1. Definitions and issues in corporate governance Flashcards
What is corporate governance?
Corporate governance is the ‘system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditor’s role is to satisfy themselves that an appropriate governance structure is in place’.
Why did Sir Adrian Cadbury start the Cadbury Committee?
Various bodies such as the FRC, LSE and accounting profession were concerned with the increasing lack of investor confidence in the honesty and accountability of listed companies following the financial collapses of Coloroll and Polly Peck
What did Bob Tricker say about corporate governance?
‘If management is about running business, governance is about seeing that it is run properly. All companies need governing as well as managing.’
Outline the shareholder primacy theory and its criticisms
The shareholder primacy theory focuses on maximising the value of shareholders before considering other stakeholders.
Key criticisms: inappropriate stewardship, short termism, company is a separate entity, decline in average holding period of shares
Outline the agency theory and its criticisms
The agency theory was developed by Berle and Means - principal-agent relationship between shareholders and directors. The directors are expected to represent the best interests of the shareholders above their own.
Criticisms -
- conflicts of interests and costs
- focuses exclusively on maintaining value for shareholder
- short termism at the expense of long-term performance
As part of agency theory, what are the 4 areas of conflict identified by Jensen and Meckling? Clue: MELT
- Moral Hazard (higher if no interest in company)
- Earnings retention (use profits differently)
- Level of effort (naturally)
- Time horizon (short v long term)
How would you avoid or manage conflicts between shareholders and directors?
- Adoption of conflict of interest and related party transaction policies
- Long-term incentive share award or options based on total shareholder return to align interests
What are the agency costs? Clue: MRB
- Costs of monitoring performance of the board and executive management – e.g. auditors, general meetings
- Residual loss – costs to the shareholders with actions by directors which in the long run turn out to not be in the interests of the shareholders, for example a major acquisition or disposal or fraud
- Bonding costs – the cost of paying directors and executive management
What is the stakeholder theory?
This is a corporate governance theory on the ideology that companies should meet the objectives of everyone that has an interest within the respective company. Companies should act as ‘good corporate citizens’ when making decisions, taking into account the impact on society and the environment
What is a stakeholder?
A stakeholder is any group or individual who can affect or be affected by the achievement of an organisation’s objectives.
What are the four approaches to corporate governance?
- Shareholder value approach – relates to shareholder primacy theory – maximise the wealth of shareholders via dividends and increasing the share price
- Stakeholder approach – pluralist approach – civil law countries – France, Germany, Japan and China – critics: views of all will lead to no decision
- Inclusive stakeholder approach – King - consider the legitimate interests and expectations of key stakeholders on the basis that this is the best interests of the company – s/h does not have predetermined precedence – reflects African needs and culture – sustainability and ‘good citizenship’
- Enlightened shareholder value approach – s.172 approach – have regard to other stakeholders (short term and long term)
What are the principles of corporate governance? FART
- Fairness – all key stakeholders treated fairly
- Accountability – justify, exercise or account for the exercise of authority
- Responsibility – having authority, held accountable
- Transparency – outsider can make a meaningful analysis – being clear on historical performance and future intentions
What is the rules-based approach?
A rules-based approach is when a country adopts mandatory laws, regulations and standards which companies must adopt i.e. a minimum standard of corporate governance. This approach is rigid and does not allow for any adaptation. It is accompanied with civil or criminal sanctions.
An example of a rules-based approach is the US via the Sarbanes Oxley 2002 Act
What is the principles-based approach?
The principles-based approach is a voluntary set of best practice, usually contained in a code of best practice e.g. the UK Code 2018.
An advantage of this approach is that it allows a company to deviate from a provision if it believes it is best to do so and therefore recognises a diversity of circumstances from different companies. As it is a flexible approach, there are no sanctions for failing to ensure a minimum standard and some would argue that this does not protect shareholders and other stakeholders.
What does a corporate governance framework usually consist of?
- Applicable laws, regulations standards and codes
- Constitution - articles of association, bylaws, charters or trust deeds
- Structures - board, committees, role profiles, etc
- Policies - whistleblowing, bribery, sexual harassment, risk, IT, etc
- Procedures - business continuity, risk management and internal controls, recruitment, etc
