Professional Documents
Culture Documents
Corporate Governance Presentation
Corporate Governance Presentation
By Dr Ola Brown
Contents
Unit 1 Introduction to Corporate Governance
Unit 2 Theory of the Firm
Unit 3 Corporate Governance and the Role of Law
Unit 4 Corporate Governance Around the World
Unit 5 Board Composition and Control
Unit 6 CEO Compensation
Unit 7 International Governance
Unit 8 Overview of Corporate Governance Codes
Unit 1
Introduction
to Corporate
Governance
Corporate governance refers to ‘the ways suppliers of
finance to corporations assure themselves of getting
return on their investment’
-Gen. 35:22
Car vs Corporation
• The way modern corporations have evolved produced a situation such that
the interests of owners and managers have diverged-Berle & Means
• The total number of McDonald's restaurants in the United States is greater than the number of hospitals available in the
country.
• Japan is the second country with the highest number of McDonald's restaurants. It has about 2975. Also, China has 2391, and
Germany has 1470 to emerge third and fourth, respectively. McDonald's serves more than 70 million customers daily. It was
reported that the customer traffic recorded by McDonald's is greater than the entire population of the United Kingdom.
• Contracts with vendor of supplies (beef, cheese, milkshake), employment contracts (alchemy; usually from teenagers that
can’t even be trusted to clean their own rooms), suppliers of capital etc
The importance of
specialization
• The emergence of the corporate structure is as important in transforming commerce as the
assembly line is in mass production. Both are based on ‘specialisation’.
• Specialisation is at the core of the corporate form. For example, you don’t need to know how
to make a complete chair to work in a chair factory – your job is likely to be simply to put the
chair leg into the seat. You don’t need to know how to make a chair to invest in a chair
company. All you need to do is to buy some shares.
• The corporation form – in particular, the joint-stock company – is necessary for the efficient
organisation of talent, money and other factors and energies in the pursuit of technological
and industrial progress.
Why has there been such
as large uptick in interest
in corporate governance?
• Globalisation
• Scandals
• Deregulation
• Financial crises
• Shareholder activism
Choice vs contract Science of choice refers to the orthodox ‘black box’ approach i.e no soul.
The science of contract refers to individuals seeking to secure their own
private interests through contracts.
Choice vs
contract II
• Williamson divides the contracts into
private and public ordering.
• Public ordering concerns the rules of
the game, affairs to do with public
finance and political concerns. Politics
is a system of complex exchange
between individuals where people seek
to collectively secure their own
objectives that can’t be secured
through market exchanges-Buchanan,
1987. Non-market strategy.
• Private ordering refers to the ‘play of
the game’, incentive alignment to deal
with the problems of contracting as
well as implementation of existing
contracts. Private ordering refers to
self help efforts by parties to a
transaction to find the optimal
structure.
Ministry of enjoyment:
Choice vs Contract
• Economics throughout the twentieth century has been developed
predominantly as a science of choice
• Choice has been developed in two parallel constructions: the theory
of consumer behavior, in which consumers maximize utility, and the
theory of the firm as a production function, in which firms
maximize profit.
• But the science of choice is not the only lens for studying complex
economic phenomena, nor is it always the most instructive lens.
The other main approach is what James Buchanan (1964a, b, 1975)
refers to as the science of contract.
• Internal organisational structure emerged as an attempt to
minimise transaction costs. This ‘cooperation’ approach focuses on
how and for what reasons a given organisational structure emerges.
In this model, the firm is no longer viewed as a ‘black box’, but
instead as a series of contracts designed to minimise the costs
associated with economic activity.
Investor-owned firms vs Employee-owned firms vs Consumer owned firms
Market Contracting Costs versus Ownership Costs
developments ownership and contracting. These are significant because they impact
upon the level of contracting and ownership costs, thereby affecting the
governance arrangement of firms.
