COURSE CONTENT

Corporate governance objectives,

principles, and evaluation

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SUSTAINABLE ANALYSIS (ESG - ENVIRONMENT,
SOCIAL, AND GOVERNANCE)
Sources:
• CFA Institute curriculum
• External data providers
• Various internet sites including samples of academic researches
• Author’s documentation

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COURSE CONTENT

1. Objectives and guiding principles

2. Forms of business and conflicts of interest

3. Specific sources of conflict: agency relationships

4. Corporate governance evaluation

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OBJECTIVES AND GUIDING PRINCIPLES

• Corporate governance is the system of principles, policies, procedures, and

clearly defined responsibilities and accountabilities used by stakeholders to
overcome the conflicts of interest inherent in the corporate form (hence,
the importance of understanding the different forms of business).
• Corporate governance affects the operational risk and, hence, sustainability
of a corporation.
- The quality of a corporation’s corporate of governance affects the risks and
value of the corporation.
- Effective, strong corporate governance is essential for the efficient
functioning of markets.

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OBJECTIVES AND GUIDING PRINCIPLES

Source: CFA Institute – Guidance and case studies – ESG Integration for equities and fixed income
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OBJECTIVES AND GUIDING PRINCIPLES

• There are inherent conflicts of interest in corporations in which the

ownership and management are separate (e.g., agency theory).
• Objectives of corporate governance:
- To eliminate or mitigate conflicts of interest, particularly those between
corporate managers and shareholders.
- To ensure that the assets of the company are used efficiently and
productively and in the best interests of its investors and other stakeholders.

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OBJECTIVES AND GUIDING PRINCIPLES

• Core attributes: delineation of the rights of shareholders and other core

stakeholders:
- Clearly defined manager and director governance responsibilities to
stakeholders.
- Identifiable and measurable accountabilities for the performance of the
responsibilities.
- Fairness and equitable treatment in all dealings between managers,
directors, and shareholders.
- Complete transparency and accuracy in disclosures regarding operations,
performance, risk, and financial position.

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COURSE CONTENT

1. Objectives and guiding principles

2. Forms of business and conflicts of interest

3. Specific sources of conflict: agency relationships

4. Corporate governance evaluation

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FORM OF BUSINESS

• The form of business will dictate, in part, the relationship between the owners
of the business and management:
- The degree of separation may be minimal (e.g., sole proprietorship) or
significant (e.g., large corporation).
- When there is a separation between owners and managers, there is a
potential for agency problems, which may affect the value of the business.

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FORMS OF BUSINESS

• A sole proprietorship is owned and operated by a single person

• Sole proprietorships are the most numerous in terms of number of
businesses.
• Who bears governance risk in a sole proprietorship?
- There are few risks with respect to governance from the perspective of
the owner.
- Creditors, including trade creditors, have the highest risk with respect to
governance.

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FORMS OF BUSINESS

• A partnership has two or more owner/managers.

• Who bears governance risk in a partnership?
- There are few risks with respect to governance from the perspective of the
owners, with ownership rights and responsibilities detailed in the partnership
agreement.
- Creditors, including trade creditors, have the higher risk with respect to
governance.

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FORMS OF BUSINESS

• A corporation is a legal entity that has rights similar to an individual.

- For example, a corporation can enter into contracts.
• Corporations account for most business revenue around the world.
- Corporations around the world:
- Limited Company (U.K.).
- Gesellschaft (Germany).
- Societé Anonyme (France).
- 公司 (China).
- şirket (Turkey).
- บริษัท (Thailand).

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PROS OF CORPORATE FORM

• A corporation can raise capital, grant ownership stakes (that is, issue stock) or
borrow (that is, issue bonds).
• Owners need not know how to run the business, as the corporation hires
experts to manage the business.
• Ownership interests are transferrable.

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CONS OF CORPORATE FORM

• Corporations are more highly regulated than are partnerships or sole

proprietorships.
• Separation of owners and managers.
- This is the agency relationship, in which someone (the agent) acts on
behalf of another person (the principal).
- The potential conflict between owners and managers is the agency problem
or principal-agent problem:
- Principals: shareholders.
- Agents: Management and members of the board of directors.
- There are costs to this agency relationship arising from conflicts of
interest.

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FORMS OF BUSINESS AND CONFLICTS OF
INTEREST
Sole
Characteristic Partnership Corporation
Proprietorship
Ownership Sole owner Multiple owners Unlimited ownership
Legal requirements and Few; entity easily Few; entity easily Numerous legal
regulation formed formed requirements
Legal separation
Legal distinction between
None None between owners
owner and business
and business
Unlimited but
Liability Unlimited shared among Limited
partners
Ability to raise capital Very limited Limited Nearly unlimited
Non-transferable
Transferability of ownership (except by sale of Non-transferable Easily transferable
entire business)
Owner expertise in
Essential Essential Unnecessary
business

Source: CFA curriculum

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COURSE CONTENT

1. Objectives and guiding principles

2. Forms of business and conflicts of interest

3. Specific sources of conflict: agency relationships

4. Corporate governance evaluation

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AGENCY RELATIONSHIP CONFLICTS

Management - Shareholder conflicts

Managers Board of Shareholders

directors

Director - Shareholder conflicts

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MANAGEMENT – SHAREHOLDERS CONFLICTS

• Shareholders entrust management with funds from reinvested earnings or

newly issued stock, which management invests.
• The overarching objective is to maximize shareholders’ wealth.
• Issue: managers are human.
- Managers may be more interested in expanding the size of the business,
bonuses based on earnings, taking on excessive risks, or job security.
- Managers may consume excessive perquisites, or in effect, take advantage
of their position to spend excessively on things for themselves.
- There may be agency costs in terms of the explicit and implicit costs when
managers do not act in the best interest of shareholders.

