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CORPORATE

GOVERNANCE

CHAPTER 1

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What is Corporate Governance?2

Deals with the problems arising from

the separation of ownership andcontrol.

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Separation of Ownership and Control

3

The thousands, or more, investors who ownpublic corporations could not collectively

make the daily decisions needed to operatea business. Therefore:

The shareholders are owners of the firm

The shareholders elect directors to act as theiragents in supervising the firm

The directors appoint officers (or executives) to

actually run the firm on a day-to-day basis

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Separation of Ownership and

Control4

Shareholders

Board

Employees

Management

Ownership

Control

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Focus of Corporate

Governance Shareholders elect directors who represent them.

Directors vote on key matters and adopt the majority decisions.

Decisions are made in a transparent manner so thatshareholders and others can hold directors accountable.

Company adopts accounting standards to generate the

information necessary for directors, investors and otherstakeholders to make decisions.

The company's policies and practices adhere to applicable

national, state and local laws.

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Principal-Agent Problem6

Principal-agent problem represents the conflictof interest between the principal and the agent.

Primary principal-agent problem incorporations: Principal = Shareholders

Agent = Officers

If shareholders cannot effectively monitor theofficers behavior, then officers may be temptedto use firms assets for their own personal use.

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Solutions to Principal-agent problem

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Incentivesaligning executive incentives with

shareholder desires.

Monitoringsetting up mechanisms for

monitoring the behavior of managers.

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Can Shareholders Influence Managers?

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Shareholders do not directly hire/firemanagersso they cant vote to replace them

Shareholders can influence managers

indirectly through the board of directors Changing board members can be difficult as

management controls the process and some

inactive shareholders will go along with

whatever management wants.

Some active shareholders are large enough

to try and influence management or change

the board, but they are often met with defeat.

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Monitors9

Monitors are called for because managers

may not act in the shareholders best

interest. Figure 1.1 shows that monitors exist:

inside the corporate structure

Board of directors

outside the structureAuditors, analysts, bankers, credit rating agencies, and attorneys

in government

SECP

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Figure 1.110

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Inside monitors-Board of

directors11

Oversee management and are supposed to

represent shareholders interests.

Evaluates management and design

compensation contracts to tie managementssalaries to the firms performance.

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Outside monitors12

Interact with the firm and monitor manager

activities

Auditors

Analysts

Bankers

Credit agencies

Attorneys

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Government monitors13

The SECP regulates public firms for the

protection of public investors

The SECP also makes policy and prosecutes

violators in civil courts.

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Governance is more than just

Board Processes and Procedures

It involves the full set of Relationship between

a companys management

Its Board

Its Shareholders

Its other stakeholders

One size doesnt fit all. The Board Objectives and

Procedures may be the same to all societies but when it

comes to applying them to individual countries we have

to reckon the peculiar, socio-cultural characteristics, the

history of its people, their value systems, their economic

system, etc.

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Corporate Governance

Guidelines

Most worldwide organizations have strongly

promoted good corporate governance by

application of the following corporate

governance guidelines: 1. Rights of shareholders

2. Equitable treatment of shareholders

3. Role of stakeholders in corporate governance

4. Disclosure and transparency

5. Responsibilities of the board

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Corporate Governance

Guidelines

1. Rights of shareholders

All shareholders must be given their due rights

i.e. They all should have

Secured ownership of their shares Voting rights

Right to full disclosure of information

participation on decisions on sale or change in

corporate assets or new share issues Capital structure must be disclosed

All transactions should be at transparent prices and

under fair conditions

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Corporate Governance

Guidelines

2. Equitable treatment of shareholders

All shareholders should have equal opportunity for

redressal of the violation of their rights

Insider trading should be prohibited

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Corporate Governance

Guidelines

3. Role of stakeholders in corporate

governance

Corporate governance framework apart from the

rights of shareholders allow Employees representation on BOD

Profit sharing

Creditors involvement in insolvency proceedings

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Corporate Governance

Guidelines

4. Disclosure and transparency

Financial details, operating results, policies,

governance structure should be disclosed

Annual audits should be performed byindependent auditors

When in

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Corporate Governance

Guidelines

5. Responsibilities of the board

Board is responsible for

Protecting the company, its shareholders and other

stakeholdersMaking policies, strategies

Monitoring effectiveness

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Market Model Governance

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Market Model Governance

ChainMore common in US, UK, Canada & Australia22

Institutional

Context

Independence & Performance

Corporate

Context

Shareholder environment

Transparency & AccountabilityCapital Market Liquidity

Non-

executive

Majority

Boards Aligned

incentives

Active

equitymarket

Active

takeover

market

Dispersed

ownershipSophisticate

d

institutional

ownership

Shareholder

equality

High

disclosure

Control Model Governance

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Control Model Governance

ChainMore common in Asia, Latin America, parts of Europe23

Institutional

Context

Independence & Performance

Corporate

Context

Shareholder environment

Transparency & AccountabilityCapital Market Liquidity

Insider

boards

Incentives

aligned withcore

shareholder

s

Under

developednew issue

marketLimited

takeover

market

Concentrate

d ownershipReliance on

family, bank,

public

finance

Inadequate

minority

protection

Limited

disclosu

re

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Corporate Governance Concerns

