cg Lec 1

Corporate GovernanceLec 1 By:Saif UllahPhD 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?

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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

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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.9

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 Rolein the Company

Classified on basis of opportunity to protect individual interests

Those with Full Opportunity

Those with aPartial Opportunity

Those withVirtually No opportunity

OwnersControllingShareholders

Institutional Investorswith Board representation

Minority and individualshareholders with no boardRepresentation

LendersFinancial institutionswith elaborate lendingContracts

Buyers of listed bondswith trustee arrangements

Other lenders

Employees Executive Directors Senior ManagersOther employeeson regular orcontract terms

Business AssociatesSuppliers who sellonly on cash terms

Major Suppliers andclients with contracts

Smaller suppliers and smaller clients

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. Shareholders2. Management Board of Directors CEO Senior Managers3. 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 Sustainable growth in net worth

General ManagementLegal frame workProfessional CodesIndustrial practices

Lenders Security / timely interest payments

Employees Continued employment at good terms

Business Associates

Continued business at good terms

Society Good citizenship by the company

Collective Interest of all stakeholders

Continued profitable existenceStrategic ManagementRisk Management

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Ind

ivid

ual

Inte

rest

s

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Different Board Types: The Good, Bad, and Ugly

‘Yes-men’ Board‘Rubber Stamp’

Board

‘Country Club’ Board

‘Good Old Boys’ Board

‘The Real Thing’

‘Paper’ Board

?‘Trophy’ Board

Responsibilities of the Board • Oversight (Watchful and Responsible)• Directional• Advisory

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The Oversight Function

Approving and monitoring Company’s Strategic Plans.

Approving annual budgets and plans.

Engaging outside auditors.

Ensuring integrity of financial statements

Review of major operational activities.23

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.24

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

Code of Conduct for all staff26

Issues in Corporate Governance

1. Distinguish the role of board and management2. Composition of the board and related issues3. Separation of the roles of CEO and Chairperson4. Should the board have committees5. Appointment to the Board and Directors re-election6. Director’s and executives remuneration7. Discloser of audit8. Protection of shareholder’s right9. Dialogue with institutional shareholders10. 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 32

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 processes35

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:

• Shareholder’s Approach• Stakeholder’s Approach• Enlighten Shareholder’s Approach

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Shareholder’s 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 shareholder’s 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 owner’s will be served at the expense of other stakeholders.

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Stakeholder’s 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. 40

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

shareholder’s, 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

• Shareholder’s Approach

• Stakeholder’s 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• Adelphia Communications

• Illegal loan to founder• Enron

• Gross misuse of power by directors• Waste Management Inc.

• Overstatement of earnings by $17 billion over 6 yrs.

• Tyco• Evasion of sales tax on personal

purchases.• Peregrine Systems

• Overstatement of earnings by $100 million.

• Imclone Systems• Insider trading by CEO

• 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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