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SPECIFIC SOURCES OF CONFLICT: AGENCY
RELATIONSHIPS – EXAMPLES

• Example: Tyco International.

- Use of corporate funds for personal expenses.
• Example: Parmalat.
- Reporting assets the company did not have (accounting mis-reporting).
• Example: Adelphia.
- Undisclosed personal loan between Adelphia and founders/managers.

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SPECIFIC SOURCES OF CONFLICT: AGENCY
RELATIONSHIPS – EXAMPLES

Source: CFA curriculum

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SPECIFIC SOURCES OF CONFLICT: AGENCY
RELATIONSHIPS – EXAMPLES

Source: CFA curriculum

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SPECIFIC SOURCES OF CONFLICT: AGENCY
RELATIONSHIPS – EXAMPLES

Source: CFA curriculum

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DIRECTORS – SHAREHOLDERS CONFLICTS

• The board of directors is an intermediary between the shareholders and

management, and represent shareholders’ interests by:
- Monitoring managers.
- Approving strategies and policies.
- Approving mergers and acquisitions.
- Approving audit contracts.
- Reviewing audit contracts and financial contracts.
- Establishing management compensation.
- Disciplining poorly performing managers.

A conflict of interest may arise if the board members align with

management, and reciprocally.

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RESPONSIBILITIES – BOARD OF DIRECTORS

• Establish corporate values and governance structures for the company.

• Ensure that all legal /regulatory requirements are met in a timely fashion.
• Establish long-term strategic objectives for the company.
• Establish clear lines of responsibility and a strong system of accountability
and performance measurement.
• Hire the chief executive officer, determine the compensation package, and
periodically evaluate the officer’s performance.
• Meet regularly to perform its duties.
• Acquire adequate training.

The company’s senior management needs to supply the board with sufficient
and relevant information to be fully informed and prepared to make the decisions
that are its responsibility / be able to adequately monitor and oversee the
company’s management … in practice: another potential agency issue !!!
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COURSE CONTENT

1. Objectives and guiding principles

2. Forms of business and conflicts of interest

3. Specific sources of conflict: agency relationships

4. Corporate governance evaluation

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CORPORATE GOVERNANCE EVALUATION

Source: CFA Institute Surveys (2017)

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BOARD OF DIRECTORS – KEY ATTRIBUTES

• The board should be comprised primarily of independent directors (that is,

not insiders).
• The Chairman of the Board should be independent.
• Directors should be qualified.
• There should be a regular election of members of the Board.
• There should be a regular self-assessment of the Board.
• The board should hold separate meetings of the independent directors.
• The board should require audit oversight by independent directors who have
sufficient expertise in finance, accounting, and the law.

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EXAMPLE: BOARD ATTENDANCE

Source: Aegon N.V. annual report, 2017

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INDEPENDENT DIRECTOR – KEY ATTRIBUTES

• Not an insider.
• Not employed or has not been employed by the company.
• Does not have a business relationship or a personal relationship with a
manager.
• Does not have a directorship with another company that has either a
relationship. with the company or with a manager.

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Monetary Authority of Singapore (MAS).

Principle 1: Every Institution should be headed by an effective Board.

Principle 2: There should be a strong and independent element on the Board
which is able to exercise objective judgment on corporate affairs
independently from management and substantial shareholders.
Principle 3: The Board should set and enforce clear lines of responsibility
and accountability throughout the Institution.
Principle 4: There should be a formal and transparent process for the
appointment of new directors to the Board.
Principle 5: There should be a formal assessment of the effectiveness of the
Board as a whole and the contribution by each director to the
effectiveness of the Board.
Principle 6: In order to fulfill their responsibilities, Board members should be
provided with complete, adequate and timely information prior
to board meetings and on an on-going basis by the management.
Principle 7: There should be a formal and transparent procedure for fixing the
remuneration packages of individual directors. No director should
be involved in deciding his own remuneration.

Source: Singapore Monetary Authority

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Monetary Authority of Singapore (MAS).

Principle 8: The level and composition of remuneration should be appropriate

to attract, retain and motivate the directors to perform their roles
and carry out their responsibilities.
Principle 9: The Board should establish an Audit Committee with a set of
written terms of reference that clearly sets out its authority and
duties.
Principle 10: The Board should ensure that there is an adequate risk
management system and sound internal controls.
Principle 11: The Board should ensure that an internal audit function that is
independent of the activities audited is established.
Principle 12: The Board should ensure that management formulates policies to
ensure dealings with the public, the Institution’s policyholders and
claimants, depositors and other customers are conducted fairly,
responsibly and professionally.
Principle 13: The Board should ensure that related party transactions with the
Institution are made on an arm’s length basis.

Source: Singapore Monetary Authority

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