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THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES
THE INSTITUTE OF CHARTERED SECRETARIES AND
ADMINISTRATORS
International Qualifying Scheme Examination
CORPORATE GOVERNANCE
MAY 2013
Suggested Answer
The suggested answers are published for the purpose of assisting students in their
understanding of the possible principles, analysis or arguments that may be identified
in each question
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SECTION A
1. Gold Billion Properties Limited is principally engaged in the property development
business and is listed on the main board of the Hong Kong Stock Exchange. Samuel
Tan, a businessman, has recently acquired a majority stake in the company. Following
the change of control of the company, Samuel became the new chairman. With the
assistance of a major human resources consultancy firm, he recruited William Tso to be
the new chief executive officer (CEO). The board of directors comprises six persons
including Samuel, William, the chief financial officer (CFO) and three independent
non-executive directors.
William has extensive experience in property acquisition and development. He managed
to grow the company via a number of property acquisitions in China and the United
States in the first two years after joining the company. With such rapid expansion, the
company has successfully expanded its property portfolio and its share price has
increased two-fold. Samuel, as the controlling shareholder, is happy to see the
increasing return to his equity investment in the company as a result of the increase in
share price.
At a recent board meeting held the week before, William pushed through another
property acquisition, this one in Shanghai. As usual, having sought the prior
endorsement of Samuel, William presented the board papers on the acquisition proposal
to the board members one day prior to the discussion at the board meeting. The
independent non-executive directors have asked for a due diligence report to be done on
the acquisition target and for a cash flow analysis, as these have not been included in the
board papers. However William explained to the directors at the meeting that he would
take care of the due diligence and cash flow for the acquisition; the board then approved
the proposal without further questions.
Behind William’s aggressive strategy for rapid business expansion is the incentive driven
by his remuneration package. William’s executive pay is mainly determined by Samuel
and the remuneration committee simply acknowledges and endorses it. Although
William’s base salary is low, his bonus is generous and awarded only when the company
has achieved an annual 20% increase in its profits. As part of the remuneration package,
substantial share options have also been granted to him and other key executives upon
joining the company. These share options are vested six months after the date of the
grant. Share options have boosted William’s pay considerably as a result of the
substantial increase in the company’s share price following the announcement of a
series of property acquisitions over the past two years.
To finance the rapid growth via various acquisitions, the company is already at a high
gearing level. Recently, William has conspired with the CFO to adopt some off-balance
sheet financing schemes to hide the company’s debts through some vehicle companies
which are not intended to be consolidated into the financial statements. Some creative
accounting measures are also being used to disguise operating expenses as capitalised
expenditure so as to make the profitability of the company look good. As a result of these
moves, William and the CFO can look forward to being awarded substantial bonuses
based on the improved financial results.
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The external auditor has noted such creative accounting measures, but is hesitated to
report this to the audit committee as he is afraid of losing this client. The internal auditor
has recently joined the company and needs time to find out what is happening and to
establish what best to do.
REQUIRED:
1. (a) Identify and analyse the corporate governance issues regarding the
company, the board and its committees as presented in this case.
Ans (a) Corporate governance issues:
Lack of checks and balances at board
With powerful CEO and weak INEDs, despite INEDs comprising one-half of
board members
Dominant influence from Chairman/substantial shareholder on CEO, e.g.
acquisition proposal was endorsed by Samuel before William sending it to the
board
Powerful CEO
Dominates the decision-making process
Pursues aggressive business strategy for self-serving purpose – to boost the
share price through acquisitions and benefit from share option gains
Uses creative accounting measures to boost profitability to secure a high
bonus
Weak diligence from INEDs
INEDs fail to constructively challenge the proposals presented by
management
INEDs fail to exercise due diligence and peruse adequate information before
giving approval of acquisition proposals
Failure of board committees to perform oversight roles
Failure of audit committee to perform oversight role effectively on risk
management and internal control systems, including the financial reporting
process
Failure of remuneration committee to review and monitor the remuneration
package of CEO
Appointment of William as CEO/Executive Director was determined by the
Chairman without going through any formal approval procedure from any
nomination committee
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Adequate and timely information not provided
Chairman fails in his duty to procure timely information – board papers are
presented to the board members only one day prior to board meeting.
