Chapter 5 pt 1 Flashcards
(50 cards)
1
Q
What is the board of directors responsible for?
A
- Representing the owners of the company
- Holding management teams accountable for running the business in the interest of its owners
2
Q
What does the effectiveness of the board of directors depend on?
A
- Whether good governance practices are applied
- Principles that shape the practices are codified into corporate government codes
3
Q
What are the types of issues that investors will consider about a company’s governance?
A
- shareholder rights,
- the likely success of the intended company strategy and the effectiveness of the leadership in place to deliver it,
- executive pay,
- audit practices,
- board independence and expertise,
- transparency or accountability,
- related-party transactions, and
- dual-class share structures.
4
Q
What are dual-class share structures?
A
- A dual-class share structure is when a company issues two or more types of shares, usually with different voting rights E.g.
- Class A shares: Often have more voting power (e.g., 10 votes per share)
- Class B shares: Often have less or no voting power (e.g., 1 vote or none)
5
Q
What are the 2 ‘A’s’ in corporate governance?
A
- Accountability
- Alignment
6
Q
What does accountability mean for corporate governance?
A
- People need to be given authority and responsibility for decision-making
- held accountable for the consequences of their decisions and the effectiveness of the work they deliver.
7
Q
What is the role of chair of the board and what do investors expect the chair to be like?
A
- The role of the chair of the board is vital in facilitating a balanced debate in the boardroom.
- Consequently, many investors prefer that the chair be an independent, non-executive director.
8
Q
What happens if the chair is not independent e.g. Is the CEO
A
- hamper the board’s ability to
a. exercise their oversight responsibilities;
b. challenge and debate performance and strategic plans;
c. set the agenda, both for board meetings and for the company as a whole;
d. influence succession planning;
e. debate executive remuneration
9
Q
List the flow of accountability bottom up
A
- Workforce
- Management
- Corporate board
- Portfolio management
- Asset Owner
- Beneficiaries
10
Q
When is the auditor normally appointed?
A
- the auditor reports formally to shareholders each year and is reappointed annually in most countries at the AGM.
11
Q
Describe the role accounts play in accountability
A
- The annual accounts of the company represent the formal process of the directors making themselves properly accountable to the shareholders for financial and broader business performance
- Why the first item at many annual general meetings ( AGMs ) is acceptance of the report and accounts, often through a formal vote.
12
Q
What does it mean to ‘discharge’ the board?
A
- Shareholders formally approve the actions of the board and management for the past financial year.
- If the vote passes, it releases (or absolves) the board from liability for decisions made during that year—as long as all relevant facts were disclosed.
13
Q
What is the agency problem?
A
- Arises when the interests of the professional managers—the agents—are not wholly aligned with the interests of the owners of the business, and so the company may not be run in the way the owners wish.
14
Q
What does Corporate governance try to do address agency problem?
A
attempts to ensure that there is greater alignment of the interests of the agents with the interests of the owners, through both incentives and appropriate chains of accountability, to mitigate the potential negative consequences of the agency problem.
15
Q
Describe alignment and executive pay
A
- helping to ensure that executives are not given incentives to perform in their own interests
- creating a balanced compensation package that includes performance-related remuneration based on short- and long-term goals and with a significant portion of compensation that vests over the long term.
- The goals ideally include a mix of key performance indicators (KPIs) related to business (both financial and non-financial) and share price performance.
- Many of the incentives often come with some form of equity linkage—which can, on occasion, cause the risk that management is more focused on share price development than on the performance of the business itself.
16
Q
What are the 3 key committees of the board?
A
- The Nominations Committee (in some markets, this is called the Corporate Governance Committee or some combination of these terms) aims to ensure that the board overall is balanced and effective, ensuring that management is accountable.
- The Audit Committee oversees financial reporting and the audit, delivering accountability in the accounts. The Audit Committee also oversees internal audits (where they exist) and is responsible for risk oversight unless there is a separate risk management committee.
- The Remuneration Committee (in some markets, this is called the Compensation Committee) seeks to deliver a proper alignment of interests through executive pay.
17
Q
When and where was the world’s first corporate governance code?
A
- UK
- 1992
- The Cadbury Committee had been brought together in May 1991 by the Financial Reporting Council, the London Stock Exchange, and the accounting profession to consider what were called “the financial aspects of corporate governance.”
Its creation followed the Caparo and Polly Peck scandals
18
Q
What were the Caparo and Polly Peck scandals?
A
- Caparo had mounted a successful takeover bid for Fidelity
- only to subsequently discover that Fidelity’s profits were significantly overstated.
- The market had pumped up the share price of Polly Peck for years based on financial reporting that later turned out to be misleading.
- The Cadbury Committee was created because of the perceived problems in accounting and governance
19
Q
What other scandals emerged once the Cadbury Committee had begun its work?
A
- The Maxwell/Mirror Group scandal was beginning to emerge
- The Bank of Credit and Commerce International (BCCI) collapsed spectacularly in the wake of money laundering and other regulatory breaches. It was clear that much needed to change.
20
Q
What are examples of what the Cadbury Committee recommended?
