1 - Definitions and issues in CG Flashcards

1
Q

UKCG Code - purpose of CG (previous definition)

A

To facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company

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2
Q

Cadbury Committee definition of CG

A

The system by which companies are directed and controlled

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3
Q

2 key theories to CG

A
  • Shareholder primacy theory (shareholder value approach / agency theory)
  • Stakeholder theory (stakeholder approach)
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4
Q

Focus of shareholder primacy theory to CG

A

Maximising value to shareholders before considering other corporate stakeholders

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5
Q

Opinion of shareholder primacy view of those opposing theory

A

Shareholders don’t actually own the company as it is a separate legal entity in itself - it should therefore comply with societal norms of its country, such as considering impact on other citizens and the environment

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6
Q

2 reasons why shareholder primacy governance has come under increased criticism from 2008 global financial crisis

A
  • Inappropriate stewardship
  • Short termism
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7
Q

Briefly, what is meant by inappropriate stewardship

A

No shareholders taking responsibility for checking performance and behaviour of board and management

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8
Q

Briefly, what is meant by short termism

A

Not enough focus on developing fundamental operational capabilities of the business, or allocating capital to tackle major challenges faced by UK such as infrastructure, research and development

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9
Q

When does the principal-agent relationship exist?

A

Agent represents the principal in a particular transaction and is expected to represent the best interests of the principal above their own

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10
Q

Which relationship underpins agency theory?

A

Principal-agent relationship

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11
Q

What is the key conflict in principal-agent relationship? ‘Agency conflict’

A

Shareholders usually want to see income and wealth grow over the long term, while directors and managers will be looking for more short-term increases in their remuneration and bonuses

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12
Q

4 areas of agency conflict identified by Jensen and Meckling

A
  • Moral hazard - managers have interest in receiving remuneration, and this is more so the case if they have no or few shares
  • Level of effort - managers work less hard than if they were owners
  • Earnings retention - remuneration is often linked to revenue, so managers often take decisions to increase revenue rather than profits
  • Time horizon - Shareholders concerned about long-term whereas managers may only be interested in the short-term
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13
Q

What does agency theory say on CG?

A

CG practices should be used to avoid or manage agency conflict(s)

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14
Q

What are agency costs?

A

Costs associated with maintaining the principal-agent relationship

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15
Q

3 types of agency costs

A
  • Bonding costs - costs of paying directors and management
  • Performance monitoring costs (including GMs, annual reports)
  • Residual losses - relating to actions of directors/execs not in interests of companies
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16
Q

Focus of stakeholder theory to CG

A

Meeting the objectives of all stakeholders. Boards should balance their various interests (inc. non-financial) when making decisions.

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17
Q

4 key approaches to CG

A
  • Shareholder value approach
  • Stakeholder approach
  • Inclusive stakeholder approach
  • Enlightened shareholder value approach
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18
Q

Inclusive stakeholder approach to CG

A

Developed by South Africa - similar to stakeholder approach but incorporates ethics and CSR

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19
Q

Enlightened shareholder value approach to CG

A

Board should look to the long term as well as the short term when maximising shareholder value. Views of other stakeholders considered but only insofar as it is in the interests of the shareholders to do so
ie. ‘promoting the success of the company’

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20
Q

2 reasons why directors still very much primarily favour interests of shareholders

A
  • No provision in CA2006 to enforce duty, only stakeholder having rights are members through derivative action
  • No guidance as to how directors should take other stakeholder interests into account, particularly conflicting ones
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21
Q

Convergence of approaches to CG, briefly

A

Newer approaches of enlightened shareholder value and inclusive stakeholder are closer than older approaches which were considered diametrically opposed.

Shareholder focus ‘in the best interests of the shareholders’ is being redefined as ‘long-term sustainability of the company’, which is far closer to the stakeholder focus

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22
Q

4 agreed principles underlying development of CG

A

Responsibility
Accountability
Transparency
Fairness

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23
Q

Explain responsibility as principle of CG

A

Those in authority should accept responsibility for powers they have been given authority to exercise

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24
Q

Explain accountability as principle of CG

A

Those responsible should be able to honestly account for exercise (or non-exercise) of their authority to those from whom it is derived

25
Q

Explain transparency as principle of CG

A

The ease with which an outsider can make a meaningful analysis

26
Q

Explain fairness as principle of CG

A

All stakeholders should be treated fairly when decisions made or actions taken

27
Q

An emerging issue in CG, in addition to 4 key principles

A

Reputational management - maintaining reputation for high standards of business conduct

28
Q

5 elements of a company’s CG framework

A
  • Applicable laws, regulations, standards and codes
  • Organisation’s constitution
  • Structures
  • Policies
  • Procedures
29
Q

3 main approaches to developing framework of applicable laws, regulations, standards and codes

A
  • Rules-based approach
  • Principles-based approach
  • Hybrid approach
30
Q

Rules-based approach to CG

A

Consists of mandatory set of laws, regulations, standards and codes

31
Q

2 criticisms of rules-based approach to CG

A
  • Only works if challenges faced by companies are substantially similar
  • Only works if rules and their enforcement direct, modify or preclude behaviours they aim to affect
32
Q

Benefit of rules-based approach to CG

A

Statement that country takes seriously their protection from nefarious practices.
In reality, this is dependent on enforcement of laws, which is often weak.

