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Hayley K - Corporate Governance November 2022 > Chapter 1 - Definitions & Issues In Corporate Governance > Flashcards

Chapter 1 - Definitions & Issues In Corporate Governance Flashcards

1
Q

How does Cadbury Report 1992 define Corporate Governance?

A

System by which companies are managed and controlled

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2
Q

How does CGI define Corporate Governance?

A

Combination of structures and processes implemented by the board to inform, direct, manage and monitor the objectives of the organisation towards the achievement of its objectives

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3
Q

How does OCED 2005 define Corporate Governance?

A

Set of relationships between the company and management, directors, shareholders and other stakeholders… by which objectives set, means of obtaining objectives and monitor performance.

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4
Q

List key issues of Corporate Governance

A

Remuneration
NED Role
Role of Chair
Board Effectiveness
Independent Professioanl Advice
Director training & induction
Board Structure & procedures
Role of the Company Secretary
Directors’ responsibilities
Internal financial controls (and audit)

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5
Q

What are the three main theories of Corporate Governance?

A

Shareholder Primacy Theory
Agency Theory
Stakeholder Theory

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6
Q

Briefly describe Shareholder Primacy theory.

A

Directors should govern in the best interests of shareholders over any other.

Premise that shareholders own the company - directors/managers are engaged to to them maximise their wealth

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7
Q

What are the 3 main criticisms of shareholder primacy theory?

A

Inappropriate stewardship (caused by incidental/small % holdings)

Short-termism (at expense of long-term company performance) - KAY REPORT

Decline in average holding periods of shares (investment in business itself not as important)

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8
Q

Briefly describe Agency theory.

A

Berle & Means in 1932

Principal - agent relationship : agents represent their principal and should represent their best interest over their own.

Shareholders= principal
Directors/managers = agent

Managers as agents task = promote value for shareholder as the principal

Requires separation of ownership & control

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9
Q

What are the 4 areas of conflict are put forward by Jensen & Meckling in respect of agency theory?

A

Moral Hazard
Earning retention
Level of Effort
Time Horizon

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10
Q

What are the main costs of agency

A
  • MONITORING - cost of GMs, production etc shareholder information
  • BONDING - costs - payment of directors/management
  • RESIDUAL LOSS - costs to shareholders from actions that have not ended up being in their interest in long-run- ex. major acquisitions/disposals, fraud, forrays into new business lines)
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11
Q

How can companies minimise the conflicts and costs of agency?

A
  • Good overall corporate governance
  • Adopt RPT/Conflict of Interest policies
  • Improving monitoring of management
  • Incentives for management that align their interests more closely with the shareholders (ex. share options)
  • Use of electronic communications.
  • Remuneration packages based on profit and long-term interests (share option schemes)
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12
Q

What are the main criticisms of agency theory?

A
  • Exclusive focus on maintaining value for shareholders = short-termism at the expense of long-term performance.
  • Costs
  • Differing interests (conflict of interests) of agent and principal
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13
Q

Briefly define Stakeholder theory.

A
  • Purpose of CG = meet objectives of everyone with an interest in the company (the stakeholders)
  • Non-financial interests to be considered as important as financial ones.
  • Company is a SEPARATE LEGAL ENTITY accountable to the society it operates in.
  • Board should balance all interests on a case by case basis (and set priority based on specific circumstances)
  • Companies should comply with societal norms especially re - laws, regulations and environment -
  • Companies should be GOOD CORPORATE CITIZENS
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14
Q

What are the main approaches to Corporate Governance?

A
  • Shareholder Value
  • Stakeholder (pluralist)
  • Inclusive Stakeholder
  • Enlightened Shareholder

(Stakeholder Capitalism)

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15
Q

What are the main features of shareholder value approach?

A
  • Directors should govern in best interest of owners who are the shareholders
  • Main objective is to maximise shareholder wealth whilst conforming to laws and customs of society.
  • Relies on the concept of separation of ownership & control.
  • Directors accountable to shareholders - they hold the power to appoint/remove them.
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16
Q

What is the main argument against shareholder value approach?

A

Not sustainable in the long-run

  • Companies are not islands - need to interact with other stakeholders/groups
  • Other stakeholder interests must be considered if company is be sustainable/successful in the long-run
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17
Q

What are the main features of stakeholder approach?

A
  • Companies should have regard to all stakeholder views - not just shareholders
  • Including public at large.
  • Boards should attempt to balance all interests
  • Common in civil law countries ex. Germany and Japan
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18
Q

What is the main criticism of stakeholder approach?

A

If companies need to take all conflicting views into account they would never reach a final decision.

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19
Q

What is the enlightened shareholder value
approach?

