UNIT III The Internal and External Institutions of Corporate Governance PDF

Preview

Summary

What is a Corporation? “A Corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence” (The Revised Corporation Code of the Philippines)Objective of a Corporation To ...

Description

UNIT III: THE INTERNAL AND EXTERNAL INSTITUTIONS OF CORPORATE GOVERNANCE What is a Corporation? “A Corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence” (The Revised Corporation Code of the Philippines) Objective of a Corporation To conduct a lawful, ethical, profitable and sustainable business in order to ensure its success and grow its value over the long term. Purposes of a Corporation 1. To increase profit 2. To offer vital services to the general public 3. To offer goods and services to the mass market For Whom Does the Corporation Exist? 1. Stakeholders - it is a party that has an interest in a company and can either affect or be affected by the business. The primary stakeholders in a typical corporation are its investors, employees, customers, and suppliers wherein these stakeholders can be both internal or external. Internal stakeholders are people whose interest in a company comes through a direct relationship, such as employment, ownership, or investment. External stakeholders are those who do not directly work with a company but are affected somehow by the actions and outcomes of the business. Examples of these are suppliers, creditors, and public groups. 2. Shareholders - also referred to as stockholders are any person, company, or institution that owns at least one share of a company’s stock. As equity owners, shareholders are subject to capital gains or losses and/or dividend payments as residual claimants on a firm’s profits. Shareholders also enjoy certain things such as voting at shareholder meetings to approve things like board of directors’ members, dividend distributions, or mergers. Also, a shareholder has two types, these are preferred and common shareholders. Their main difference is that preferred shareholders has no voting rights while common does. However, preferred shareholders have priority over a company’s income compared to common shareholders. Also, common shareholders are last in line when it comes to company assets, which means that they will be paid out after creditors, bondholders, and preferred shareholders. 3. Community - Communities in which companies operate essentially provide a home. As a corporate citizen of the community, companies are often expected to participate actively and ethically in the community life. This includes giving to local charities or education programs, as well as allowing employees paid time to volunteer. When a big company enters or exits a small community, there is an immediate and significant impact on employment, income, and spending in the area. With some industries, there is a potential

UNIT III: THE INTERNAL AND EXTERNAL INSTITUTIONS OF CORPORATE GOVERNANCE health impact too, as companies may alter the environment depending on their operations. 4. State - The state basically affects most corporate stakeholder relations through its regulations and participation in the financial sector. Through its government, it is possible to have several interests in private companies through the form of taxes. Also, corporate activities help the economy and its individuals in the form of salaries which translate to purchasing power. Internal Institutions of Corporate Governance 1. Shareholders - Are those who contribute capital towards the setting up and running of the company. The shareholders of any company have the responsibility to ensure that the company is well-run and well-managed. They do this by monitoring the performance of the company and raising their objections or giving their approval to the actions of the management of the company. Whereas many shareholders act through institutional and large investors as their representatives, minority shareholders have the option of expressing either their disapproval or agreement at the Annual General Meetings of the assembly. The concept of having shareholders for the companies is to make the companies accountable for their actions. As mentioned, shareholders are usually represented by the BOD and the BOD acts as custodian for shareholder’s interests. In cases where the BOD is not acceding to the requests of the shareholders, the former can directly act by asking the management for an extraordinary general meeting so that they can voice out their opinions. 2. Directors - The BOD is the primary direct stakeholder influencing corporate governance. Directors are elected by shareholders or appointed by other board members, and they represent the shareholders of a company. Directors either (1) have a vested interest in the company; (2) work in the upper management of the company; and (3) independent from the company but are known for their business abilities. The board is tasked with making important decisions, such as corporate officer appointments, executive compensation, and dividend policy. Board obligations also stretch beyond financial optimization, for instance when shareholder resolution calls for certain social or environmental concerns to be prioritized. The BOD must ensure that the company’s corporate governance policies incorporate the corporate strategy, risk management, accountability, transparency, and ethical business practices. 3. Managers - Corporate managers are business professionals who oversee an organization’s general operations. They can work in a variety of industries including finance, marketing, manufacturing or technology. They are a part of the executive team, and they can help design and implement business strategies. Corporate managers work as executive leaders that supervise and lead all departments within a business. Their responsibilities will vary depending on the industry and business, but some common duties include ● Designing business strategies and growth plans

UNIT III: THE INTERNAL AND EXTERNAL INSTITUTIONS OF CORPORATE GOVERNANCE ● ● ● ● ● ● ● ● ● ● ● ● ● ●

Reviewing financial statements and performance reports Managing and delegating general business operations and tasks Choosing key performance indicators or tools to measure and track a company’s success Collaborating with a team of executives and managers to implement changes Designing goals for the company or departments Creating and implementing a corporate budget Creating a timeline for an organization’s business plan and goals Planning and leading business meetings with other managers or investors Establishing responsibilities and delegating tasks to departments Reviewing employee or department performance regularly Recruiting and training new employees Organizing professional training programs and providing resources to help employee’s development Performing administrative or operational tasks to help a business operate Planning events and travel for employees Choices with Legal Constrains

