Corporate Governance Company Assignment PDF

Preview

Summary

Introduction Corporate governance centers on accountability those who runs the business with the view to maximum profitability to those who have stakes in the company. Thus, effectual checks and balances are crucial to any model of corporate governance, for absolute powers unchecked would only be th...

Description

Introduction Corporate governance centers on accountability by those who runs the business with the view to maximum profitability to those who have stakes in the company. Thus, effectual checks and balances are crucial to any model of corporate governance, for absolute powers unchecked would only be the recipe for corporate scandals and failures. Central to the corporate governance movement in the United Kingdom, are the roles of the independent non-executive directors as emphasized by the Higgs Review which examined the roles and effectiveness of nonexecutive directors and the Walker Review more specifically in relation to the banking and financial sector, and the institutional shareholders in promoting shareholder engagement and activism as emphasized by the Stewardship Code, in particular since the onset of the global financial crisis and the more recent oil and gas slump.

“Command and Control” – Unitary Board of Directors All corporate powers are entrusted in a single body known as the board of directors. Composition of the board of directors is essentially in the hand of the majority shareholder – real risk or possibility of conflict of interest between the interest of the company and the personal interest of the majority shareholder, whose interest would more often than not be aligned with the interests of the directors. This model lacks external mechanism of checks and balances, and thus, with the centralization of decision making powers with the board of directors (which composition is greatly influenced by the majority shareholder), it is alleged that this model lacks effective accountability. This is a violation of the natural justice principle of nemo iudex in causa sua non potest. In fact, it is purported that it is this capitalist model which constitutes the nucleus of most of the prominent corporate failures, such as Maxwell affairs, Enron Corporation and MCI Worldcom, saw public monies, from the employees, the trade creditors or generally the investors, evaporated.

Common Characteristics of Corporate Failure From the string of examples of prominent corporate failures, from the Maxwell Affairs in the UK, to Enron Corporation and MCI Worldcom in the US, the following common characteristics, rather peculiar to the unitary model, could be discerned. These common characteristics are as follows – • Centralization or concentration of decision making powers in one body, which is dominated by one or a handful of individuals; • Lack of independence of those who are to act as checks and balances against those entrusted with powers; • Conflict of interest, between the interest of the company and the personal interest of those entrusted with powers; • Lack of transparency and proper disclosure; and • Lack of shareholders’ participation and public scrutiny.

Dual Board of Directors As opposed to the “unitary body of command and control”, the alternative model is that which is presently practices by most countries in the continental Europe, such Germany, where a dual board is the feature of corporate governance. The dual board structure, offers a structure of corporate governance whereby shareholders (and, often, workers) elect members of a supervisory board which then appoints and supervises a management board. Thus, structurally there are 2 organs within the corporate structure, one, being the management board is vested with the executive powers over the affairs of the company, and the other, being the supervisory board acts as the requisite checks and balance to the management board.

Rather the Devil that you know than you don’t The unitary board model is well entrenched in the English company law, probably entrenched since the day of Solomon v Solomon, to an extent that this model provides the definition of the current company law we have. Despite the shortfalls of this model, it is undeniable that any drastic shift from the unitary model to another model would be akin to stepping into an unfamiliar territory with its unfamiliar difficulties. In fact, there are examples of corporate scandal involving corporations adopting the dual board model, for e.g the VW scandal, the Mitsubishi motors fraud, the Toshiba accounting scandal, and more recently, the near collapse of Hitachi Corporation. Therefore, it is recommended that we rather improve on inadequacies of the current model which seems to work fine for a majority of corporations with the exception of a few corporate failures, than to adopt something absolutely new and to deal with the difficulties that come with the new model. Higgs Review supports this stand.

Governing Principles The governing principles behind the corporate governance move in the UK, as identified as early as the Cadbury Report 1999, are the promotion of enterprise on the one hand, and the effective accountability to the shareholders (and also those who have any interest in the company). These 2 principles continue to form the very 2 pillars behind the ongoing reform and revamp of English company laws, as seen in the Company Law Reform Steering Group Report up to the White Paper 2005 and the recent Companies Act 2006.

Historical Background of Corporate Governance Sentiment Corporate governance sentiment in the UK had seen its mark with the establishment of the Cadbury Committee in the wake of the Maxwell affairs and the Polly Peck affairs, which had greatly undermined public confidence in companies listed in the stock exchange. The Cadbury Committee focused on the control and reporting functions of the board, and the role of auditors. It was intended to bring greater clarity to the respective responsibilities of directors, shareholders and auditors, so as to strengthen trust in the corporate system. It was first advocated by the Cadbury Committee that the directors are to act as checks and balances to each other in conducting the affairs of the company. The Cadbury Committee first proposed the creation of non-executive directors within the unitary board so as to act the necessary checks and balances against the executive directors. The legacy of the Cadbury Report was carried

subsequently in the Greenbury Committee and the Hampel Committee, which ultimately culminated in the Combined Code 1998.