A
  • When considering actions maximising shareholder value, boards should also look to long term and consider views and impact on other stakeholders
  • Views of others should only be considered in so far that they are in interests of shareholders
  • Will not apply to creditors and s.172 CA2006 will overrule any other law/regulation requiring a company to act in the best interests of its creditors
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20
Q

What are the 6 factors directors’ should consider re s.172 duty? (6)

A
  • Long-term consequences of decisions
  • Employees
  • Fostering business relationships
  • Impact of operations on community and the environment
  • Desirability to maintain a reputation for high standards of business conduct
  • Need to act fairly between members of company
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21
Q

What are the main issues of enlightened shareholder value approach/application of s.172 duty?

A
  • No enforcement powers
  • No guidance how to take stakeholder interests into account - particuarly where there are conflicts of interest.
  • Redress may be found in other areas of law such as Health and Safety/Employment Law

Companies - Misc Reporting Regulations 2018 aims to asist

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22
Q

What is the inclusive stakeholder approach?

A

Introduced by King Report -
* Shareholder has no predetermined precedence over other stakeholders
* Board to consider legitimate interests/expectations of key stakeholders on basis they are in the best interests of the company
* Maximise shareholder value within parameters of company as a sustainable enterprise/corporate citizen
* Incorporates concepts of sustainability, ethics & CSR (‘good citizenship’) into definition of corporate governance

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23
Q

What are some ways in which these approaches converge?

A
  • Common law systems (ex. Japan, France) - what is considered shareholders best interest is becoming what is best for long-term sustainability of the company. This may appear as being a stakeholders approach but this is not seen as at odds with the shareholders own best interests.

<br></br>
- Companies are independent legal entities with potential for indefinite life - the duty of leadership is to sustain the company in the long-term and make decisions in the best interests of the company rather than any particular stakeholder (group) - Bower/Paine
<br></br>

Shareholders should not take primacy : they have no duty to serve/protect<br></br>
* Shareholders are protected by limited liability (and can usually buy/sell shares without restriction)<br></br>
* Are not one cohensive group (and so have differing interests) <br></br>
* Generally expect shorter-term ROI (may pressure mgmt focus on short-med term performance rather than longer-term)
<br></br>

Companies have the power over people and power to transform societies / impact the environment - should create value for multiple stakeholders (ex. employees, customers) <br></br>
Leadership should focus on how to maintain these relationships and manage trade-offs in long-term interests of company - rather than maximising value for the shareholders.
<br></br>
- Civil law countries - a pressure to give priority to interest of shareholders (ex. France) - Japan sees providers of capital as at the core of CG

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24
Q

What are the underlying issues with both main approaches?

A
  • Conflicts of interests
  • Director short-termism (can move on with limited personal loss if the company begins to fail, whereas shareholders/other stakeholders must ‘suffer’ the consequences)
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25
Q

What is stakeholder capitalism?

A
  • Creation of shareholder returns by creating value for society as a whole.
  • Growing idea that the most valuable assets a company has are intangible.
  • Alignment of interest ‘grows the pie’ for all (Edmonds) - everyone can benefit
  • Re-examination of traditional governance models due to modern day changes (ex. technology, geopolitics,socio-economic)
26
Q

What are the criticisms of stakeholder capitalism?

A
  • Outside of the US, countries already have their own forms of stakeholder governance and prefer these as they are already embedded in their various organisations.
  • Cannot dismantle 50 yrs of shareholder primary in a day/year especially if it appears companies in capitalist countries are ‘still winning’ by the old rules.
27
Q

What are the four main principles of Corporate Governance?

A
  • Fairness
  • Accountability
  • Responsibility
  • Transparency
28
Q

What are Larkin’s 9 main benefits of effective reputational management?

A
  • Improved shareholder relations
  • Premium prices for products and/or services
  • More favourable environment for investment and access to capital
  • Recruit/retain best employees
  • Attract best business partners, suppliers and customers
  • Reduce barriers to development in new markets
  • Reinforce credibility and trust for stakeholders
  • Minimise threat of litigation/more stringent regulation
  • Reduce potential for crises
29
Q

What does a CG framework consist of?

A
  • Laws, regulations, standards & codes
  • Organisation’s constitution (ie. Articles)
  • Structures (board, AC, Remco, gov committee etc)
  • Policies (ethics, whistle-blowing, insider trading etc.)
  • Procedures (strategic planning, business continuity etc)
30
Q

What are the 4 main approaches to application of Corporate Governance Frameworks?

A
  • Laws, regulations, standards and codes
  • Rules-based approach
  • Principles-based approach
  • Hybrid approach
31
Q

List 6 factors that should be considered in determining an organisation’s structure(s)

A
  • Type of company
  • Size of company
  • Its people
  • Risks associated with operations
  • Laws/Regulations/Codes applicable
  • Strategic objectives
32
Q

Why is it so important that organisations adequate procedures in place?

