Corporate Governance Lec 1

By: Saif Ullah PhD Finance Scholar

Lecture Outline
Defining Corporate Governance Difference Between Governance and Management Corporate Body Stakeholders Scope of corporate Governance Different Board Types Responsibilities of The Board Responsibilities of CEO and Senior Management Tools Available to Board Functions of Corporate Governance Objective of Corporate Governance

Tools Available to the Board for Better Corporate Governance Practices Corporate Governance as a filed of Study Approaches to CG Corporate Wrongs

Definition
According to OECD:
Corporate Governance is the system by which business
corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different

participants in the corporation, such as, the board, managers, shareholders

and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining these objectives and monitoring performance.

Another Definition
According to LaPorta et al., (2000), Corporate governance is a set of mechanisms through which outside investors protect themselves against expropriation by the insiders. They define the insiders as both managers and controlling shareholders.

Yet Another Definition

Corporate governance refers to the manner in which the affairs of a corporate body should be conducted in order to serve and protect the individual and collective interests of all stakeholders. (Safdar A Butt)

Governance and Management

How do these terms differ? Does Governance include Management? Or Does Management include Governance?

Governance
Strategic Setting Objectives Devising plans to achieve these objectives

Setting rules or parameters

Not directly concerned with routine affairs Protection of Interests of all stakeholders
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Management
Current Affairs Implementing the Plans Developing Suggestions and Alternatives Operational Matters

What is a Corporate Body?

Any Company is a corporate body. However, in a broader sense only public limited companies are taken to be the subject matter of CG. So far the thrust of CG is only on listed companies. Greatest emphasis is on those that are controlled by closed groups. In USA and Europe, companies are frequently run by minority shareholders. Hence, they require even greater degree of CG.
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Stakeholders in a Company
Management and Employees Lenders Suppliers and Clients Shareholders Society at large (this includes government)
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Classification of Stakeholders
Classified on basis of Role in the Company Classified on basis of opportunity to protect individual interests Those with Full Opportunity Controlling Shareholders Financial institutions with elaborate lending Contracts Those with a Partial Opportunity Institutional Investors with Board representation Those with Virtually No opportunity Minority and individual shareholders with no board Representation

Owners

Lenders

Buyers of listed bonds with trustee arrangements

Other lenders

Employees

Executive Directors

Senior Managers

Other employees on regular or contract terms Smaller suppliers and smaller clients

Business Associates

Suppliers who sell only on cash terms

Major Suppliers and clients with contracts

Society

Government

Public at large

Opportunity to protect individual interests

Managers and Employees have the greatest opportunity to protect their interest(s) Suppliers and Clients essentially go by each transaction or contract.

Lenders and Shareholders are most vulnerable.

Society depends entirely on law

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Shareholders
Controlling Groups (Internal Equity)

Outsider Shareholders (External Equity)

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Controlling Groups
If in Majority: Can protect their interest easily Needs monitoring

If in Minority:
Can protect their interest easily Needs highest degree of monitoring
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Outsider Shareholders
Institutional Investors Have some means of protecting their interest but still require protection Individual or General Public They require the greatest degree of protection, as they have virtually no means of protecting their interest.
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Lenders
Institutional Investors Have some means of protecting their interest through legal documentation, are relatively at lower risk but still require protection Individual or General Public They require the greatest degree of protection, as they have virtually no means of protecting their interest.
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Society at Large
Government (Taxes, Law and Order) Clients (Value for money) Community (Social Rights) How do we ensure that these stakeholders get their dues?

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Corporate Hierarchy
1. 2. Shareholders Management Board of Directors CEO Senior Managers 3. Employees

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Key Players
Shareholders (Voting power)

Board of Directors (Represents interests)

CEO (Delegated executive powers) Senior Managers (Delegated executive powers)

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Scope of Corporate Governance

Stakeholders Objectives / interests Tools / Techniques

Shareholders
Lenders Employees

Sustainable growth in net worth

Security / timely interest payments Continued employment at good terms General Management Legal frame work Professional Codes Industrial practices

Individual

Interests

Business Associates
Society

Continued business at good terms

Good citizenship by the company Continued profitable existence

Collective Interest of all stakeholders

Strategic Management Risk Management

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Different Board Types: The Good, Bad, and Ugly

Yes-men Board

Rubber Stamp Board

Good Old Boys Board

The Real Thing

Country Club Board Trophy Board

Paper Board

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Responsibilities of the Board

Oversight (Watchful and Responsible) Directional Advisory

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The Oversight Function

Approving and monitoring Companys Strategic Plans. Approving annual budgets and plans. Engaging outside auditors. Ensuring integrity of financial statements

Review of major operational activities.

