Concepts of Corporate governance Flashcards
What is corporate governance?
It is a system by which organisations are directed and controlled, based on concepts of transparency, independence, accountability and integrity.
What are theoretical frameworks of governance?
What is a stakeholder theory?
Stakeholder theory - proposes corporate accountability to a broad range of stakeholders.
CG introduction: To succeed in long term, the directors and the companies they lead must build relationships with a wide range of stakeholders. Provision 5 - Board need to understand views of stakeholders, esp WORKFORCE.
Shareholder primacy theory - maximise value to shareholders before considering other stakeholders.
Shareholder supremacy theory?
Shareholder supremacy theory - maximising value of shareholders before considering other stakeholders.
What is the main difference between the agency and stakeholder theories?
Agency theory deals with the relationship between shareholders and directors where there is a separation between ownership: the shareholders playing the part of the principal and the directors and managers playing the part of the agent.
Challenges associated with the agent-principal relationship occur.
These relate to conflicts of interest and the costs associated with avoiding/managing those conflicts.
The stakeholder theory, in direct contrast to the agency theory, states that the purpose of corporate governance should be to meet the objectives of everyone that has an interest in the company.
How do the agency theory and stakeholder theory affect the objectives of the companies?
A company whose governance is based on the agency theory will be focusing on creating and maintaining shareholder value through managing conflicts of interest and the costs associated with avoiding/managing those conflicts. This is usually reflected in a focus on financial objectives such as return on investment, sales and profit targets. Objectives also tend to be short-term.
In contrast, stakeholder theory requires boards to balance the interests of the different stakeholder groups when making decisions, deciding on a case-by-case basis which interests should take priority in a particular circumstance. This means that non-financial objectives, such as employee elations or limiting environmental impact would be considered. Objectives tend to be longer-term.
How can a company manage conflicts of interest between shareholders and directors
Agency theory - companies should use corporate gov practices to avoid or manage these conflicts by:
- Long-term incentive share awards based on TSR to align the interests of shareholders and management
- Adopt policies to manage conflict of interests and related party transactions
Approaches to corporate governance
- Shareholder value approach
- Stakeholder approach
- Inclusive stakeholder approach
- Enlightened shareholder value approach
What is the difference between the enlightened shareholder value and inclusive stakeholder approaches to corporate governance?
The 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 the conflicting inte ests
of stakeholders in the best interests of the company.
Which approaches see boards taking a longer-term view in decision-making?
Enhanced shareholder value, stakeholder, and inclusive stakeholder approaches
tend to take a longer-term view than the shareholder value approach.
Which approaches put shareholders first?
The shareholder value and enhanced shareholder value
What are the pros and cons of a rules-based approach versus a
principles-based approach to corporate governance?
Cons of rules-based approach:
- Only works the challenges faced by companies are similar - common approach to common problems
- Only works if the rules and enforcement effectively direct and modify or preclude the behaviours they are aiming at affecting.
Pros:
- Sends out clear message to owners, investors and stakeholders that the country take seriously their protection from nefarious practices by those managing and overseeing the company.
What is the ‘comply or explain’ rule for listed companies in the UK?
‘Comply or explain’ refers to the system whereby a company is asked to comply
with a voluntary principles-based code of best practice. Where the company
believes that it is not in its best interests to ‘comply’ with a provision of the
code it is required to ‘explain’ to shareholders why they have not complied.
The company’s shareholders and shareholder representative bodies are then
expected to assess whether the explanation is acceptable or not. The UK
corporate governance code works on the premise of a ‘comply or explain’ code.
How does it differ from the ‘apply and explain’ rule in King IV?
The term ‘apply or explain’ was adopted in the South African King Code for two main reasons.
Firstly, the code, for the first time, applied to all types of entities regardless of their form of establishment or incorporation. These entities under a ‘comply or explain’ regime would only have had the option of complying or not. As many of the entities were not listed companies, which the corporate governance practices had originally been designed for, it was felt that that regime would
put off many entities from adopting good corporate governance.
Asking them how they were ‘applying’ the principles within the code was a less harsh way of reporting on what they were doing as they did not have to give a yes or no answer, they could tell a story of how corporate governance was being adopted in their organisations. Secondly, to avoid a ‘mindless response’ to the corporate governance recommendations contained within the code. There was a feeling amongst many stakeholders that the ‘comply and explain’ regime was leading to companies adopting a tick-box approach to corporate governance, adopting the provisions without considering whether they were suitable for their companies or not.
Why is knowing your purpose important for an organisation?
Knowing the organisation’s purpose is very important as everything stems from it: the organisation’s vision, mission, strategic goals and governance framework, including risk management. It is only through knowing the purpose of the
organisation and focusing efforts and resources on achieving that purpose that organisations can be successful in the long run.
If an organisation has clarity of purpose then its employees know what they are working towards, investors know what they are investing in and boards and management know how to focus their resources and manage their risks.
For the company secretary, knowing the organisation’s purpose helps set up the organisation’s governance framework of structures, policies and procedures.
What is the difference between compliance and governance?
Compliance answers ‘what is required’. It leads to an organisation adopting the appropriate structures, policies and procedures. On its own it is a purely boxticking exercise.
Governance answers ‘how do we make this effective’. The company secretary needs to ensure that the infrastructure is appropriate for the organisation, that people are focused and work well together, resources are used effectively, and information flows smoothly. Decisions are then made effectively, and this
all contributes to a successful, sustainable organisation. If the infrastructure is not appropriate for the organisation, then the anticipated ‘cultures’ will not be developed. Those within the organisation will develop their own cultures which, as they are not being managed, often leads to bad practices, such as failure to
follow policies, the misuse of resources, breakdown of important relationships, etc. This in turn threatens the performance and long-term sustainability of the organisation.