The era of institutional
investor
The rise of institutional investors has created a three-way
separation of ownership and control involving:
Vs
• Politics is key
• A Finnish sauna
Bernie Sanders
• FDI: the world’s largest seventh largest recipient and Asia’s second largest
• Stock market capitalisation: seventh highest in the world and third in Asia
• In the aftermath of the global financial crisis despite its history as a British
colony, therefore similar legal structure to the UK, Hong Kong was relatively
unscathed financially due to strong regulation, corporate governance and
supervision. Regulation isn’t the same thing as poke nosing/ personal
interest centered interference.
Lessons for emerging and
transition economies
• Strong regulation i.e Hong Kong
• Free market competition goes hand in hand
with capital market development
• Legal bonding can occur when companies in
emerging markets list on foreign stock
exchanges
• Competition domestically or internationally
between stock exchanges can induce self
regulation
Race to the top vs
Race to the bottom
John Coffee presents two possible
future scenarios that could occur in
countries with weak investor
protection as companies from these
countries continue to cross listing on
foreign exchanges to improve their
growth prospects.
(Coffee, 2002)
Race to the top
• One scenario they present is a "race to the top". In
this scenario, countries with weak investor
protection rapidly improve their corporate
governance standards in order to compete with
larger foreign exchanges. In some cases, they
envisage that regional "super" exchanges will be
formed to provide the depth and liquidity along
with the associated regulation/transparency
required to provide investors with comfort.
• There are examples of countries/regions that this
has begun to happen. Since 2000, the major Latin
American markets-Argentina, Brazil, Chile, and
Mexico-have passed major corporate governance
reform legislation. One of the major factors that
influenced this new legislation appears to have
been the loss of liquidity in Latin American
markets as a result of listing migration to the New
York Stock Exchange (NYSE).
Race to the bottom
• The second potential future scenario is the "race to the
bottom" scenario. In this case, countries with weak
investor protection are unable to respond rapidly
enough with appropriate corporate governance
reforms partially due to entrenched private interests
that lobby against regulation and reform to maintain
the benefits of private control for their companies. As a
result of this lack of reform, global capital flows
gravitate to a few trusted stock markets.
• In this scenario, a virtuous cycle is created where the
good reputation, transparency and liquidity of these
chosen few exchanges attract more foreign companies
to cross list on them. The fact that these stock
exchanges attract the world's largest and most
innovative companies with the best returns,
encourages more investors, increasing their depth and
liquidity.
Unit 4
Corporate
Governance Around
The World
Unit Overview
• Governance at the level of the board of directors: the cord that connects internal structures to
external environment
Mayer (2000) argues that ‘outsider’ systems have a ‘market control bias’. This
means that the more outside equity that is raised, the less control the original
owner is likely to have. As a result, the original owner or supplier of finance is likely
to have a short influence or control period. Conversely, an ‘insider’ system is more
likely to have a ‘private control bias’ and thus a longer influence or control period.
Insiders can therefore retain control through holding voting shares or anti-takeover
pacts with other investors.
Governance at board level
In market based the board plays a central role whereas
in bank based it’s a lesser role, usually due to the banks
over-riding role.
In terms of incorporation, banks have more of a
stakeholder perspective whilst market-based systems are
more focused on stakeholder value.
• As an intermediary governance
mechanism, they must not only
represent the owners, but also
individual employees charged
with the day-to-day running of the
firm.
• Post Enron NYSE rules require boards to have majority outside independent directors and
all committees composed exclusively of independent outsiders.
• Before this rule 13% of boards did not have majority independent directors
• Greater demands on time, increased turnover, financial expertise disclosure for audit
committee have made it impossible to serve on 8-10 boards
• Splitting chairman and CEO so agenda can be set to discuss perhaps thorny issues that the
CEO would rather not have discussed.
• General motors, HP, Amex shareholders all took the opportunity to separate roles
through shareholder resolutions at some point.
• Key trend for directors is a preference among companies to appoint either board
members or CEOs of other companies to their own board. The result is interlocking
directorships or a type of director network.
• The position of director is no longer easily filled by a friend of the board or the CEO.
Nominating committees with independent directors have adopted methodical and
transparent recruiting processes.
• Prospective board candidates are weighing more carefully the time and the risks and
rewards associated with each directorship.