The Company Law Reform Steering Group In 1998 the government established a steering group to carry out a fundamental review of company law in the UK. The objective was to streamline procedures for all companies, especially smaller companies; to make the law clearer, more accessible and responsive to developments. The sentiment generated by the Company Law Reform Steering Group had sparked of a 2nd round of review of the UK’s position of corporate governance, particularly in light of the major corporate failures experienced across the Atlantic ocean.

Higgs Review The Higgs Review made the following recommendations, predominantly concerning the constitution of the board of directors, the roles and effectiveness of non-executive directors, and the independence of non-executive directors, to enhance accountability by the management to the shareholders via the nonexecutive directors as an important element of checks and balances within the unitary board: • the role and functions of the board, and disclosure of the activities of the board in the Annual Report; • to clearly identify and set out the roles and functions of the nonexecutive directors, in particular the independent non-executive directors in board meetings and meetings of the committees; • to clearly identify and set out the criteria to determine the independence of the non-executive directors; • to clearly identify and set out the role of the Chairman, and demarcate the role of the Chairman from that of the Chief Executive Officer/Managing Director; • to clearly identify and set out the roles, functions and importance of the Nomination Committee; • to clearly identify and set out the roles, functions and importance of the Remuneration and Audit Committee (as more elaborate addressed by the Smith Review); and • to encourage the participation by institutional shareholders via dialog with non-executive directors. Higgs Review recommends that at least 50% of the board members, excluding the Chairman, should be independent non-executive directors, in that they should all be independent of mind and willing and able to challenge and question the decisions made by the executive directors. Higgs Review also proposes the position of a senior independent director, who would serve as the conduit between the board and the shareholders. Ultimately, the success of the reforms as proposed by the Higgs Review, will depend on the quality of those assuming the role as an independent non-executive director and their effectiveness would very much depend on various practical limitations as highlighted by Sarah Kiarie, namely the extent of their independence particularly in respect of appointment and nomination, the availability and extent of

information given to them, the time and sufficient knowledge of the company affairs, remuneration and liability that would otherwise apply to them as directors.

Smith Report The Smith Report sets out certain essential requirements to enhance the roles and functions of audit committees. Amongst the recommendations, it emphasizes on the need for independent non-executive directors’ participation in audit committees, clearly delineate the roles and responsibilities of audit committees and underscores the importance of allocating sufficient resources to audit committees to undertake their functions.

Combined Code 2003 The Higgs Review and the Smith Report (together with the Turnbull Report) had culminated in a new Combined Code in 2003. Most of the recommendations in the Higgs Review and the Smith Report are incorporated in the Combined Code. As similar to the 1998 Combined Code, the 2003 one is a code of good corporate governance, applicable to public listed companies, whereupon companies are expected to “comply or explain”.

Walker Review 2010 Walker Review was commissioned in response to the global financial and the near melt down of the banking and financial sector and made recommendations on corporate governance in UK banks and other financial institutions (BOFIs). The review focuses on 5 areas of governance, i.e composition of the board, functioning of the board and evaluation of performance, role of the shareholder engagement, governance of risk and remuneration. Having reviewed the problems with the UK financial industry following the global financial crisis that resulted in the government bailing out big banks using taxpayers’ monies, the Walker Review considered that: • the boards of big bank fail to understand the scale of the risks their organizations were running; • non-executive directors (NEDs) of big banks did too little to rein in the excesses of executive directors; • shareholders in banks also failed to curb reckless gambling by financial institutions and exercise proper stewardship; and • bankers were paid in a way which encourages them to speculate imprudently. In response, the Walker Review suggested a number of changes to their governance regimes of financial institutions, including: • increase the training of NEDs, increase their oversight by the Financial Services Authority (now the Financial Conduct Authority) and increase the amount of time NEDs should be expected to spend each year performing their duties;

• ensure that the chairmen of financial institutions have significant and relevant ‘financial industry experience’, face re-election by shareholders every year and devote two thirds of their time to the company; • ensure greater rigour and transparency in setting the remuneration of ‘high end’ individuals. ‘High end’ individuals are those ‘who as executive board members or other employees perform a significant influence function for the entity or whose activities have, or could have, a material impact on the risk of the entity; • bonuses or any element of performance pay should have time delays of up to 5 years, or enough time to assess that the transactions that engaged the bonus or performance pay did indeed benefit the bank in the way intended; and • institutional shareholders and fund managers should be more engaged with the companies they invest in – to encourage this, they should comply or explain non-compliance, with the ‘stewardship code’ overseen by the Financial Reporting Council in the same manner as the UK Corporate Governance Code. It further emphasized on the importance of non-executive directors and institutional shareholders as the pillars to enhancing if not achieving effectual accountability by those managing the companies. It further identified the importance of having a risk committee spearheaded by the Chief Risk Officer. The review also emphasized on the need for greater transparency in the remuneration of executives, proportionality in remuneration and alignment of remuneration with the long term sustainability of the company. On executive pay, Sir David Walker was careful in striking a balance to ensure that good talents are attracted to lead financial institutions and to curb abuses in excessive executive pay despite poor performance.

