lecture 5 - corporate governance

Question 1

define corporate governance

Answer 1

the system by which orgs and its activities are directed and controlled

Question 2

what elements make up good corporate governance?

Answer 2

mgment and reduction of risk - combined code 2024 reemphasises importance of risk mgment systems.

good supervision and effective mgment

framework to pursue ethical and effective strategies

clear lines of accountability

willingness to apply spirit of governance - not just rules

Question 3

what are the aims of corporate governance?

Answer 3

create framework of executive control

raise standards of controls

orgs answerable to stakeholders

ensure behaviour socially responsible

protect investors

Question 4

what reasons does the roads to ruin report give for corporate governance failure?

Answer 4

autocractic leadership - strong CEO personality-wise, with perhaps weak board or particularly weak chairman. typical example is RBS in GFC with Fred Goodwin as CEO.

disregard of rules - includes tax rules

ignoring interests of stakeholders

too few controls including audit

accounting and reporting lapses

Question 5

what are the three main streams of reports in UK corporate governance?

Answer 5

main reports in 1990s
cadbury report - 92
greenbury report - 95
hampel report - 98

in 2000s
turnbull report - 99
smith report - 2000
higgs report - 2003

combined codes.

Question 6

what is contained in the cadbury report?

Answer 6

best practive gov mechanisms

exec and non-exec directors (inside and outside). outside to provide independent monitoring and control systems, and offer business experience. also should differentiate between these inside and outside directors.

Question 7

what does the greenbury report contain?

Answer 7

remuneration of directors (recommended ESOPs (executive share options) for execs but not for non-execs). thought ESOPs for non-execs would compromise their independence and encourage risky behaviour.

around this time, lots of media concerns that directors getting bonuses when producing losses. lack of disclosure on what directors were getting. report emphasised aligning incentives for directors so public can see link between performance and pay.

Question 8

what does the hampel report contain?

Answer 8

advanced general gov issues e.g. regarding schedules for frequency and info on attendance at board meetings. met public concern that directors weren’t turning up and meeting contractual/fiduciary duties.

Question 9

what does the turnbull report contain?

Answer 9

focused on risk mgment and internal control.

elements of CG ‘best practice’

robust system of internal controls

annual review of controls - report to shareholders in annual statements (shareholders should also be more active, in UK a lot of the investors were pension funds and insurance companies), review covering all controls, disclose risks

risk mgment - collective responsibility of the board.

regular evaluation of risks

review need for internal audit dept

recommendations

1. forward looking risk process
2. open system
3. doesn’t seek to eliminate risk
4. highlighted importance of ERM
5. gov a strategic issue driven by business objectivescan’t ignore risk, it is an important part of doing business. emphasised need for holistic view for first time (ERM).

Question 10

what is the focus of the smith report?

Answer 10

role of internal audit and audit committee

Question 11

what does the higgs report contain?

Answer 11

focused on role of non-exec directors (NEDs), ensuring they have the skills needed to do the job and not just because they’re friends with the CEO.

Question 12

summarise the 2006 combined code

Answer 12

required on ‘comply or explain’ basis for all companies listed on main list of LSE.

code covers four main areas:

directors and their responsibilities

directors remuneration

relations with shareholders - encourage active shareholders.

accountability and audit

Question 13

summarise the UK corporate governance codes 2010/12/14/16/18

Answer 13

evolved from 2006 code. covers principles of good corporate governance for UK listed companies - helps compete with international exchanges. code has no legal force/sanction unlike US SOX act 2002.

comply or explain - i.e. if you don’t comply, you need to explain why.

sets investor expectations

implemented by significant moral force

emphasise broad stakeholder responsibilities

shareholders - should actively monitor boards

Question 14

what are the themes of the corporate governance codes?

Answer 14

1990s reports emphasised structural issues -

importance of board committees, at least 3 NEDs etc

2000s reports emphasised accountability and public accountability

chairmans report (and it being subject to audit), auditing directors report, majority of NEDs

recent codes emphasise best behaviour issues

risk mgment, managerial professionalism, ethics, diversity, integrity, responsibility etc.

hasn’t been new code for 6 yrs but there is now a 2024 code.

Question 15

what are the corporate governance code requirements for directors?

Answer 15

the board = strategy-setting and decision-making body —> CG therefore important strategic issue.

chairman and CEO = split roles to avoid autocracy

doesn’t always work —> again RBS example.

board balance and independence = split between ed and neds

appointments to board = formal, rigourous, transparent procedures

information and professional development = ensure directors properly informed

performance evaluation = again formal, rigourous, transparent

re-election = regular intervals, at least 3 yrs (2-3 terms max.)

Question 16

what are the corporate governance code requirements for directors remuneration?

Answer 16

level and make-up of remuneration

sufficient to attract, retain and motivate

link rewards to corporate and individual performance

procedure

formal, rigourous, transparent

set by remuneration committee, NEDs

disclosure

annual report contains statement of remuneration policy

include details of remuneration of each director

Question 17

what are the corporate governance code requirements for relations with shareholders?

