Chapter 1 - Definitions & Issues In Corporate Governance

Question 1

How does Cadbury Report 1992 define Corporate Governance?

Answer 1

System by which companies are managed and controlled

Question 2

How does CGI define Corporate Governance?

Answer 2

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

Question 3

How does OCED 2005 define Corporate Governance?

Answer 3

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

Question 4

List key issues of Corporate Governance

Answer 4

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)

Question 5

What are the three main theories of Corporate Governance?

Answer 5

Shareholder Primacy Theory
Agency Theory
Stakeholder Theory

Question 6

Briefly describe Shareholder Primacy theory.

Answer 6

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

Question 7

What are the 3 main criticisms of shareholder primacy theory?

Answer 7

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)

Question 8

Briefly describe Agency theory.

Answer 8

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

Question 9

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

Answer 9

Moral Hazard
Earning retention
Level of Effort
Time Horizon

Question 10

What are the main costs of agency

Answer 10

• 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)

Question 11

How can companies minimise the conflicts and costs of agency?

Answer 11

• 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)

Question 12

What are the main criticisms of agency theory?

Answer 12

• 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

Question 13

Briefly define Stakeholder theory.

Answer 13

• 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

Question 14

What are the main approaches to Corporate Governance?

Answer 14

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

(Stakeholder Capitalism)

Question 15

What are the main features of shareholder value approach?

Answer 15

• 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.

Question 16

What is the main argument against shareholder value approach?

Answer 16

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

Question 17

What are the main features of stakeholder approach?

Answer 17

• 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

Question 18

What is the main criticism of stakeholder approach?

Answer 18

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

Question 19

What is the enlightened shareholder value
approach?

Answer 19

• 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

Question 20

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

Answer 20

• 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

Question 21

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

Answer 21

• 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

Question 22

What is the inclusive stakeholder approach?

Answer 22

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

Question 23

What are some ways in which these approaches converge?

Answer 23

• 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.

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- 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
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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)
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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.
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- 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

Question 24

What are the underlying issues with both main approaches?

Answer 24

• 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)

Question 25

What is stakeholder capitalism?

Answer 25

* 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)

Question 26

What are the criticisms of stakeholder capitalism?

Answer 26

* 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.**

Question 27

What are the four main principles of Corporate Governance?

Answer 27

* Fairness * Accountability * Responsibility * Transparency

Question 28

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

Answer 28

- 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**

Question 29

What does a CG framework consist of?

Answer 29

* **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)

Question 30

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

Answer 30

* Laws, regulations, standards and codes * **Rules**-based approach * **Principles**-based approach * **Hybrid** approach

Question 31

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

Answer 31

* **Type** of company * **Size** of company * Its **people** * **Risks** associated with **operations** * Laws/Regulations/Codes **applicable** * **Strategic objectives**

Question 32

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

Answer 32

* **Efficient utilisation** of **resources** to operate the business * Enables **efficient and effective implementation** of **policies** and **strategies** adopted

Question 33

What is a rules-based approach to CG ?

Answer 33

* **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

Question 34

Benefits of rules-based approach to corporate governance.

Answer 34

- **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**

Question 35

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

Answer 35

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

Question 36

What is a principles-based approach to CG?

Answer 36

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

Question 37

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

Answer 37

* 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**

Question 38

Benefits of principles-based system of Corporate Governance?

Answer 38

- **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.**

Question 39

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

Answer 39

* 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.

Question 40

What is the hybrid approach to CG?

Answer 40

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

Question 41

What is 'comply or explain'

Answer 41

* **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**

Question 42

What is 'comply or else'?

Answer 42

**Obligation** to comply with a **rules-based** system. **Failure** to do so = **sanction/punishment**

Question 43

What is 'apply or explain'?

Answer 43

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.

Question 44

What is 'apply and explain'?

Answer 44

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.**

Question 45

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

Answer 45

- 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

Question 46

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

Answer 46

* 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.

Question 47

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

Answer 47

- Organisation's **purpose** - **Assimilation** of CG **practices** - What constitutes '**success**'

Question 48

What should structures do?

Answer 48

- Meet strategic needs - Manage risks - Comply with any laws/regulations/standards/Codes

Question 49

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

Answer 49

- Appropriate **structures** in place - **People** (are focused and work well together) - **Resources** available and used effectively - Smooth **information** flows

Question 50

What are the main consequences of inappropriate CG structures?

Answer 50

- **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**

Question 51

What are some benefits in adopting good corporate governance practices?

Answer 51

- 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)

Question 52

What are the arguments against CG?

Answer 52

- 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**

Question 53

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

Answer 53

***Governance of the organisation*** - setting up structure, polices and procedures in place to ensure effective operation.
**Management** of **day to day** affairs is *usually delegated* to **CEO/exec team**

Question 54

What are the 2 main delegations of board authority?

Answer 54

- 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

Question 55

What are the consequences of weak corporate governance?

Answer 55

- **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 bodie**s (ex. Hermes / CalPERS) - Focus on **regulation/disclosure** of senior **execuctive pay** - **Establishment** of powerful **regulators** (ex. SEC)

Question 56

List examples of bad corporate governance.

Answer 56

* 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**.

Question 57

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

Answer 57

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

Question 58

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

Answer 58

* **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.

Question 59

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

Answer 59

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

Question 60

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

Answer 60

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.