Chairman fails in his duty to procure adequate information for directors prior to
making important decisions – information about due diligence of acquisition
target and cash flow is not provided.
CEO dominates the decision-making process and chairman fails to encourage
INEDs to give their views at board meetings.
CEO executive pay issues
Base pay may be too low and this contributes to an aggressive business
strategy for expansion to secure generous bonus and share option gains.
Share options and bonuses are largely based on short-term achievements,
such as share price growth or profitability, and insufficient attention is given to
longer-term consideration.
Short-term performance measures are themselves unreliable and often open
to manipulation by management, such as adopting creative accounting
measures.
Share-based incentives are not linked to performance over the longer term:
preferable for vesting to be based on performance conditions measured over
a long period, say three years.
Overall issues: structure of executive pay package encourages CEO or
executives to undertake a higher risk business strategy, or to focus on
short-term profit or manipulate the financial figures, using aggressive
accounting treatments to make the company performance seem better.
Inadequate risk management and internal control
High risk arising from aggressive business strategy – over expansion will lead
to cash flow problems and corporate collapse
Weakness in internal control system to detect aggressive accounting
practices, which might hide the true financial position and affect the reliability
of the financial statements
Internal audit not functioning effectively to identify accounting malpractices
and report to the audit committee
Weakness in communication between external auditor and audit committee
about issues on appropriate accounting treatment or policy
Weakness in safeguard procedure to ensure that there is no threat to the
objectivity and independence of the external auditor who can report audit
issues on the financial statements to the audit committee without fear of losing
his contract
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1. (b) Suggest what procedures or processes the board or its committees should
strengthen in order to address the issues mentioned in this case.
Ans (b) To put in place checks and balances in the board
The monitoring role of INEDs should be strengthened to counteract the
dominant influence of the CEO
INEDs must exercise independent judgment and ensure accountability and
consideration of shareholders’ interests
INEDs must demand timely and proper information when it is not forthcoming
and must strongly challenge management proposals before reaching
unanimous decisions
INEDs who are members of the audit committee and remuneration committee
must perform their oversight roles over risk management and internal control
and executive pay issues
To strengthen boardroom practices
To send board papers to directors in a timely manner, at least three days
before the meeting
A.7.1 of CG Code: An agenda and accompanying board papers should be
sent in full to all directors in a timely manner and at least three days before the
intended date of a board or board committee meeting (or such other period as
agreed).
To provide adequate information about proposed acquisitions
A.2.3 of CG Code: The chairman should be responsible for ensuring that
directors receive adequate information, which must be complete and reliable,
in a timely manner.
Chairman to brief directors and encourage INEDs to give their views
A.2.2 of CG Code: The chairman should ensure that all directors are properly
briefed on issues arising at board meetings.
A.2.6 of CG Code: The chairman should encourage all directors to make a full
and active contribution to the board’s affairs and take the lead to ensure that
the board acts in the best interests of the issuer. The chairman should
encourage directors with different views to voice their concerns, allow
sufficient time for the discussion of issues and ensure that board decisions
fairly reflect board consensus.
INEDs to actively participate in the discussion and bring an independent
judgment to the discussions before arriving at a decision
A.6.8 of CG Code: Non-executive directors should make a positive
contribution to the development of the issuer’s strategy and policies through
independent constructive and informed comments.
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To conduct board evaluation regularly to assess the performance of the board
and its committees to identify weaknesses for improvement
To conduct continuous professional training program for directors to refresh
their skills and knowledge so as to enable them to perform their duties
effectively
To establish nomination committee to oversee the appointment of directors
and CEO and to assess the independence of INEDs
To strengthen the oversight role over executive pay
The remuneration committee needs to review the structure of the CEO’s
remuneration package, taking into account the relevant principles:
CG Code B.1 Principle: Remuneration levels should be sufficient to attract
and retain the directors needed to run the company successfully, but
companies should avoid paying more than is necessary for this purpose.
