What to look for (and what not to) in a Corporate Governance Report

What to look for (and what not to) in a Corporate Governance Report

Massimo Belcredi Carmine Di Noia

London2006, September 28th

Italian Stock Exchange listing rules (Borsa Italiana: Regulation, § IA.2.6)• the board of directors of Italian listed companies shall provide

information annually on their CG systems;• companies that have not implemented the recommendations of

the Code, or have implemented only some of them, shall also provide information on the reasons for such decisions (Comply or explain)

CG Reports: sourcesNew self-regulatory code as term of reference (Comply or explain)

Consolidated law on Financial Intermediation (reports issued in 2007)

as amended by law n. 262/05 (on protection of savings):

• Italian listed companies shall annually disclose information on their adoption of codes of conduct promoted by companies managing regulated markets or by trade association of market participants…

• … and on their compliance with the subsequent obligations, explaining the reasons for any failure to comply (Comply or explain)

… see also amended 4th and 7th Company Law EU Directives

CG Reports: roadmapCG reports show:

•level of compliance with best practices•level of disclosure about deviations from the code

CG reports are NOT tools for the identification of frauds

•“comply OR explain” not “comply AND explain”CG reports contain relevant information on a number of items, but they are not all-embracing

One should not look for information CG reports cannot provide

The past experience: Cirio• Virtually no disclosure to the market

• No corporate information on website Comply or explain rule + absence of adequate

disclosure:

• Silence may be a (bad) signal in itself

• High risk of bad corporate governance practices (incentive to conceal the real situation)

The past experience: Parmalat

• CG structure disclosed in detail to the market• However: CG not in line with best practices

Comply or explain rule + disclosure of bad governance:• CG transparency is achieved (“comply or explain” approach);

• Full disclosure (bad) CG: who read the report?

• Disclosure of (bad) CG and accounting frauds

The past experience: Bpl• Detailed disclosure to the market

• How effective were internal and external controls?

Comply or explain rule + fair disclosure:

• Fair evaluation of executive/non executive directors

• Internal controls apparently aligned with best practice… but how effective?

Governance structure:•one tier/two tier; board of auditors; committees•power of each board and committee•directors’ classification (executive, non exe,

independent)

Quantitative data:•board activity (N. of meetings per year)•members’ activity (attendance to meetings)•number of other positions held

Information available in CG Reports

Information available in CG Reports

Assonime –Emittenti Titoli standard Table (1 of 3):

Information available in CG Reports

An Example: Trevisan Cometal S.p.A

Some data (2005)

Virtually all companies disclose• directors’ classification and info on other offices; (info on remuneration/stock options is mandated by law/Consob)

• board and committee composition, N.meetings, data on attendance to meetings• info on the structure of delegated powers (e.g. value limits, approval of important transactions, especially those carried out with related parties)

Some data (2005)

• 70% of the companies (virtually all the S&P-Mib issuers) report the Assonime Tables

• on average, no significant compliance problem arises from “hard” data…

• …although red flags may appear for single topics from single CG Reports (e.g. no meetings; Attendance =Ø):

• the market is the judge• a red flag is a stimulus to gather further info

• it does NOT necessarily mean non-compliance or a bad CG practice (e.g.: a newly appointed committee/director)

Efficiency and effectiveness of internal audit function and internal controls

Activism of board and committees members outside meetings

Information NOT in CG Reports

CG ratings cannot rely only upon CG reports

A staggered implementation?

1st step: the new Code as a term of reference• CG report 2006, issued in 2007

2nd step: “comply or explain” rule• CG report 2007

• Procedural aspects will be implemented first (comply…)• Structural aspects (e.g. board composition) (… or explain) may take longer 3rd step: “comply or explain” rule

• Following CG reports

How will CG Reports look like?

A further increase in quality of Reports is expected• quality and detail, rather than mere quantity of info• especially among smaller firms (outside S&P-Mib)

Some of the most important changes• role of the Board (powers delegated to executives, transactions with

related parties)• directors’ classification• appointment of directors/statutory auditors• chairman-CEO and lead independent director (LID)

They should generate additional info in the CG Reports

The Role of the Board

Directors shall pursue the priority of creating value for the shareholders

• Consistent with this goal, they shall also take into account group’s directives and policies, as well as the benefits deriving from the issuer being a member of a group

The crucial point of the Code of Conduct• Goals and modus operandi of the Board are spelled out more clearly