2 ways of Business Combination 1. Friendly Combination – the board of directors of both the potential combining companies negotiates mutually agreeable terms of a proposed combination. 2. Unfriendly (Hostile) Takeover – the result when the board of directors of the targeted company resist the combination. Anti-Takeover Defenses 1. Poison Pill – ammending the articles of incorporation and by-laws to make it difficult to obtain stockholder approval for a takeover. 2. White Knight or White Squire – searching for a candidate to be the acquirer. 3. Greenmail – practice of buying enough shares in a company to threaten a hostile takeove so that the target company will instead repurchase it shares at a premium. 4. . Pacman Defense – a company that is threatened with a hostile takeover turns the table by attempting to aquire the would-be-buyer. 5. 5. Selling the Crown Jewel – selling the valuable assets to other company making the firm less attractive to the would-be-buyer. 6. 6. Shark Repellent – acquiring substantial amounts of outstanding common stocks for treasury or for retirement.

UNIT III: THE INTERNAL AND EXTERNAL INSTITUTIONS OF CORPORATE GOVERNANCE Mitigation and Indemnification of Director and Officer Liability Revised Corporation Code of 2019 SEC. 30. Liability of Directors, Trustees or Officers. – Directors or trustees who willfully and knowingly vote for or assent to patently unlawful acts of the corporation or who are guilty of gross negligence or bad faith in directing the affairs of the corporation or acquire any personal or pecuniary interest in conflict with their duty as such directors or trustees shall be liable jointly and severally for all damages resulting therefrom suffered by the corporation, its stockholders or members and other persons. Personal Liability of Officers and Directors Officers and directors may be personally liable for financial harm caused to the corporation if they:  Breach their duty of care to the corporation  Breach their duty of loyalty to the corporation  Misappropriate a corporate asset for personal use or use by another business  Commingle personal and business assets  Fail to disclose potential or actual conflicts of interest Indemnification of Officers and Directors Indemnification of officers and directors means that the corporation will reimburse them for expenses incurred and amounts paid in defending claims brought against them for actions taken on behalf of the corporation. Directors’ and Officers’ Insurance (DOLI) Insurance policies can cover matters that cannot be indemnified under state law or in instances where the corporation does not have the financial resources to pay for the indemnification. Directors and Officers Liability Insurance (D&O) is a liability insurance that covers “individual directors and officers (D&Os), for loss arising from claims against them for which they are not indemnified by the corporate entity” and covers, as well, “the corporate entity, for the amount it pays on behalf of the D&Os to indemnify them for loss they sustain.” The latter is known as the “company reimbursement clause.” The necessity of a D&O insurance lies in the fact that directors and officers can be held personally liable for corporate acts. Being a liability insurance, it does not cover suits filed by the directors or officers. Directors’ and Officers’ Insurance (DOLI) Covers:  Defense costs, legal representation expenses, damages, judgements, settlements, bail bond costs, crisis costs, deprivation of asset costs, prosecution costs, public relations expenses  Costs arising from extradition proceedings  Tax contributions where the parent company has become insolvent and there’s personal liability of an insured  Losses incurred for civil fines and penalties

UNIT III: THE INTERNAL AND EXTERNAL INSTITUTIONS OF CORPORATE GOVERNANCE Shareholder’s Limitation Through Classes of Shares Common Stock 



   

Voting power on major issues. Voting power includes electing directors and proposals for fundamental changes affecting the company such as mergers or liquidation. Voting takes place at the company’s annual meeting. If the shareholder cannot attend, they can do so by proxy and mail in their vote. Ownership in a portion of the company. Common shareholders own a piece of something that has value. Common shareholders have a claim on a portion of the assets owned by the company. As these assets generate profits and as the profits are reinvested in additional assets, shareholders see a return as the value of their shares increases as stock prices rise The right to transfer ownership. The right to transfer ownership means shareholders are allowed to trade their stock on an exchange. Entitlement to dividends. Along with a claim on assets, investors also receive a claim to any profits the company pays out in the form of a dividend. Opportunity to inspect corporate books and records. Shareholders have the right to examine basic documents such as company bylaws and minutes of board meetings. The right to sue for wrongful acts. Stockholders have the right to sue any director or officer if they have done unlawful act.

Preferred Stock   

  

Ownership in a portion of the company. Preferred shareholders will have claim to assets over common shareholders in case odf company liquidation. Voting Power. Generally, common stock carries voting rights while preferred stock does not. However, this will vary from company to company. Entitlement to dividends. Preferred shareholders have superior rights to dividends and assets of tthe company over common shareholders. Preferred stock can gain cummulative dividends, convertibility to common stock, and callability. The right to transfer ownership. The right to transfer ownership means shareholders are allowed to trade their stock on an exchange. Opportunity to inspect corporate books and records. Shareholders have the right to examine basic documents such as company bylaws and minutes of board meetings. The right to sue for wrongful acts. Stockholders have the right to sue any director or officer if they have done unlawful act.

Supermajorities in a Company  A super majority is an amendment to a company’s corporate charter requiring a larger than normal majority of shareholders to approve inportant changes in the company.