CG Code B.1.7: A significant proportion of the executive director's
remuneration should be structured so as to link rewards to corporate and
individual performance.
Base pay should be competitive and reflect the contribution of the executives
concerned, taking into account salaries paid by comparable companies.
Performance-based bonus/incentive measurement should be carefully
defined, setting annual versus long-term performance targets
Vesting of share options should be based on performance conditions
measured over a period (not less than and possibly more than three years)
appropriate to the strategic objectives of the company.
To strengthen the risk management and internal control system
To strengthen the oversight role of the audit committee over risk management
and internal control system
To strengthen the oversight role of the audit committee in reviewing the
financial statements and ensure the integrity and reliability of financial
reporting
To strengthen internal audit function to review risk assessment and control
and to detect fraud or error in the financial reporting process
To establish or strengthen whistle-blowing procedure for reporting fraud and
malpractices
To strengthen the communication process between the internal auditor,
external auditor and audit committee, with meeting held at least annually
without presence of management
To formulate code of ethics to guide executives and employees on ethical
behaviour
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1. (c) Critically evaluate the roles that the internal auditor and the external auditor
can play to contribute to sound governance in this case.
[Where appropriate, candidates may refer to the Corporate Governance Code of
Hong Kong].
Ans (c) Role of internal auditor:
- Reviews the adequacy of the risk management system and internal control
systems
- Reports to the audit committee and management on issues relating to risk
management and internal control
- Provides assurance on compliance with corporate policies, legislation and
regulations
- Alerts management and the audit committee about fraud or other internal
control failures or weaknesses that might occur
In this case, the internal auditor should investigate into the off-balance sheet
financing schemes and creative accounting measures and report on them to
the audit committee
He should assess the risk profile regularly and report to the audit committee
about the high financial risk attached to the aggressive business expansion
strategy adopted by the CEO.
To perform the role effectively, he should function independently of the CFO and
have direct access to the audit committee, and also familiarise himself with the
business operations, policies and procedures of the company as soon as possible
in the case.
Role of external auditor:
- to perform an audit on the financial statements and give an independent
opinion on whether they provide a true and fair view about the company’s
financial position and whether they comply with accounting standards and
relevant laws
- to provide assurance that the financial statements are objective and can
be relied upon by shareholders or investors
- In this case, the external auditor should assess the impact of the
off-balance sheet financing schemes and creative accounting measures
which might disguise the company’s true financial position and affect the
reliability of the financial statements.
- He should report to the audit committee about the accounting malpractices
which might involve fraud and breach of accounting standards
- He should uphold his independence and integrity, without fear of losing the
client
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SECTION B
2. The United States has a corporate governance structure that promotes stricter statutory
rules while the United Kingdom and other European countries emphasise voluntary
compliance with corporate governance codes and practices.
REQUIRED:
2. Discuss the rule-based approach and the principle-based approach to corporate
governance, including an analysis of each approach’s merits and drawbacks.
Ans Rule-based approach to corporate governance
In the US, the emphasis has been on statutory regulation and enforcement of the
rules.
In the US, a stricter statutory regime was introduced by the Sarbanes-Oxley Act
2002 in response to the collapse of Enron.
The Sarbanes-Oxley Act contains various specific requirements and directs the
Securities and Exchange Commission to issue rules implementing its measures
relating to corporate governance, including the powers to investigate and punish
auditors that certify inaccurate financial statements and criminal penalties for a
range of corporate crimes.
This approach requires companies to adopt specific corporate governance
practices by legislation or regulation.
Legal systems and regulatory frameworks have an important role to play in
corporate governance. Statutory rules offer certain degrees of protection for
investors.
Merits:
Investors’ or stakeholders’ rights are better protected by the basic mechanism of
laws accompanied by predictable legal enforcements.
Prescriptive rules have the advantages of relative certainty and enforceability –
companies need to follow and support good governance.