A
- the committee proposed that every public company should have an audit committee that meets at least twice a year.
- when the report was released, only two-thirds of the largest 250 companies in the UK had such committees at all
- The report’s core theme is that no individual should have “unfettered powers of decision”; so, for example, the roles of chair and CEO should not be combined, as they frequently were at the time.
21
Q
What are different models of boards?
A
- Two-tier boards: wholly non-exec supervisory boards overseeing management boards
- Single-tier boards: some dominated by exec directors (Japan), some with combined CEO and Chair (US & France)
- In between the models: UK
22
Q
Which is the only major world market which doesn’t have a corporate governance code
A
- USA
- Largely a consequence of corporate law being set at the individual state, rather than the federal, level.
23
Q
Why do some companies view corporate governance codes negatively?
A
- They may see them as inflexible or rigid, especially when deviations are not well explained or understood
- A mix of poor communication from companies and investors relying too much on proxy adviser recommendations cause view that it is inflexible
24
Q
What role do proxy advisory firms play in governance?
A
- They interpret governance codes strictly and offer voting recommendations to investor
- ISS (Institutional Shareholder Services) and Glass Lewis.
25
What have been other scandals that have continued to fuel the development of governance standards around the world?
1. Pay levels at newly privatised utilities in UK: Greenbury Report
2. Enron and WorldCom scandals in US: Led to Sarbanes-Oxley Act
3. Ahold and Parmalat failures in Netherlands and Italy: led to pressure for heightened standards of corporate governance and board and auditor independence across Europe
4. Financial crisis : Renewed focus on corporate culture and exec pay, led to stewardship codes
5. Olympus and Tobisha scandal in Japan where losses were hidden to maintain perception of good corporate health and jobs: advanced governance standards in Japan
26
What was the Greenbury Report?
1. revised the UK’s corporate governance code in 1995
2. It increased the visibility of remuneration structures and pressed toward transparency over the KPIs that drive performance pay and the time horizons over which pay is released
3. (for long-term schemes, the time horizon is a minimum of three years).
27
What is the Sarbanes-Oxley Act?
1. This law lifted expectations for greater integrity in financial reporting
2. created the Public Company Accounting Oversight Board (PCAOB) as the country’s audit standard setter and inspector, establishing a standard for auditor independence and challenge.
28
What were some of the stewardship codes that resulted from the Financial crisis?
1. 2010 Dodd–Frank Act in the USA (formally, the Dodd–Frank Wall Street Reform and Consumer Protection Act), which, among its multiple clauses, tightened standards for, and oversight of, banks.
29
What was the Enron scandal?
1. An electric utility turned energy-trading business, Enron used a range of off-balance-sheet vehicles and other aggressive accounting techniques to appear hugely profitable, even on projects that had barely begun.
2. Its collapse led to the dismantling of its auditor, Arthur Andersen, which split apart rapidly after some of its staff in Houston were discovered to have shredded documents linked to Enron and the US Securities and Exchange Commission’s (SEC’s) investigation.
3. Governance failings included weak oversight of the executives (reinforced by the founder, Ken Lay, remaining as executive chair) by the non-executive directors.
4. There were also failures of commission, most clearly the decision to waive the board’s own code of conduct to enable the CFO to participate personally in some of the off-balance-sheet structures whose purpose was to facilitate the removal of losses from Enron’s accounts.
30
What was the WorldCom scandal?
1. Internal audit of telecom business found accounting deceit- Booking current expenses as capital investments
2. Boosts profits by $3.8 billion
3. Assets exaggerated by $11 billion
4. Chair invited internal audit team to speak with external auditors
5. When comittee finally met, confronted execs leading the finance function with full evidence
6. Execs departures, public announcements, SEC investigation and bankruptcy followed
31
What was the Royal Ahold scandal?
1. Dutch grocery chain
2. Deteriorating performance was hidden by fraud
3. While making decisions to grow internationally, the board failed to ensure that its skills and its processes also developed so that it could oversee the new broader spread of the business.
4. Therefore, the US operations faced more limited oversight and challenge than they might have, allowing frauds to develop without being uncovered until they were very substantial.
32
How did poor corporate governance contribute to Ahold's failure?
1. Absence of both internal and external oversight of international operations enabled the CEO and the CFO to improperly book sales in international subsidiaries.
2. Initially, the company’s owners maintain absolute control of the company. By issuing non-voting certificates instead of voting shares, they prevented shareholders from holding management accountable, undermining good governance and enabling unchecked control.
3. Ahold had a two-tier board structure where the supervisory board was meant to monitor strategy and performance. However, this oversight was weakened because many members of the supervisory board were former managers, compromising their independence and objectivity.
4. Ahold had board members with extensive portfolios, which limited their time commitment to the firm.
5. Several board members had ties with financial institutions related to Ahold which led to conflicts of interest with these stakeholders.
6. Although board members were generally qualified based on experience and background, several politicians with little business experience served on Ahold’s board.
7. Ahold’s incentive compensation plans focused heavily on earnings growth, prioritize short-term earnings 8. There were lax internal controls and poor financial and accounting practices on the part of Ahold in the USA, as identified and documented in the forensic audit by (PwC).