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The Directional Functions

Setting Mission Statement, Vision Statement and Value Statement. Appointment of CEO / Senior Managers Planning for succession of these managers as well as outside directors Appointing various committees

Prescribing code of conduct for the management.

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The Advisory Function

General guidance to management. What is happening in the rest of the world. Specialized input in certain areas

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Responsibilities of CEO & Senior Management

Operating the company in an effective and ethical manner.
Drawing the strategic plans Drawing annual plans and budgets Selection of managerial and other staff Identifying business risks Financial reporting Internal Controls
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Code of Conduct for all staff

Issues in Corporate Governance

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Distinguish the role of board and management Composition of the board and related issues Separation of the roles of CEO and Chairperson Should the board have committees Appointment to the Board and Directors re-election Directors and executives remuneration Discloser of audit Protection of shareholders right Dialogue with institutional shareholders Should investors have a say in making a company Socially responsible corporate citizen.
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Tools Available
Composition of the Board
Independence Committees Incentives External Help

Government Intervention
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Distinguish the roles of Board and Management

Board

Select, decide the remuneration and evaluate and when necessary changes CEO Oversee the conduct of the company Review and where necessary approve companies plans and objectives Render advice Identify and recommend candidates to shareholders for selecting as BOD All other functions required by law

Day to day affairs Mangement of the company Prepare

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Composition of the Board

The Board should not represent interests alone. Experienced and qualified practitioners

Pool of talent covering all areas

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Independence
Independent from those who appointed them (?)

Management Stakeholders
No special interests (linked directorships) Meeting in absence of CEO or Chairman

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The Concept of Independent Directors

Relatively a new concept in Pakistan Only public sector companies have tried it Private sector companies rarely appoint independent directors No pool of professional directors available Regulators trying to popularize the concept
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The Role of Independent Directors

Providing Independent Professional View point Protecting the interest of all stakeholders Serving on Independent Committees

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Committees
Audit Committee CG Committee Other Committees

Ad hoc Committees (e.g. investigation)

Permanent Committees (e.g. HR) Remuneration Committee
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Functions of C G Committee
Compliance with CG Regulations Nominating Independent directors Monitor and Safeguard the independence of directors Review of all information to the Board from Management Drawing up CG Policy and processes
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Incentives to the Board

Financial (Carrots) Others (Carrots) Legal Obligations (Sticks)

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CG as a Field of Study
CG has existed for as long as companies have existed. But as a field of study it is less than 70 years old. Last 40 years:
A lot of activity in this field. Codes, reports and laws have come out. Number of research papers and theories have evolved.
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Approaches to Corporate Governance

There are three essentially approaches to governing a company:
Shareholders Approach Stakeholders Approach Enlighten Shareholders Approach

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Shareholders Approach to CG
Board of Directors of a company should govern the company in the best interest of its shareholders the owners of the company According to this approach, Board should formulate policies that aim at maximizing the shareholders value often at the expense of other stakeholders.
A company can improve its profits by paying poor wages to its workers. The interest of shareholders will be served at the expense of employees. A company can have more profits for its shareholders by not paying taxes. The interest of owners will be served at the expense of other stakeholders.
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Stakeholders approach to CG
According to this school of thoughts
Board of directors should formulate policies that provide for equal care of interest of all stakeholders Not practical because, Board of directors are elected by and accountable to shareholders.
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Enlightened Shareholders Approach

This approach is between the above discussed two approaches It requires that Board of Directors to work for the best interest of shareholders, but without misappropriating the interests of other stakeholders. This approach keeps balance between owners and stakeholders

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Which one is the Best Approach

Shareholders Approach Stakeholders Approach Enlightened Shareholders Approach

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Corporate Wrongs
Loss of ethics Earnings became every thing. Ineffective boards, smart executives. Huge remunerations for executive directors. Greed leading to disparity among senior managers and other employees. Short term goals and considerations. Collusion between directors and auditors. Pressure from institutional investors Loss of interest by small investors in big companies. In Pakistan, family control of companies.

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Some Scandals in USA

WorldCom
Overstatement of profits by $3.8 billion

Tyco
Evasion of sales tax on personal purchases.

Adelphia Communications
Illegal loan to founder

Peregrine Systems
Overstatement of earnings by $100 million.

Enron
Gross misuse of power by directors

Imclone Systems
Insider trading by CEO

Waste Management Inc.

Overstatement of earnings by $17 billion over 6 yrs.

Rite Aid
Accounting and securities fraud.
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Some Scandals in UK
BCCI Bank of Credit and Commerce International
Improper accounting and policies

Barings Bank
Ineffective internal controls, $1.4 billion loss

Mirror Group
Gross misappropriation of funds including pensions

Polly Peck
Diversion of funds to personal use.
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Some Scandals in Pakistan

Crescent Bank Islamic Investment Bank Bankers Equity Pakistan Steel Mills Indus Bank
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