Rules are specific and can normally be applied with no dispute (certainty)
Mandatory regulations are the means to achieving the appropriate corporate
governance standards in the public interest, especially when market failure has
been revealed.
Drawbacks:
Rule-based approach is an one-size-fits-all approach and one standard might not
suit all circumstances of companies with different size, nature and culture.
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Mandatory regulation is rigid and cannot accommodate grey areas, resulting in
compliance only with the letter rather than the spirit of the law.
It leaves open the question of what to do when there is no specific rule to apply to a
given situation and so it requires continual growth of rules to cover new situations
It takes a lengthy legislative process to amend rules to suit changing circumstances.
There may be conflicting rules emanating from different hierarchical governing
mechanisms and this requires another set of rules to help decide what to do.
The cost of compliance with the rules and laws might be burdensome to small
companies which have limited resources
Principle-based approach to corporate governance
In the UK and Europe, the response to corporate crisis has been to examine and
emphasise the principles of good governance.
The Cadbury Code and the OECD Principles, in particular, have each played a
major role in the development of corporate governance codes around the world.
In the UK, the development of corporate governance principles and best practices
began with the Cadbury Code in 1992. This identified many of the key issues,
including the balance of power on the board and the need for INEDs, the
transparency of financial reporting, the role of the external auditor and the need for
risk management.
Principles of good corporate governance have also been issued by some
international bodies, notably the OCED and the Commonwealth Association. These
principles are intended to provide guidelines for individual countries in formulating
their own national codes and guidelines.
Under this approach, companies are allowed to design and determine the specific
corporate governance practices that best suit their circumstances subject to
appropriate disclosures.
A comply-or-explain approach is adopted where companies are expected to comply
with, but may choose to deviate from, the code provisions. Companies have to give
considered reasons for any deviations from the code provisions and make
appropriate disclosures.
Merits:
Codes aim to provide boards with a checklist against which to review their
governance structures and processes and to provide investors with an agenda for
their dialogue with boards.
There is no universal or one-size-fits-all approach to promoting good corporate
governance. Codes allow for flexibility in implementation and are not framed as rigid
rules.
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They are to be followed by companies in the light of their own particular
circumstances relating to their size, complexity and operations.
Codes are not statutory rules and are therefore easier to update without lengthy
legislative process
Voluntary compliances with codes and principles involves less costs than
mandatory rule-based approach
Drawbacks:
Weak enforcement - non-statutory codes are voluntary, without binding force and
have no teeth; there can be a lack of incentives or resources to enforce standards.
Codes are followed by the well-intentioned and ignored by the less conscientious.
Compliance with codes might be a box-ticking exercise, without meeting the spirit of
the codes.
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3. Should the chief executive officer also be the chairman of the board? Discuss and
present your arguments for both sides with the application of corporate
governance principles.
Ans The role of chairman is to provide leadership for the board and ensure that the
board works effectively and performs its responsibilities, and that all key and
appropriate issues are discussed by it in a timely manner.
The role of CEO is to manage the day-to-day operation of the business of the
company and formulate and implement the business strategies
Most codes of corporate governance practices recommend that the roles of
chairman and CEO should be held by different people.
Hong Kong Corporate Governance Code
Principle A.2: There are two key aspects of the management of every issuer – the
management of the board and the day-to-day management of business. There should
be a clear division of these responsibilities to ensure a balance of power and authority,
so that power is not concentrated in any one individual.
Code Provision A.2.1: The roles of chairman and chief executive should be separate
and should not be performed by the same individual. The division of responsibilities
between the chairman and chief executive should be clearly established and set out in
writing.
Or
UK Corporate Governance Code
Main Principle: There should be a clear division of responsibilities at the head of the
company between the running of the board and the executive responsibility for the
running of the company’s business. No one individual should have unfettered powers of
decision.
Code Provision A.2.1: The roles of chairman and chief executive should not be
exercised by the same individual. The division of responsibilities between the chairman
and chief executive should be clearly established, set out in writing and agreed by the
board.