33
Q

Principles-based approach to CG

A

Consists of voluntary set of best practices contained in code of best practice, requiring more active role of institutional shareholders

34
Q

Benefit of principles-based approach

A

Many claim that long-term econ dev is best achieved when business leaders are permitted to exercise judgement

35
Q

Criticism of principles-based approach

A

Catalogue of business scandals over last 20 years indicate more stringent CG regulation may be beneficial

36
Q

What is the hybrid approach to CG?

A

Combing mandatory laws and regulations with voluntary principles-based codes of best practice

37
Q

What is meant by ‘comply or else’?

A

Obligation to abide by mandatory rules-based system of CG - failure usually results in some form of sanction

38
Q

What is meant by ‘comply or explain’?

A

Voluntary principles-based code of best practice - company need not comply but must explain why they haven’t to shareholders who can assess explanation

39
Q

Under which concept does UKCG Code operate?

A

Comply of explain

40
Q

What is meant by ‘apply or explain’?

A

No need to comply in full, but explain how principles were applied if they were

41
Q

2 reasons for introduction of ‘apply or explain’

A
  • To not put off entities that did not have to comply under previous ‘comply or explain’ - seems less harsh
  • To avoid compliance through box-ticking as it was thought was happening under ‘comply or explain’
42
Q

What is meant by ‘apply and explain’?

A

Companies must apply principles and explain how they have done so

43
Q

How do Wates CG Principles define their ‘apply and explain’ system?

A

Companies should ‘apply each principle by considering them individually within the context of company’s specific circumstances. They should be able to explain in their own word how they have addressed them in their governance practices’

43
Q

5 examples of types of structures that may be appropriate to a company

A
  • Audit committee
  • Risk committee
  • Remunerations committee
  • Exec committee and senior management team
  • Board with a charter and statement of reserved powers or delegated authorities
44
Q

What is the purpose of an organisation’s policy?

A

A policy governs how an organisation conducts its operations

45
Q

5 examples of policy

A
  • Bribery
  • Conflicts of interest
  • Whistleblowing
  • Insider trading
  • Gifts, entertainment and gratuities
46
Q

What is the purpose of an organisation’s procedures/processes

A

Enable organisation to utilise resources available to operate business and implement policies and strategies effectively and efficiently

47
Q

5 examples of procedures/processes

A
  • Strategic planning
  • Risk management and internal controls
  • Managing information
  • Business continuity
  • Recruitment
48
Q

3 key considerations when implementing an organisation’s CG framework

A
  • Org’s purpose
  • Assimilation of CG practices
  • What constitutes success
49
Q

4 advantages to having clarity of org’s purpose (for different stakeholders)

A
  • Employees know what they are working towards
  • Investors know what they are investing in
  • Boards/management know how to focus resources and manage risks
  • CoSec has more direction in setting up CG framework
50
Q

5 elements of CG framework (in order)

A

1 - Org purpose
2 - Compliance (what is required)
3 - Governance (how do we make this effective)
4 - Culture
5 - Org success

51
Q

What is the difference between compliance and governance?

A

Compliance is what is required, while governance is the practice of making the compliance practices effective for the organisataion

52
Q

4 of the ways CG practices can be assimilated into corporate culture

A
  • Demonstrating leadership
  • Openness and accountability
  • Aligning values
  • Exercising stewardship
53
Q

5 of the many benefits of effective CG

A
  • Long-term sustainability
  • Improved operational performance
  • Reduced risk of crisis and scandals
  • Improved oversight, monitoring and evaluation
  • Improved share performance
54
Q

2 primary consequences of weak governance

A
  • Failing companies
  • Reputational problems
55
Q

4 causes of failing companies

A
  • Accounting fraud
  • Lack of knowledge or skills on board
  • Dominant personalities
  • Failure to understand and manage risk
56
Q

4 causes of reputational problems for companies

A
  • Unethical business practices
  • Lack of transparency and disclosure
  • Poor relationship between board and shareholders
  • Inappropriate remuneration and reward systems for directors, senior execs
57
Q

5 consequences of weak CG from wider econ perspective

A
  • Excessive regulation
  • Lack of investment
  • Development of shareholder rep bodies
  • Focus on regulating and disclosing exec pay
  • Establishment of powerful regulators