UNIT III: THE INTERNAL AND EXTERNAL INSTITUTIONS OF CORPORATE GOVERNANCE  A majority would be any percentage above 50%, however, a supermajority stipulates a higher percentage, usually between 67% and 90%.  Corporate decisions that usually require a supermajotity include mergers and aquisition, executive changes and taking a company public. Contractual Matters 1. Voting Trust Agreement – an agreement where a shareholder may assign his right to vote to another person. The purpose of such agreement is to control the voting of the share and to empower the trustee to vote the shares. Voting trusts may be used to lock a majority block by combining the voting strength of several minority shareholders. However, where the trust agreement gives the trustee unbridled discretion over the vote, then the trustee is still a trustee and owes fiduciary duties to the equitable owner, including presumable the duty to vete the stock in the best interests of the owner and not to personally benefit from the voting power. A copy of the voting trust agreement must be deposited with the corporation and made avaible for shareholders inspections. 2. Shareholder Voting Rights Agreement – an agreement where shareholders contract among themselves to vote in a certain way on specific matters. Such agreement may sometimes allow a group of shareholders to obtain or maintain control, particularly where cumulative voting is permitted. Voting rights agreement differs from voting trust agreement in that the stockholders remains the stockholder in record and ther is no trust. The agreement should be conspicuously noted ont he certificate; otherwise the agreement will not be enforceable against a transferee for value who buys the stock without knowledge of the agreement. A copy is deposited at the principal office of the corporation and is available for inspection to all shareholders. 3. Investment Agreement – a contract to formalize a transaction between an investor and a company whereby the investor acquires an ownership interest in a company in exchange for an investment of some kind. It allows a company to obtain capital in exchange for giving away a percentage of the ownership of the company to the investor. The purspose of an investment agreement is to protect an investor who will become a new shareholder of the company. A copy of the investment agreement must be deposited with the corporation and made avaible for shareholders inspections. 4. Confidentiality Agreement or Non-Disclosure Agreement – provides that the recipient of proprietary informantions holds the information in strict confidence and will only use the information for the purposes of evaluating whether or not to enter into a business relationship with anyone. External Institutions of Corporate Governance There are corporate governance institutions which play a role in aligning the interests of managers and shareholders, controlling shareholders and minor shareholders and the society and the firm. These institutions are known as the institutions of corporate governance.

UNIT III: THE INTERNAL AND EXTERNAL INSTITUTIONS OF CORPORATE GOVERNANCE Regulators and governments They consist of government and some other institutions that ultimately articulate accurately the community's voice concerning power relationships, responsibility, and accountability. Specifically, government agencies regulate corporate governance through formulation and implementation of rules and regulations on the operations of corporate institutions within of its jurisdiction. For instance, the Corporation Code of the Philippines (Batas Pambansa Bilang 08) is where all other laws and interpretations are derived concerning a corporation and corporate governance. In addition to company law and listing rules, some companies and industrial sectors are subject to further external control by government-appointed regulators or by governments themselves. This usually applies to companies or sectors involved in areas considered strategically or politically important by governments; these include the control of monopolies or the supply of utilities (such as water or energy). In some countries, this also applies to military equipment and medical supplies. When this is the case, regulation typically applies to pricing and supply contracts. In some countries, many large companies are owned, directly or indirectly, wholly or partially, by the host government. Nationalized companies are part of the economic fabric of many developing countries but tend to feature less prominently in more developed countries. It is generally believed that the profit motive, created by the agency relationship in a conventional shareholder—director arrangement, creates and stimulates greater economic efficiency than in nationalized companies. Governments control corporate governance through the imposition of legislation and the enforcement (through a judiciary) of common and statute laws. Although governments usually have a range of political and social objectives in mind when controlling business, they also rely heavily on tax revenues levied on company profits and, where relevant, sales and other transaction taxes. One reason for the deregulation of much economic activity is the need to increase tax revenues and create employment by gaining the economic efficiencies offered by competition and executive reward packages that are aligned to added shareholder value.

Auditor Auditors is one of the most important external institutions in governance. Their job is to help to ensure that firms are run efficiently by keeping public records accurate, adhering standards of reporting for public purposes, and taxes paid properly and on time. The most obvious role of audit in corporate governance is to report to shareholders that, having audited the company's accounts, the accounts are accurate ('a true and fair view' is the term used in some countries). Audit is also a legal requirement in compliance with company law as a condition of company registration and the granting of limited liability.

UNIT III: THE INTERNAL AND EXTERNAL INSTITUTIONS OF CORPORATE GOVERNANCE

Independent Auditors Independent auditors analyze and communicate financial information for various entities such as companies, potential investors, individual clients, government both at the local and national level. They may also engage in consultancy services which may include, financial and investment planning, information technology consulting, and limited legal services. Some independent auditors and public accountants specialize in forensic accounting investigating and interpreting white-collar crimes such as securities and fraud and embezzlement, bankruptcies and contract disputes, and other complex and possibly criminal financial transactions, including money laundering by organized criminals. Users Of the entity's financial information such as investors, government agencies, and the general public, rely on external auditors to present an unbiased and retain transparency among the internal and external us...