Separation of roles will help:
provide checks and balances to ensure a balance of power at the board
establish a clear division of responsibilities at the head of the company, between
the running of the board and the executive responsibility for the running of the
company’s business
avoid concentration of power in the hands of one individual so that he does not
have unfettered powers to dominate decision making
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reduce the risk of an all-powerful individual taking on excessive and inappropriate
risk or taking self-serving action for his own interest rather than the interests of the
shareholders and the company
allow the burden of responsibilities at the head of a business to be shared
Family businesses may benefit from bringing in an outside chairman in terms of
objectivity in relation to family issues and his/her experience in other fields.
Different mixes of ability and experience are required for the two posts. The two
posts call for somewhat different qualities and strengths and need to be performed
by different persons.
There is increasing pressure from outside investors for companies to enhance
corporate governance standards. The chairman and the CEO should play distinct
roles in developing and maintaining a sound corporate governance structure.
The UK Corporate Governance Code does recognise that in some circumstances a
single leader may be inevitable; in this case, it calls for a strong group of non-executives
on the board with their own appointed leader.
The Hong Kong and UK Corporate Governance Codes allow for deviation from the code
provisions by providing an explanation for the combination of the two roles in the
corporate governance report.
There are circumstances under which the combination of the roles of chairman and
CEO is justified:
In the US, the roles of chairman and CEO are typically combined and held by a
powerful individual who leads the company in both managerial and governance
matters.
It is common practice, especially where the companies are started from
family-owned business; it is the way which companies are run by their founders,
and it provides undisputed leadership internally and externally.
The combined role may have advantages particularly for small high-growth firms
that require strong direction and leadership to grasp business opportunities.
The two posts are naturally combined in one person in the formative stages of a
company’s development, but should split as the company grows and leadership
responsibilities increase.
The combination is justified when particularly strong leadership is needed quickly at
a time of crisis or financial difficulties to turn around.
When two persons of different personalities or characters work together, there may
be conflict or disagreement among them and that may lead to inefficient decision
making. Combination of the two roles can reduce such conflict.
Chairman normally focuses on long term strategy planning while CEO normally
focuses on short term profitability. Long term goals might be in conflict with short
term goals. It is difficult for the same person to perform both roles at the same time.
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Same person may not have sufficient time and expertise to perform both roles at the
same time
Both Chairman and CEO assume important roles and represent the company from
time to time. General public will be confused if there are two spokesmen for the
company.
Decision over whether the two posts should be separate or combined depends on
circumstances of individual companies.
The question is which is preferable: a dominant leader who enhances performance; or
shared responsibility, which reduces risk?
The success of separation of the two roles depends on the way in which the two
individuals share power between them and build a relationship of trust.
Where the chairman is also the CEO, it is essential that there should be a strong and
independent element on the board – need counterbalance provided by the other board
members.
more INEDs may be appointed to the board or
a deputy chairman may be appointed to deal with issues where potential conflict of
interests arises (UK Combined Code)
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4. You are the company secretary of a listed company in Hong Kong. One of your
independent non-executive directors suggests to your chairman that the company should
carry out a board performance evaluation.
REQUIRED:
4. (a) Advise the chairman of the importance of board performance evaluation
Ans (a) Importance of board evaluation:
Good corporate governance involves a strong effective board that
understands its own roles and its own accountabilities. Board evaluation is
part of good corporate governance
Recommended best practice B1.9 of Corporate Governance Code
B.1.9. The board should conduct a regular evaluation of its performance.
Principle A1
The board should regularly review the contribution required from a director to
perform his responsibilities to the issues and whether he is spending sufficient
time to perform them.
Focus board members' attention on their roles and duties and identify areas
for improvement
The evaluation process will be used constructively as a mechanism to improve
board effectiveness, maximise strengths and tackle weaknesses
Useful in boosting board performance
Board evaluation enables the company to link remuneration to performance.