Disney
CEO Compensation
Unit Overview
• Introduction: Major
Challenges Faced by CEOs
• Why CEOs Fail
• An ‘Ideal’ CEO
• CEO Compensation and
Employment Contract
• Stock Options
• Case Study: General
Electric
• Conclusion
Learning outcomes
• Post Enron/GFC
Why CEO’s
People problems
fail? II
Execution problems
Decision gridlock
“Say you have a dog, but you need to create a duck on
the financial statements. Fortunately, there are
specific accounting rules for what constitutes a duck:
yellow feet, white covering, orange beak. So you take
the dog and paint its feet yellow and its fur white and
you paste an orange plastic beak on its nose, and then
you say to your accountants, ‘This is a duck! Don’t you
agree that it’s a duck?’ And the accountants say, ‘Yes,
according to the rules, this is a duck.’ Everybody knows
that it’s a dog, not a duck, but that doesn’t matter,
because you’ve met the rules for calling it a duck.”
• How performance is measured and more precisely what measures are used
against which to benchmark performance. The most simplistic and readily
available measure of performance for a listed company is its share price.
Standard measures include Earnings Per Share (EPS) and Total Shareholder
Return (TSR). Both of these measures are essentially focused on the
company’s share price and as such they are short-term in nature.
Change in the air?
• A number of high profile cases of shareholder activism involving such large companies as Glaxo-
Smith-Kline (GSK) and Shell have witnessed some backtracking on overly generous awards. In the
aftermath of WorldCom and other corporate scandals, the NYSE has issued new regulations
regarding the composition of board level committees.
What about
incentives?
There is no incentive plan
that can make a weekend
athlete into an Olympic
gold medallist. And no
incentive plan will make a
CEO who is in over his
head suddenly able to
turn the company around.
Joseph Stiglitz (2010) a former winner of the Nobel Prize for Economics has put forward some powerful reasons for why he believes the
system of incentives is flawed. His principle argument is that a better alignment of private rewards (i.e. remuneration) and social returns and
better regulation including that of incentives, has better prospects of incentivizing innovation.
The six basic points he makes are highlighted below:
(Brookings)
HP Case study
• In the case of HP, their former CEO, Carly Fiorina, received a golden handshake worth up to US$42
million. Ms Fiorina, who was supposedly dismissed for not meeting targets, had clauses written
into her contract five years earlier that required such compensation in the event of her being
forced to leave.
Stock options
Stock options are the 800-pound gorilla that has yet to be caged
by corporate reform. Corporate scandals have shown how
current U.S. accounting rules are fuelling stock option abuses
linked to excessive executive pay, dishonest accounting, and non-
payment of taxes by profitable corporations. International
accounting experts have already proposed treating stock options
as an expense, and FASB ought to follow their lead. Honest
accounting of stock options would strengthen the accuracy of
U.S. financial statements and help restore investor confidence in
our financial markets.
• Since the 1990s, stock options have become a central if controversial aspect of CEO
pay. A case in point is Disney. In 1999, its CEO Michael Eisner took home US$575
million, mostly in stock option gains.
• Because popular because they seemed like the best way of linking compensation to
performance. The argument goes that the CEO will not make any money from the
option unless the company’s share price goes up. Therefore, at least in theory, the CEO
should have a strong incentive to maximise increase in share price. Since an improved
share price also improves shareholder value, the logic is that the incentives of CEO and
shareholder have been aligned. Perfect? Or not….
Why stock options can
be problematic
I’ll be happy to accept a lottery ticket as a gift…but I’ll never buy
one.’
Gap between
Summary Share
buybacks
compensation
and
performance
• Just like earlier studied, international investors want certain things. A legal
system that protects them , audited accounts, reporting that showcases
future growth opportunities, ability to sell shares to the highest bidder and
fair voting rights.
• Countries benefit from trading goods with each other, but also benefit
‘trading’ capital. Recall how railroads were built in America using capital
from Europe when insufficient capital was available at the time in America.
