable asset which can be harmed by unethical or inappropriate behavior by the business or it staff.
mutiple forms of single-tier board:
USA/France
single executive sits on the board and bears the responsibility of both chair and CEO
AU - CEO is the board’s single executive director not elected by shareholders
JP - single - tier board dominated by executive directors with only a small handful of non-executive directors
in most other countries - single tier boards have a few executive directors and a majority of non-executives, one of whom acts as chair
Best practices in organization structure have been identified and incorporated in glonbal initiatives such as
ICGN Principles and
Organization for Economic Co-operation and Development OECD Principles
OECD’s Corporate Governance Factbook
a good source for detail on the governance strucures and approaches in 49 jurisdictions.
Corporate governance in France
single-tier led by a combined chair/CEO, referred to as PDG President Director General
Standard require that 40% of the directors be female, and around a 3rd of the board should be employee representatives, ensuring that the stakeholder voice is clearly heard in the boardroom.
the only major market to require two audit firms to look at financial statements for AUDIT
2014 Florange Act France
unless 2/3 shreholder vote the contrary, French compnies would award double voting rights to long-standing shareholders, defined as those who have held shareholdings in particular way for at least 2 years.
two controversial cases:
1. at Renault, the French gov’t was a 15% shareholder and failed to persuade the company’s mgmt and its business partner, Nissan, not to propose an opt-out of the legislation at the 2015 AGM.
- Vivendi, the French media conglometrate,
Corporate governance in Germany - two-tier
distances shareholders from the operations and from holding mgmt accountable.
Shareholders appoint half the members of the supervisory board, and the other half are appointed from among the workforce .
inclusion of worker is caleld co-determination and enables boards to take long-term decisinos and to gain staff support even for difficult decision.
A symbnol of distancing os shareholders from decision-marking is the position on remuneration: the German code on corp. governance - the Kodex
insists that shareholders vote on mgmt remuneration structures through advisory votes only, with the actual decision making resting with the supervisory board.
the most controversial term of the Kodex is in Principle 7
“The Supervisory Board Chair should be available - within reasonable limits- to discuss Supervisory Board-related issues with investors.
Corp. Governance in Italy
single-tier
a single executive director and an independent chair
this framework arises from its history where most company shareholders bases have been dominated by a single shareholder or a group of shareholders.
The dominance of these shareholder groupws could mean that the nomination and election of the boards of such companies was entirely in their hands, leaving minority shareholders feeling unrepresented and facing wholly non-independent boards.
voto di lista approach was developed
to reassure minorities that their interests would be represented
a designated portion of the board (30%) reserved for minority shareholders only.
Itlian gov’ernance strucuture unique feature
there are election for statutory auditors, not independent , charged with assessing the accuracy of the financial statements.
the statutory auditors have a legal role to affirm the legality of certain actions by the board.
both the boards and the statutory auditors are elected for multi-year period (5), and are not subject to re-election.
Corp. Governance in Japan
Zaibatsu - financial clique refers to industrial and financial business conglometrates in Japan ,usually family controlled, whose influence and size allowed control over significant part of the Japanese conomy up until the end of WWII.
statutory auditors, in addition to the independent audit firm that assures the accounts.
alternative structure: board with committees -
non-executive directors
Japanese Corporate Governance Code 2015
is on the independence of non-executive directors rather than the value that they can bring to companies through their insights
focus purely on independence has led to the appointment of some individuals whose value in a business boardroom might be doubted, but a greater understanding of the role of the non-executive director.
discourage cross-shareholding due to less strategic thinking and innovation
Corp. governance in the Netherlands
AkzoNobel case
shows that other than in the case of a takeover, the influence of shareholders is strong: the longer-term outcome of the disputes was board change and a significant streamlining of the company and return of value to shareholders.
Corp. governance in Sweden
shaped by the dominance of major shareholders in the registers of many lending companies.
To mitigate disproportionate influence from the dominance of the share capital, Sweden has developed an unusual structure whereby the nomination committee at companies is not in fact a committee of the board, but is instead appointed from among the shareholders.
Corp. governance in the USA
is the only major market not to have a code of its own. due to fundamental issue of the US politics, relationship b/w federal and state.
attempts to establish market-led best practices -
1. The Commonsense Corporate Governance Principles
focus mostly on the inner workings of corp. governance, board effectiveness and accountability, also alignment through pay.
- The Investor Stewardship Group’s (ISG) Corporate Governance Principles for US Listed companies
more about the relationship of us companies with their shareholders rather than about their internal governance.
- The Corporate Governance Policies of the Council of Institutional Investors CII
more on indication of the likely positions of CII members on issues that might go to a shareholder vote or be subject to pubic policy debate.
SEC regulates governance
sets requirements for independence and skills of members of the audit committees of companies listed in the USA.
standards were set by Sarbanes-Oxley Act
Under Dodd-Frank legislation
- there is a resolution to consider executive remuneration, ‘say on pay’ vote
- ‘access to the proxy’ standard permits shareholders that fulfil certain criteria to add a candidate to the company’s formal proxy statement, avoiding the cost and administrative complexity of mounting a full proxy fight over board membership.
auditing
is a sampling process trying to identify anomalies that can then be followed up.
auditor checks and assures the financial statements in detail, must read this segment and should comment if they discover something that is inconsistent with what have learned through the process of audit
Independence of the audit firm is critical
scope of the audit
how many parts of the company the audit has covered and in what depth.
Materiality
the level of transaction or valuation below which the auditor spends little time.
75% of the overall materiality threshold is typical
50-60% low level of confidence in financial controls
lower might indicate a highly devolved organization
Key audit matters
best auditor reports highlight the key areas of judgement, and indicate whether the company’s reporting on them is conservative, neutral or aggressive.
auditor liability
unlimited
of the 3 ESG factors, governance is the element most often taken into consideration by traditional analysis.
has closest link to financial performance
62% of the studies showed a positive correlation b/w governance and corp. financial performance
58% of environmental studies and 55% of social studies showed the same correlation
integrate governance factors in to inv. decision-making
- threshold assessment
- a formal minimum criterion before they will consider making an inv. at any price
- risk assessment tool
when building corp. governance into valuation
typically done through recognizing negative gov. characteristics by way of adding a risk premium to the cost of capital
scandal that help set the context for the creation of the 1st corp. gov. code:
polly peck
Mirror Group Newspapers
Caparo
corp. gov in UK
Comply or explain
created by Cadbury code
executive pay is mostly like to include metric based on EGS on :
Annual bonus
two major scandals in europe in 2003 that led to a reassessment of the continent’s approach to gov:
Ahold and Parmalat
an audit firm in the role at an EU public company can stay for
up to 20 years
G in sovereign debt does not mean governance but
corruption
rule of law
regulatory effectiveness