The remuneration committee may determine the remuneration packages of
individual directors based on their performance
Through board evaluation, the composition of the board will be reviewed to
see if the existing mix of skills and knowledge of the board members is
appropriate and what kind of additional skills, knowledge and experience is
necessary for the requirements of the company's business. It helps ensure
that the directors continue to contribute to the board and determine if there is a
need to appoint new director or remove an existing director
Board evaluation helps identify the training needs of individual directors based
on their performance. If a director is unable to perform his duties well by his
existing knowledge and skill, the company can arrange for the professional
training and development for the director.
Undertaking board evaluation may improve accountability. By conducting
board evaluation, the board is demonstrating to shareholders that they are
serious about fulfilling their fiduciary obligations
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4. (b) Suggest criteria for evaluating the performance of the board as a whole and
of individual directors.
Ans (b) Criteria for performance evaluation of the board:
Overall performance
How well has the board performed against any performance objectives that
have been set?
What has been the board's contribution to the testing and development of
strategy?
What has been the board's contribution to ensuring robust and effective risk
management?
How has the board responded to any problems or crisis that have emerged
and could or should theses have been foreseen?
Are the matters specifically reserved to the board the right ones?
How well does the board communicate with the management team, company
employees and others? How effectively does it use mechanisms such as the
AGM and the annual report?
Is the board as a whole up to date with latest developments in the regulatory
environment and the market?
Board structure
Is the size of the board appropriate taking into account the size and complexity
of business of the company?
Is the composition of the board and its committee appropriate, with the right
mix of knowledge and skills to make quality decision and maximise
performance?
Are INEDs enough and genuinely independent? This means ensuring that the
INEDs have no relationships with the company that could affect the exercise of
genuinely object judgment?
Are the posts of chairman of the board and CEO separate so that there is no
concentration of power in one individual?
Board process
Is the board getting appropriate, timely and unbiased information, of the right
length and quality?
Are sufficient board and committee meetings of appropriate length held to
enable proper consideration of issues? Is time used effectively?
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Are board procedures conducive to effective performance and flexible enough
to deal with eventualities?
Board leadership
Is the chairman demonstrating effective leadership of the board?
Are the processes for setting the agenda working! Do they enable board
members to raise issues and concerns?
Are all directors allowed or encouraged to participate fully in board
discussions?
Are relationships and communications within the board constructive?
Are relationships and communications with shareholders well managed?
Is the company secretary being used appropriately and to maximum value?
Board committees
Does each board committee have adequate and appropriate written terms of
reference?
How effective are the board's committees? Do such committees have the right
composition? How do they interact with the main board? Do they fulfill their
roles?
Criteria for evaluation of performance of individual directors:
How well prepared and informed are they for board meetings and is their
meeting attendance satisfactory?
Have they devoted sufficient time and effort to understanding the company
and its business?
How successfully have they contributed to strategy development and risk
management?
How effectively have they tested the information and assumptions with which
they are provided?
How resolute are they in maintaining their own views and resisting pressure
from others?
How effectively and proactively have they followed up on any areas of
concern?
Does their performance and behaviour engender mutual trust and respect
within the board?
Do they have specialist legal, financial, marketing or other skills critical to the
performance of the company?
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How actively and successfully do they refresh their knowledge and skills? Are
they up to date with market and regulatory developments?
Are they able to present their views convincingly yet diplomatically? Do they
listen and take on board the views of others?
Do they constructively challenge management's proposals in meetings?
Do they generate a supportive environment for management in meetings?
Do they work well with other fellow directors?
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5. Discuss how institutional investors can help improve corporate governance
standards of the companies in which they invest and the factors determining the
extent to which they are effective in their activism or interventions.
Ans Institutional investors are organisations that have large amounts of funds to invest and
put much of these funds into company shares. They include pension funds, insurance
companies, collective investment institutions and private equity funds.
In the wake of various corporate collapses and financial scandals in recent years,
institutional investors become more proactive in trying to ensure that the companies in
which they invest deliver the best available shareholder value. Vigorous shareholder
activism can lead to better corporate governance.
Institutional investors help improve corporate governance through the following
interventions with investee companies:
Dialogue with invested companies
To be more active in making their views known to the companies they invest in by
engaging in an active dialogue with the board of directors in the hope of influencing
its decisions.