A
  • Efficient utilisation of resources to operate the business
  • Enables efficient and effective implementation of policies and strategies adopted
33
Q

What is a rules-based approach to CG ?

A
  • Mandatory set of laws, regs, standards and codes (Ex. Sarsbonne-Oxley in the USA)
  • Failure to comply may result in sanction/fees
  • Directors may be fined/imprisoned and/or disqualified from holding directorships for a period of time
34
Q

Benefits of rules-based approach to corporate governance.

A
  • Certain laws are essential to protect stakeholders (e.g. employment law)
  • Laws are required to punish actions that are so unethical they would be illegal
  • Regulation restores public faith : sends a message to investors that their protection is taken seriously
35
Q

What are the disadvantages of/issues with having a rules-based approach to corporate governance?

A

Only works :
- If challenges under purview of the regulation are substantially similar that it justifies a common approach
- If the rules and their enforcement efficiently and effectively direct, modify or preclude behaviours they are aimed at. <br></br>

Excessive regulation may deter companies from listing/entering the market - or force them to migrate

36
Q

What is a principles-based approach to CG?

A

Voluntary code based on general principles of best governance rather than detailed rules and guidelines.

Choice and flexibility

37
Q

What is the main issue of a principles-based approach to CG?

A
  • For it to work, institutional shareholders need to take an active role in the governance of companies in which they invest.
  • Such institutional shareholders will often lack time and resources to do this effectively
  • Given financial scandals of recent years - evidence may NEED more regulation/legislation
38
Q

Benefits of principles-based system of Corporate Governance?

A
  • No one size fits all solution
  • The biggest concerns apply to stock market companies with public shares
  • The largest companies are the most problematic, and can be targeted
  • Onerous regulation may encourage companies to migrate
  • Flexibility: allows directors/managers to utilise their own discretion in/and consider the company’s own specific circumstances(sometimes non-compliance may be in the company’s best interests at a particular point in time)
  • Extensive/over-regulation may deter companies from becoming listed.
39
Q

Why might more regulation (in contrast to retaining a more principles-based approach) may in fact be needed?

NB

A
  • Business scandals - regulation may be needed to ensure good governance prevails to ensure stakeholders and their interests are protected.
  • UK - questions over market structure and if they are still able to self-regulate (compared to the 1990s) - in the way that was originally envisioned.
  • Limited resources / time for investors to devote energies to monitoring companies’ corporate governance.
  • Overseas companies sometimes face practical barriers to direct engagement with UK companies.
40
Q

What is the hybrid approach to CG?

A

Combines mandatory laws/regulations with voluntary principles-based codes (of best practice) and standards.

41
Q

What is ‘comply or explain’

A
  • Compliance with voluntary principles-based code and explain any divergeances to shareholders in annual report.
  • If it considers non-compliance to be in the company’s best interests.
  • Shareholders/rep bodies should asess whether explanation for deviation provided is acceptable or not

KEY EXAMPLE - UK CORPORATE GOVERNANCE CODE

42
Q

What is ‘comply or else’?

A

Obligation to comply with a rules-based system.

Failure to do so = sanction/punishment

43
Q

What is ‘apply or explain’?

A

Per King III

  • Code applies to all organisations regardless of form of estbalishment/incorporation.
  • Used where comply or explain may be too harsh (this was developed for listed companies)
  • Encourages telling a ‘story’ of the adoption of governance within the org.
  • Aims to avoid ‘mindless box-ticking’ approach to CG.
44
Q

What is ‘apply and explain’?

A

Per King IV

  • Apply / consider each principle individually in context of company’s individual circumstances.
  • Explain (in own words) how each principle has been addressed in the company’s governance practices.
  • Avoids making compliance a ‘box-ticking’ exercise.
  • Hope is that stakeholders will be able to make an informed decision / see CG as something that will yield results if considered carefully within the context of a company’s specific circumstances.
45
Q

What are Larkin’s key benefits of effective reputation management? (9)

A
  • Improved shareholder relations
  • More favourable environment for investments/access to capital
  • Helps recruit/retain the best employees
  • Attracts new (and the best) business partners, suppliers and customers
  • Reduces barriers to deviate into new markets
  • Secures premium prices for products and/or services
  • Minimises the threat of litigation or facing more stringent regulation(s)
  • Reduces the potential for crises
  • Reinforces the organisation’s credibilty/trust with stakeholders
46
Q

Why is it so important to know the company purpose / what are the most important points regarding a company’s purpose?

A
  • Could be included in objects clause if company has one (if not should be set out in governance documents)
  • Must be known as everything stems from it - values, mission, strategic goals and governance framework
  • Only by knowing the purpose can efforts and resources be focused on achieving that purpose so the organisation can be successful in the long run
  • CS being aware means can use it to help set CG frameworks/structures/policies and procedures.
  • In reality it is not as simple to define as many would think.
47
Q

What are the main considerations a company’s Gov Professional/CoSec should make when implementing the corporate governance framework?