The Role of the Board

The BoD shall (inter alia):• examine and approve the company’s strategic, operational and financial plans, and the corporate structure of the group, if any• delegate powers (to managing directors/executive committee) and

specify the limits to delegated powers• examine and approve in advance transactions carried out by the

issuer and its subsidiaries having a significant impact on the

company’s profitability/assets & liabilities/financial position,

paying particular attention to transactions where one or more

directors hold an interest and to transactions with related parties• adopt measures aimed at ensuring that such transactions are performed in a transparent manner and meet criteria of substantial

and procedural fairness• issue guidelines regarding the MAX number of offices compatible

with a director’s duties• evaluate board composition and performance

Transactions with related parties

The Board shall, in particular:

• establish evaluation and approval procedures for transactions carried out by the issuer and its

subsidiaries • define the specific transactions (or determine the criteria to identify such transactions) which must be

approved:• after consulting with the Internal Control Committee and/or• with the assistance of independent experts

The role of the board: disclosure

Additional info expected from future CG Reports:

• A more widespread disclosure (especially among smaller

issuers) of precise info about:• powers delegated/retained by the Board• timing of Board approval (for transactions carried out by the issuer and its subsidiaries)

• Measures and procedures adopted by the Board

Directors’ classification

A general principle: prevalence of substance over form

• improved definition of executive/non executive/independent Directors • periodic evaluation by the Board (at least once a year) according to a number of detailed criteria (covering the main problematic issues)

• such criteria are not binding;• BUT using different/additional criteria requires an explanation as to why they yield a better picture according to the general principle

• evaluation process controlled by the Board of Statutory Auditors (BoSA) (Code of Conduct AND art. 149 TUF; therefore indirect control by Consob)

• the BoSA will disclose the result of such controls to the market (in the CG Report or in its annual Report to the general meeting)

A connected point: Statutory Auditors

Statutory Auditors should meet the same independence criteria recommended for independent directors

• Statutory Auditors must already meet “independence” criteria established by the law

• The Code of Conduct recommends Statutory Auditors meet more stringent independence criteria (on a comply or explain basis)

Appointment of Directors

Slate voting mandated by law for the appointment of BOTH Directors and Statutory AuditorsThe usual “rational apathy” argument does not seem to apply to the appointment of Directors

• Majority shareholders and significant blockholders (sometimes, participating to shareholders’ agreements) are active• so are (increasingly) mutual funds• while pension funds are still smallAlthough it may apply to the appointment of

Statutory Auditors• Average threshold to present a list of candidates: 2.7% (in 2005)• however, only 72 companies (29.5% of the total) had minority Statutory Auditors

Appointment of Directors

Boards shall evaluate whether to establish a Nomination Committee (not a comply-or-explain provision)

• Functions limited to independent directors’ candidatures/ replacement and/or general issues (e.g. board size and

composition)

A transparent procedure• Lists to be deposited 15 days before the general meeting • Timely adequate information on personal and professional

qualifications of the candidates (including eligibility to qualify as as independent directors according to the Code of Conduct)• Lists and info to be timely published through the Internet site of the issuerInfo on the appointment/voting and disclosure

system to be published in the CG Report

Chairman-CEO: the issue

Average Board structure in Italy• Non-financial companies (2005): 9.3 directors

• 2.7 executives; 6.6 non-execs (3.6 of which are independent)•powers delegated to one (or more) executives

(the CEO is not always easily identifiable)• frequently, BOTH an executive chairman AND a separate CEO

• Banks/Insurance: 15.3 directors• 1.7 executives; 13.6 non-execs (9.3 of which are independent)• Quite often, no CEO• executive committee + a powerful general manager

(not necessarily a member of the board)

Chairman-CEO: the solutionChairman-CEO separation is NOT mandated

Chairman-CEO situations should be made explicitIf the Chairman is also the CEO or the person controlling the issuer, a Lead Independent Director (LID) should be appointed

• The LID will: • collaborate with the chairman in order to ensure that directors receive complete, timely information flows• convene appropriate meetings of independent directors (at least once a year, without the presence of the other directors)

• No CEO + Executive Committee? See revised criteria to identify executive/ non executive/ independent directors

New CG reports will improve transparency

ConclusionsCG reports are useful:

• They show the level of compliance with best practices ANDdisclosure about any deviations from the code

• However, one should not look for information CG reports cannot provide

• In particular, CG reports are NOT tools for the identification of frauds

Enjoy your reading and…

Arrivederci!

Carmine Di NoiaAssonime

Deputy Director GeneralHead, Capital Markets and Listed Companies

Via S. Maria Segreta, 620123, Milano

Piazza Venezia, 1100187, Roma

Tel. +39 0286997450+39 06695291

[email protected]

Massimo BelcrediProfessor of Corporate Finance

Dipartimento di Scienze Economiche

e della Gestione AziendaleUniversità Cattolica del

S.CuoreVia Necchi, 520123, Milano

Tel. +39 0272342457

[email protected]

Contacts