To have a policy in place for meeting an investee company’s board and senior
management to exchange views and information.
Considered use of votes
To attend general meetings where appropriate and practicable and take steps to
ensure their voting intentions are translated into practice.
To vote on all their shares held directly or on behalf of clients at general meetings
wherever practicable to do so.
To make positive use of their voting rights, to bring about changes when necessary
to improve the standards of corporate governance.
Proactively monitoring investee companies
To review annual reports and accounts, circulars issued by companies and general
meeting resolutions.
To raise questions about investee companies’ affairs at their general meetings
To take a positive interest in the composition of board of directors and exercise
voting rights to elect directors, with particular reference to the checks and balances
and the appointment of non-executive directors of necessary calibre, experience
and independence.
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Evaluation of governance disclosures
To evaluate disclosure of corporate governance practices by invested companies to
ensure compliance with the corporate governance code, which may be laid down by
the regulators or institutional investors.
To take a reasoned and flexible approach when judging the compliance of
companies with corporate governance requirements:
When evaluating company disclosures on corporate governance, particularly
those relating to board structure and composition, institutional shareholders
should give due weight to all relevant factors drawn to their attention.
Institutional shareholders should carefully consider the explanations given by
companies for any departure from the code provisions of corporate governance
code and make a reasoned judgment in each case.
If they do not accept the company's positions, they should explain their views in
writing to the company, and be prepared to enter into a dialogue on this matter if
necessary.
They should avoid a box-ticking approach to checking compliance with the
corporate governance code and to assessing a company's corporate
governance.
Setting strategies on intervention
To exercise their votes and, where necessary, intervene objectively and in an
informed way.
To nominate board representation to the investee companies, where necessary.
To set out the circumstances (e.g. poor company performance, internal control
failure, inadequate succession planning) when they will actively intervene and what
the nature of that intervention might be.
If boards do not respond constructively when institutional shareholders intervene,
then they will consider on a case-by-case basis whether to escalate their action, for
example, by making a public statement in advance of the AGM or an EGM or
requisitioning an EGM, possibly to change the board, to dispose of their
shareholding or to launch litigation.
To monitor and evaluate the effects of their activism.
Factors affecting the activism or interventions:
Active shareholders require a majority vote for their activism to be effective.
Institutional investors, because of the larger shareholding that they own, are in a
better position to monitor the company’s performance.
Institutional investors may have different concerns of their own and it is difficult to
organise a group of dissident shareholders into a voting majority.
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Cost concerns – there are numerous costs and risks for institutional investors who
are willing to be actively involved in the corporate governance affairs of the investee
companies.
Institutional investors aim to achieve their business goal rather than to protect the
minority shareholders’ interest. They may also have a business interest in or
business connection with the company concerned and therefore want to avoid
criticising its management.
Institutional investors may lack the capability and have little or no experience in
directly monitoring a company’s management.
Institutional investors may lack incentives to actively monitor because of the
free-rider problems among themselves in monitoring managers of their investee
companies.
Institutional investors may not have sufficient information to actively monitor the
company’s operations even though they have the information required to make their
investment decisions.
Institutional investors may not want to sacrifice investment liquidity in order to
achieve a greater voice in the activities of the investee companies. In particular,
board membership in a company brings too many responsibilities.
Highly-liquid stock markets diminish large shareholders’ incentives to monitor their
investee companies as the liquidity allows them to exit their investments easily.
Where institutional shareholders intervene, whether the board of directors of the
investee companies is willing to react positively can hinder the effectiveness of
intervention.
Where the institutional investors actively intervene, they should be aware that they
should not become too much involved in the invested company as they could
probably receive any information which is not publicly disclosed. They would be
likely liable for insider dealing under SFO if they make use of such information for
share dealing purpose.
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6. You are the company secretary of a large pharmaceutical company.
REQUIRED:
6. (a) Identify and discuss the economic, social and environmental
responsibilities that the board of directors of your company should have to
your shareholders and stakeholders.