33
What was the Parmalat scandal?
1. Italian milk business hid its losses in South American operations by inflating revenues by double billing
2. More than $4 billion turned out to be fictional
3. Not uncovered for more than a decade as people were fired, scale of profits and efforts to conceal snowballed
4. Combined Chair/CEO role
34
What was the Satyam scandal?
1. The founder and chair admitted to falsifying the accounts of this IT services company.
2. For around five years, the company had inflated revenues using thousands of false invoices
3. The auditor had apparently failed to check the bank statements that might have uncovered the fraud.
4. he entire board was removed by regulators, the chair was jailed
5. Following a lengthy regulatory procedure, the company’s auditor, PwC, was banned in 2018 from auditing any Indian public company for two years.
35
What was the Olympus scandal?
1. new CEO Michael Woodford soon became concerned about the profitability of Olympus.
2. He was ousted but acted as a whistleblower.
3. Slowly, it emerged that the Japanese camera and medical instruments maker had hidden losses for many years, principally through over-priced acquisitions whereby some of the excess advisory fees paid were returned to the company to cover losses and shore up its finances.
4. Olympus was run by long-standing executives who had sought to protect the company at all costs, with remarkably few independent checks and balances.
5. They had clearly concluded that hiding losses through convoluted schemes was preferable to honesty about the company’s issues and the potential negative consequences for its workforce.
36
What was the Volkswagen scandal?
1. cheated on US emissions tests on its diesel engines through software, so-called defeat devices.
2. Many investors had been concerned about the lack of accountability as the voting shares were predominantly held by the founding families, the local government, and the government of Qatar.
3. The differential voting rights served to entrench these groups, enabling them to dominate the board.
4. Management was thus able to operate in an insular and unaccountable way.
5. Furthermore, the company’s culture was driven by the view that engineers always knew best and that their actions were largely above criticism.
6. The company needed an engineering response to the new diesel regulations, but when it failed to find one that worked on the road, it chose to seek one that at least worked during testing.
7. The board, accustomed to not having to listen to external voices, never felt the need to ask enough questions to uncover the issue
37
What was the Wirecard scandal?
1. A hard-driving fintech and global payments processor, collapsed in June 2020 when long-running allegations of fraud and questionable accounting were largely confirmed by a special audit.
2. The audit revealed that some €1.9 billion of assets were missing from its accounts.
3. It became apparent that substantial elements of Wirecard’s business in the Middle East and Asia were no more than a sham and that the core payments-processing operations in Europe were barely profitable.
4. Media investigation fought by German regulator who should have been overseeing the business
38
What is Shareholder engagement?
the active dialogue between companies and their investors, with the latter expressing clear views about areas of concern (which often include ESG matters).
39
What could minority shareholder exploitation look like?
1. Money siphoning out of the business - benefit controlling shareholding, so higher disclosure around related-party transactions
2. Pre-emption rights
3. Dual-class shares
40
What are class tests in the UK listing regime?
1. rules used to assess how significant a transaction is (like buying/selling a company, or a big asset), based on size and financial impact.
41
How are the UK class tests currently applied in the UK Listing regime?
x
1. Class 2: If a transaction affects more than 5% of any of a company’s assets, profits, value, or capital, there must be additional disclosures
2. Class 1: If a transaction affects more than 25% of any of a company’s assets, profits, value, or capital, there must be a shareholder vote to approve the deal based on detailed justifications
42
What are pre-emption rights?
1. ensure that an investor has the ability to maintain its position in the company.
2. Pre-emption rights give existing shareholders the first opportunity to buy new shares before the company offers them to outsiders.
3. This helps investors keep the same ownership percentage in the company when new shares are issued.
4. Not in the US
43
What is a “rights issue”?
1. A fundraising method where companies offer new shares to existing shareholders under pre-emption rights.
2. BUT rights issues are slow and complex, especially for small share issuances so companies seek authority to issue shares non-pre-emptively
44
How much non-pre-emptive issuance is typically approved by investors at AGMs?
1. Usually up to 5% or 10% of the share capital.
45
What is a soft pre-emption?
1. Even when formal pre-emption is skipped, large investors expect a “soft pre-emption”:
2. They're offered a share allocation roughly equal to their ownership,
3. But in an informal, quicker process—not full legal rights.
46
What does the Hong King SAR General mandate allow?
1. Up to 20% of share capital to be issued,
2. Possibly at a discount to market price.
3. This dilutes existing shareholders’ value and is seen as harmful to minority shareholder rights.
47
What is a “sunset clause” in the context of dual-class shares?
1. A rule requiring the dual-class structure to end (merge into one class) after a set time, often 7 years.
2. Early on dual-class can be stabilising but after 7 years shown to be damaging
48
What are the Council of Institutional Investors in terms of shareholders voting rights?
1. helped foster the creation of the Investor Coalition on Equal Votes
which campaigns on the issue of dual-class shares, particularly focusing on companies in the pre-IPO(initial public offering) phase.
49
What company issued shares with no voting rights at all?
Snap Inc., the parent company of Snapchat.
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