A
  • Organisation’s purpose
  • Assimilation of CG practices
  • What constitutes ‘success’
48
Q

What should structures do?

A
  • Meet strategic needs
  • Manage risks
  • Comply with any laws/regulations/standards/Codes
49
Q

How can one ensure the implentation of CG practices is effective?

A
  • Appropriate structures in place
  • People (are focused and work well together)
  • Resources available and used effectively
  • Smooth information flows
50
Q

What are the main consequences of inappropriate CG structures?

A
  • Desired culture won’t develop
  • People develop their own ideas / won’t be managed well
  • Leads to bad practices (silos)
  • Policies not followed
  • Resources misused
  • Breakdown of important relationships
51
Q

What are some benefits in adopting good corporate governance practices?

A
  • Long-term sustainability
  • Improved access to financing (external)
  • Lower cost of capital
  • Increased valuation of firm
  • Improved share performance
  • Reduced risk of crisis/scandal (reputational risks)
  • Improved operational performance
  • Succession planning is beneficial in general
  • Improved evaluation/monitoring/oversight
  • Ethical behaviour (can act as an anti-corruption tool)
52
Q

What are the arguments against CG?

A
  • Potential for ‘box-ticking’
  • Excessive bureaucracy
  • Cost
  • Effort
  • Companies at a disadvantage to those who don’t need to compy (e.g. rivals in other countries)
  • May all discourage companies from listing
53
Q

What is the board’s main responsibility re corporate governance?

A

Governance of the organisation - setting up structure, polices and procedures in place to ensure effective operation.
<br></br>

Management of day to day affairs is usually delegated to CEO/exec team

54
Q

What are the 2 main delegations of board authority?

A
  • Authority to manage to CEO (who can subdelegate as they see fit)
  • Authority passed to several executives depending on nature of their responsibilities (ex. FD, COO)

First option is preferable as means board can one person accountable - usually the CEO

55
Q

What are the consequences of weak corporate governance?

A
  • Failing companies
    • Accounting fraud (ex. Worldcom)
    • Lack of knowledge/skills experiences (ex. Barings Bank)
    • Dominant personalities (ex. Polly Peck)
    • Failure to understand/manage risk (ex. Carillion)
  • Reputation problems
    * Unethical business practices (ex. Volkswagen ‘Diselgate’)
    * Lack of transparency & disclosure (ex. Olympus)
    * Poor relationship with shareholders (ex. Sports Direct)
    • Inappropriate remuneration/reward structures (ex. Enron)
  • Excessive regulations (ex. SOX)
  • Lack of investment in capitable markets
  • Development of shareholder representative bodies (ex. Hermes / CalPERS)
  • Focus on regulation/disclosure of senior execuctive pay
  • Establishment of powerful regulators (ex. SEC)
56
Q

List examples of bad corporate governance.

A
  • Boards that fail to perform their duties properly (dominated by 1 or more individuals or fails to carry out tasks/make effective decisions);
  • Misleading financial reporting to shareholders/investors;
  • Poor relationship between board and main shareholders;
  • Ineffective systems of risk management (exposure to errors and fraud due to inadequate internal controls);
  • Inappropriate remuneration and reward systems for directors and senior execs;
  • Unethical business practices.
57
Q

What is the difference between enlightened shareholder value and inclusive stakeholder approaches to cG?

A
  • Enlightened shareholder value approach proposes that boards, when considering actions to maximise shareholder value, should look to the long term as well as the short- term, and consider the views of and impact on other stakeholders in the company, not just shareholders. The views of other stakeholders are, however, only considered in so far as it would be in the interests of shareholders to do so.

<br></br>

  • This differs from the stakeholder and stakeholder inclusive approaches where boards balance conflicting interests of stakeholders in the best interests of the company.
58
Q

What are the differences between shareholder primacy and company/stakeholder focused approaches to corporate governance?

A
  • Shareholder primacy - directors govern in best interests of company’s owners, the shareholders. Main aims are to maximise shareholder wealth, protect investors and the value of their holding.
  • Company/stakeholder primary - directors should have regard to all stakeholders’ views, including the public. They should balance all of these interests when making decisions.
59
Q

Which approaches to corporate governance take a longer-term view in decision-making?

A

Enhanced shareholder value, stakeholder and inclusive stakeholder tend to have a longer term view than shareholder value approach.

60
Q

How can a business be sure it assimilates corporate governance practices into its culture?

A

To ensure this happens - organisation should define its critical success factors so that these can be measured.

This should/will usually be done as part of the strategic planning process.

Hayley K - Corporate Governance November 2022 (19 decks)

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