Answer 17

dialogue with institutional shareholders based on mutual understanding of objectives

constructive use of AGM

communicate w investors, encourage participation (ask appropriate questions, encourage accountability)

shareholder voting

governance on shareholders - responsibility of shareholders to use vote wisely

whether board acting in shareholders best interest

Question 18

what are the corporate governance code requirements for accountability and audit?

Answer 18

financial reporting

board - present balanced and understandable assessment on company’s performance

huge % of FTSE companys’ board members are accountants, shows importance of financial knowledge.

internal control

board - maintain sound system of internal control. safeguard shareholder investments and company assets.

audit committee and auditors

AC has at least 3 NEDs

should be formal and transparent arrangements

apply best practice in financial control and audit, inc internal audit

Question 19

what is the internal audit function?

Answer 19

Internal audit is an independent appraisal function established by management to review and report on the economic, efficient and effective operations of controls & processes

Question 20

what work is involved in internal audit?

Answer 20

Internal audit work involves probity, systems/operations, & VFM audits

Internal audit also performs advice to management but is outside of the management function (including risk management)

Internal audit can still provide a useful ‘policing’ function – e.g., in fraud investigations

Found in most large organizations esp. in public sector & financial services

Internal audit is an integral part of good governance & helps minimize operational & strategic risks

Question 21

how are non-exec directors important for good corporate governance?

Answer 21

key control of CG = use of independent nonexecs

independence: related to many things, those who used to work for the company less independent etc.

Question 22

what does the role of non-exec directors involve?

Answer 22

challenging and helping develop strategies

mitigating agency theory risks.

performance monitoring of company (audit committee)

review of risk mgment and internal controls

determine exec pay (remuneration committee)

appointing execs (nominations committee)

Question 23

why are non-exec directors needed?

Answer 23

need for no conflicts of interest amongst execs/nonexecs and for countering powerful CEOs

Question 24

what does it mean for a non-exec director to be independent?

Answer 24

no previous employment, material business relationship with company in previous 3 years, personal or financial links w company, long service on board (>9yrs) - most serve one term of 3-4 yrs. shouldn’t have board members serving for decades.

Question 25

how do the functional attributes of directors affect performance?

Answer 25

attributes: financial qualifications (obviously very important for financial services), firm or industry experience, other business commitments.

if someone with no firm or industry experience is appointed, there should be a very good reason to explain the appointment.

Shouldn’t have more than 1 or 2 other board commitments, reduces ability to focus and increases chance of corporate failure.

in some jurisdictions like norway, board composition influenced by statute like gender diversity.

Question 26

what are the key areas of the US SOX act?

Answer 26

1. membership of the board - cannot include practicing accountants/auditors for company.
2. auditing - limits on non-audit work by auditors
3. more stringent quality control and independence standards
4. audit committees - internal and external audit reports presented
5. corp responsibility for finance reports - CEO and CFO legally responsible for accounts
6. assessment of internal controls

Question 27

summarise the jurisdiction of the SOX act

Answer 27

applies to all US public corporations

affects companies operating in US and/or quoted on any US stock exchange

imposes financial/custodial penalties for non-compliance

Question 28

what are the european views on the SOX act and the US views on the european approach?

Answer 28

criticised in europe for: strict legal nature, expense, encouraging companies to seek loopholes.

US sceptical on UK&EU approach - laissez-faire, no action by regulator if CG adequately disclosed

Question 29

what are the international comparisons of corporate governance in the US and the UK

Answer 29

US & UK characterised by dispersed shareholders & unitary boards, but US more prescriptive (SOX 2002)

Both US & UK governance reflects importance of accounting & shareholder value

Question 30

who emphasises stakeholder approaches and solvency accounting in corp governance?

Answer 30

europe and japan

Question 31

where are family boards emphasised?

Answer 31

far east companies, especially japan, taiwan and south korea

Question 32

what are the different stances on board diversity?

Answer 32

Some countries (e.g., Scandinavia) emphasise gender diversity & Trade Union representation at board-level. US/UK traditionally have not.

Why is this? –e.g., different legal (shareholder ownership) traditions & corporate history

Question 33

what were the main causes for the 2007/08 GLC?

Answer 33

Misguided government intervention in US housing market

Lax external regulation & perverse incentives creates ‘sub-prime’ lending

mortgages traded again and again until investors lost sight of what they were really buying.

Moral hazard encourages risk-taking – taxpayer the ‘back-stop’

Obtuse accounting in banking sector

Financial innovation (securitization) compromises accounting disclosure (on balance sheet strength)

Poor corporate governance – bank boards didn’t see it coming!

Question 34

why was corporate governance so poor during the 2007/08 GFC?

Answer 34

boardroom denial and share price dominance

over-reliance on external prescriptive rules fostered regulatory and corporate governance complacency

exec incentive structured fostered greed

‘tame’ neds, many didn’t understand banking

dominant CEOs

decoupling of governance from risk mgment

weak external auditing

limited liability - encourages excess risk-taking and moral hazard

lessons not learned