Stewardship Code 2010 Code of Corporate Governance identifies principles that underlie an effective board, whilst the Stewardship Code sets out the principles of effective stewardship by institutional shareholders - promotes greater shareholder engagement and shareholder activism. The Stewardship Code applies to institutional shareholders e.g pension funds, insurance companies, investment trusts and asset managers - adopts the "comply or explain" approach. The Steward Code espouses 7 principles that institutional investors should adhere to, namely: • publicly disclose their policy on how they will discharge their stewardship responsibilities; • have a robust policy on managing conflicts of interest in relation to stewardship which should be publicly disclosed; • monitor their investee companies; • establish clear guidelines on when and how they will escalate their stewardship activities; • be willing to act collectively with other investors where appropriate; • have a clear policy on voting and disclosure of voting activity; and • report periodically on their stewardship and voting activities.

The Kay Review 2010 In October 2010, the Department for Business, Energy & Industrial Strategy (“BIS”) launched a review of ‘corporate governance and economic short-termism’. One major concern was whether UK equity markets in particular contributed towards the alleged ‘short-termism’ of UK companies. To explore this issue further, Professor John Kay was appointed to examine key issues related to investment in UK equity markets and its impact on the long-term performance and governance of UK quoted companies. In February 2012, Kay and his colleagues produced an interim review, which provided a wide range of evidence that British companies were indeed subject to damaging short-term pressures, particularly from shareholders. It listed 17 specific recommendations for addressing these short term pressures. The bulk of these focused on investors (both shareholders and asset managers) and included: • developing the Stewardship Code to ‘incorporate a more “expansive” form of stewardship, focusing on strategic issues as well as questions of corporate governance’; • establishing an ‘investors forum’ to facilitate collective engagement by investors; • providing that those involved in the investment chain who had discretion over the investments of others (e.g. asset managers) or who gave investment advice to others, should be subject to fiduciary standards; • increasing transparency over the costs charged by asset managers; and • ensuring that the structure of asset managers’ pay encouraged long termism. To support some of the above recommendations, Kay also proposed a set of three ‘Good Practice Statements’, aimed at directors of companies, asset managers and institutional shareholders. These statements would highlight the responsibilities of these different actors for encouraging more stewardship and more long-term decision making.

UK Corporate Governance Code 2014 The Combined Code was further updated as the UK Corporate Governance Code in 2014 following the recommendations of the Walker Review, and further in 2016. Executive pay is an important topic in the The UK Corporate Governance Code in 2014 which focuses on the role of companies’ remuneration committees in setting such pay. The code introduced performance adjustment and clawback for executives' variable pay. It places more emphasis on the remuneration policy to be designed to deliver long-term benefit to the company and on the need for greater shareholder engagement - requiring greater disclosure of dissenting votes cast at a general meeting and explain how the management intends to engage with the shareholders to address the dissenting shareholders' concerns. The problem of excessive executive pay attracted much limelight recently with the board of British Petroleum (BP) disregarding its shareholders’ vote (albeit non-binding) against the lucrative pay package for its CEO Bob Dudley and gave a 20% pay increase despite the oil and gas slump – however, such shareholders’ sentiment has prompted the remuneration committee to slash 40% of Bob Dudley’s pay for 2016 ahead of the annual general meeting (AGM) for fear of shareholders’ backlash. Such culture of accountability propagated by the series of corporate governance proposal is beginning to gain traction – this could be

evidenced by the recent open letter from the Blackrock, the world’s largest asset manager, addressed to the chairmen of all FTSE 350 companies, raising concerns that the executive pay to CEOs of FTSE 100 companies has quadrupled over the past 18 years as repeated efforts by shareholders to control spiraling awards have failed and demanded an end to pay awards that outpace ordinary employees at the UK’s biggest companies ahead of the round of critical shareholder votes in 2017. On 29 November 2016 the UK Government published a ‘Green Paper’, entitled Corporate Governance Reform. It focuses on two key areas of corporate governance in listed companies: • Executive pay: it identifies a number of options for increasing control over such pay, including giving shareholders a binding vote on the pay awards of individual directors, and requiring companies to disclose more information about the ratio between their top executives’ pay and the average pay of their other workers; and • Relations with ‘stakeholders’: here, the Green Paper again sets out a number of options, including requiring companies to disclose more information about how the company takes account of stakeholder interests, requiring companies to designate a nonexecutive to act as the voice of stakeholders within the company, and permitting stakeholders to elect some directors to the board. The Government is now consulting the public on the reform options identified in the Green Paper, and will in due course decide what, if any, changes to the law, or to existing corporate governance codes, may be appropriate.

Conclusion The history of corporate failures and scandals could be traced to a date even before the birth of the Salomon principle, the Tulipmania in 1637, the South Sea Bubble in 1720, and right up to the collapse of Enron and MCI Worldcom. These corporate failures may take different forms, but the substance remains the same, i.e the human greed. Thus, the ideology of corporate governance should be mistaken as a goal to be achieved, but rather an ongoing process to suppress the different manifestations of human greed. All the reforms which are and will be put in place, are signs of conscientiousness of the present government of a fair and equitable balance of the spirit of enterprise as the main driver of any economy, and the accountability of those exercising corporate powers to those having a stake in the company....