The Cadbury code
(Capital Market self
regulation)
• The political and economic power of large conglomerates, known as chaebol, who believed that they had much to lose from any reforms, meant that
governance reform was often of secondary concern. Prior to the financial crisis, South Korea’s chaebol built up excessive amounts of debt – the average
debt-to-equity ratios ranged from 400% to 500% and engaged in massive overinvestment.
The big five
In response to the crisis the government ordered the chaebol to follow
five principles (ACGA, 2000) these included:
i. Debt reduction
ii. Restructuring through sale and merger with the aim of
becoming smaller and more efficient
iii. Eliminating ‘mutual payment guarantees among affiliates’, a
practice that had led to the build-up of huge levels of debt with
little incentive to repay
iv. Improving transparency – one area highlighted was the need to
produce consolidated financial statements for the entire group
not just individual subsidiaries, which would give shareholders a
better picture of the financial position of the entire group (why
do you think this information might be useful to investors?)
v. Strengthening the rights of minority shareholders.
Singapore
Singapore is typically regarded as having a high standard of corporate governance and
accountability, it also shares many of the characteristics of other Asian economies with weaker
governance practices.
For example , the state run investment company Temasek, controls a large number of domestic
companies, and has been criticised for overly influencing the acquisition strategies of these
companies.
Isetan Case
• Isetan is a Japanese company listed in Singapore
• Received tax credit and didn’t explain to shareholders what they wanted to do
with it. Further issues with large amounts of money in fixed deposit, yet
consistently low dividends. Their real estate company: orchard earnings weren’t
disclosed.
• 43 shareholders, owning almost 10% organized to write a letter to management
demanding an EGM
• Chairman was initially obstructive saying that a ‘fighting stance’ would not help
the case of the minority shareholders. They responded that he should buy them
out if he felt they were not relevant enough to deserve an explanation
• Eventually resulted in a win-win, where an interim dividend was announced, but
because of the increased transparency, share price rose stimulating similar
conversations across other companies that also leveled up their governance.
DaimlerChrysler Case
• The merger in 1999 of the US car manufacturer Chrysler and the
German car manufacturer Daimler-Benz.
• Strong business logic underpinning the merger.
• Less clear was the logic in merging two companies with very different
cultures.
• This culture clash was most evident on the board
• the merger would be incorporated under German Law which stipulated
a two-tier board system with half the supervisory board taken up by
employee representatives while Chrysler was almost exclusively
dedicated to shareholder value.
• Daimler’s largest shareholders were German banks who occupied
three board seats, while Chrysler’s board was dominated by outsiders.
Moreover the management style of both companies differed in style.
• Chrysler was chaired by Kirk Kerkorian, who made his fortune investing
in gaming tables in Las Vegas and was focused on the share price, a
focus maintained through calls for buy backs, dividends and takeover
bids, whilst Daimler was chaired by Himar Kopper, also chairman of
Deutsche Bank.
Disclosure
• Another potentially fractious issue concerned disclosure - German investor relations practices and accounting standards are
far less transparent than in the US. Sure enough, the company's first annual report caused palpitations in America.
• The annual report (sans proxy statement) contained no details on executive pay, director stock ownership or information on
largest owners. Moreover, the company refused to accept any votes received electronically. And the deadline for receiving
votes by mail was four days before the meeting, not the day of the meeting as is standard in the US. “Some investors will
doubtless claim disenfranchisement,” said international governance commentator Stephen Davis.
Pay
• Purchasing was inefficient and fixed costs were far too high for a company of its size.
Break up
• Case study of a ‘failed’ merger between an America company and a European company
Unit 8
Overview of
Corporate
Governance
Codes
Content
• Discuss the main international principles
of corporate governance and explain the
reasons for their existence
• outline the complexities involved in
writing international codes of best
practice
• critically evaluate the concept of
shareholder value and explain why it has
been the focus of corporate governance
codes
• evaluate the usefulness of such codes in
practice.
Most prominent
• OECD
• ICGN
The principle of shareholder value remains a central focus in almost all codes. But it also
has its drawbacks and new doubts have been raised over the relationship between the
maximisation of shareholder value and sustainable economic growth.
References
• Corporate governance by Monks and
Minow