Ans (a) Responsibilities of board of directors
Economic responsibility :
To maximise profit for shareholders, net asset value or return to
shareholders’ investment
To produce the goods and services that society desires, and thereby to
create sustainable economic wealth
To provide job opportunities to employees and pay comparable salaries
To ensure fair dealings with suppliers and timely payment to them for their
goods/raw materials supplied
To charge a reasonable price on quality products to customers
Environmental responsibility:
To minimise the impact of the company’s activities on the environment, e.g.
control pollution, reduce waste
To ensure that all environmental legislations and regulations are fully
complied with
Social responsibility:
To take care of the interests of the company’s stakeholders, including
employees, customers, suppliers, in particular on protection of the
environment, health and safety, e.g.
providing a healthy and safe working environment to employees
providing safe and reliable products to customers
having fair dealings with suppliers
To participate actively in the betterment of society beyond the minimum
standards set by the economic, legal, and ethical responsibilities, e.g.
donation of money or pharmaceutical products
research and development of new drugs to improve health
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6. (b) Highlight the potential benefits for your company of adopting and
implementing a policy for corporate social responsibility (CSR).
Ans (b) Benefits of adopting CSR policies
The company and its management are more likely to act in an ethical way. In
the long term, business as a whole is likely to benefit from ethical business
practices, such as honesty, integrity, fairness and transparency.
A company may acquire a favourable reputation, with the public in general
and with customers.
It may be argued that there are commercial benefits in CSR policies. There is
no clear evidence of a link between CSR policies and increased profits,
although companies with an awareness of social and environmental issues
may be more alert to possibilities for innovation and opportunities for the
development of environmentally-friendly products and services.
Many investment institutions take social, environmental and ethical
considerations into account when formulating their investment strategies.
Investors might prefer holding shares in companies that adopt CSR policies.
This helps attract investment capital and boost share price.
It could be argued that companies with CSR policies are more likely to retain
employees, especially if CSR policies include measures that improve pay or
working conditions.
Customers might prefer buying from companies with CSR policies because of
their confidence in the companies and their products.
Suppliers might prefer dealing with companies with CSR policies as such
companies will have fair dealings with them and ensure timely payment.
Banks are willing to provide loans and credits because of the reputation and
credibility of companies with CSR policies.
Adopting a CSR policy, companies are more alert on identifying different risks
associated with environmental, health and safety issues and will formulate
strategy to manage such risks and protect their reputation.,
6. (c) Draft a CSR policy for your company.
Ans (c) Sample corporate social responsibility policy
Our mission is to strive toward better health for individuals and progress in
medicine by developing superior pharmaceutical products. We strive to maintain
and improve sound business processes throughout our operations and to engage
in activities to promote a sustainable society as a good corporate citizen.
Our CSR policy defines our long-term approach to specific issues in the following
cornerstones.
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Our People
We are committed to enhancing the level of engagement, health and safety,
overall wellness and personal growth of our employees and making the company
a better place to work.
We foster a supportive and quality working environment by:
upholding employment practices that treat employees fairly and equally
safeguarding employee rights and interests
providing opportunities for training and development
ensuring a healthy and safe workplace
facilitating meaningful communication within the company
Environment
We are committed to devoting systematic efforts towards the conservation of
energy and natural resources as well as reduction of waste and emissions at both
business operation and individual levels.
We care for the environment by:
minimising the environmental impact of our activities, as well as products and services engaged
preventing pollution, reducing waste, increasing recycling and minimising natural resource use by continually improving our environmental management practices and measures
educating our employees to adopt environmentally responsible behaviour
promoting environmental protection in our supply chain and marketplace
Community
We are committed to a sustainable community by supporting local initiatives that
create effective and lasting benefits to the community through corporate
philanthropy, establishing community partnerships, and mobilising our
employees to participate in volunteer work.
We care for society by:
contributing resources to educational and research initiatives
engaging in donations or philanthropic activities
emphasising employee participation as responsible citizens
This policy shall be communicated to the company’s stakeholders, including but
not limited to its employees, shareholders, suppliers, business partners and
customers.
The policy shall be reviewed by the board of directors annually.
END