1. Management Accountability

2. Providing Adequate Investments To Management

3. Disciplining & Replacement Of Bad Management

4. Enhancing Corporate Performance

5. Transparency

6. Shareholder activism

7. Enhancing Protection

8. Improving Access To Capital Markets

9. Promoting Long-Term Investment

10. Encouraging Innovation

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C

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Issues in Corporate

Governance Corporate Governance conveys different meanings to different people. But to

all, corporate governance is a mean to an end, the end being long-term

shareholder value and more importantly stakeholder value. All authorities

have identified some governance issues being crucial and critical to achieve

these objectives. These are:

1. Distinguishing the role of Board & Management2. Composition of Board & related issues

3. Separation of the roles of CEO & chairperson

4. Should the board have committees?

5. Appointments to the board & directors re-election

6. Directors and executives remuneration

7. Disclosure & audit

8. Protection of shareholders rights & their expectations

9. Dialogue with institutional shareholders

10. Should investors have a say in making a company socially responsible corporatecitizen

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Issues in Corporate Governance

1. Distinguishing the role of Board & Management

Board of the company has following functions:

Select, decide the remuneration & evaluate on regular basis and when necessary

change the CEO.

Oversee indirectly the conduct of companys business

Review and approve the companys financial objective if necessary

Render advice & counsel to the top management

Recommending candidates to the shareholders for electing them to BOD

Review the adequacy of systems to comply with all laws and regulations

All other functions required by law to be performed

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Shareholders

Owners who elect BOD

Board

Delegatesresponsibilities to CEO

Companys Management

Management responsibilities isdelegated by CEO to management

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Issues in Corporate Governance

2. Composition of Board & related issues

BOD is a committee elected by shareholders. Sometimes, full-

time functional directors are appointed, each being responsible

for some particular branch of the firms work.

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Board of Directors

Executive

Directors

Non-Executive

Directors

IndependentDirectors

Affiliated Directors(Nominee

Directors)

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Issues in Corporate Governance

3. Separation of the roles of CEO & chairperson

Combining the role of chairperson with that of

the CEO leads to conflict in decision making

and too much concentration of power in one

person resulting in unhealthy consequences. The role of CEO is to lead the senior

management team in managing the enterprise,

while

The role of chairperson is to lead the board to

evaluate the performance of senior executives

including the CEO.

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Issues in Corporate Governance

4. Should the board have committees?

Following committees if made would lessen

the burden of the board and enhance its

effectiveness:

NominationRemuneration

Auditing

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Issues in Corporate Governance

5. Appointments to the board & directors re-election

The board or its specially constituted

committee selects and appoints the

prospective director and gets the person

formally elected by the shareholders at AGM.

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Issues in Corporate Governance

6. Directors and executives remuneration

Shareholders are entitled to a full and clear

statement of Directors recent and future

benefits and how they have been determined.

Remuneration committee must be appointedfor this task.

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Issues in Corporate Governance

7. Disclosure & audit

8. Protection of shareholders rights & their

expectations

9. Dialogue with institutional shareholders

10. Should investors have a say in making a

company socially responsible corporate citizen

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Need & Importance for Corporate Governance

Corporate governance is needed to create a

corporate culture of consciousness,

transparency and openness.

It refers to the combination of laws, rules,regulations, procedures and voluntary

practices to enable companies to maximize

shareholders long-term value.

It should lead to increasing customer

satisfaction, shareholder value and wealth

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Governance & Corporate Performance

There is a positive relationship between

corporate governance and corporate

performance. Improved corporate governance

is linked with improved corporate performanceeither in terms of rise in share price or

profitability.

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I t P f f G d

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Investors Preference for Good

Governance

Majority of investors (institutional) consider

governance practices to be at least as

important as financial performance, when they

evaluate companies for potential investment. They are prepared to pay a premium for

shares in a well-governed company as

compared to a poorly governed one exhibiting

similar financial performance.

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Benefits of Good Corporate to a Corporation

1. Creation & enhancement of a corporations

competitive advantage

2. Enabling a corporation perform efficiently by

preventing fraud & malpractices3. Providing protection to shareholders interest

4. Enhancing the valuation of an enterprise

5. Ensuring compliance of laws and regulations (BCCI)

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