Chapter 5

Corporate
Governance

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc. All rights reserved.
“Earnings can be as pliable (flexible) as putty
(soft paste)when a charlatan heads the
company reporting them.”
Warren Buffet

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 Defining Corporate Governance

The system by which business corporations

are directed and controlled.

About the way BOD oversee the running of

the company by its managers and how BOD
are accountable to shareholders and the
company.

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 Defining Corporate Governance
Owners
Public shareholders
Institutional investors
Others corporation

Corporate
Compensation
Audit Committee BOD governance
committee
committee

CEO, CFO ,COO

Creditors
Managers Financial
& employee Institutions
Bondholders

Stakeholders
Customers, vendors partners, suppliers, community

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Defining Corporate Governance
BOARD OF DIRECTORS

A group of individuals hired to oversee

governance of an organization. Elected by vote
of shareholders at the AGM.

The true power of the BOD can vary from

institution to institution from a powerful unit that
closely monitors the management of the
organization to a ‘placeholder’ body that rubber
stamps the decisions of the CEO and
executive team.
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Defining Corporate Governance
AUDIT COMMITTEE

An operating committee staffed by members of

the board of directors plus independent or
outside directors.

The committee is responsible for monitoring

the financial policies and procedures of the
organization specifically the accounting
policies, internal controls and the hiring of
external auditors

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Defining Corporate Governance
COMPENSATION COMMITTEE

An operating committee staffed by members of

the board of directors plus independent or
outside directors.

The committee is responsible for setting the

compensation for the CEO and other senior
executives. Typically this compensation will
consist of a base salary, performance bonus,
stock options and other perks.

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Defining Corporate Governance

•Comply or Explain
A set of guidelines in which companies are
expected to abide by a set of operating
standards or explain why choose not to.
•Comply or Else
A set of guidelines in which companies abide
by a set of operating standards or face stiff
financial penalties.
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Effective Corporate Governance
1.Create a climate of trust and candor (terus-
terang)
• BOD & senior executive should be working
together in achieving company’s goals.
• BOD cannot be seen as an obstacle to the
realization of the CEO’s strategic vision.

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Effective Corporate Governance
2. Foster a culture of open dissent (disagreement)

• Proposal should be open for frank discussion and

review.
• Dissent ensure that all aspects of proposal are
reviewed and discussed thoroughly.

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Effective Corporate Governance
3. Mix up roles
• Rotation of assignments can avoid typecasting.

4. Ensure individual accountability

• All members should consider themselves
accountable – this would address any pretense
of being ambushed or in the dark

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Effective Corporate Governance
5. Let the Board assess leadership talent
• BOD should be actively meeting future
leaders in their current position instead of
waiting for them to be presented when a
vacancy arises.
6. Evaluate the Board’s performance
• Effective corporate governance demands
superior performance from everyone
involved in the process.
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 22 Questions for Diagnosing Your Board…

1. Are there three or more outside directors for every insider?

2. Are the insiders limited to the CEO, the COO, and the CFO?
3. Do your directors routinely speak to senior managers who are
not represented on the board?
4. Is your board the right size (8 to 15 members)?
5. Does your audit committee, not management, have the
authority to approve the partner in charge of auditing
company?
6. Does your audit committee routinely review ‘high exposure’
areas?

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 22 Questions for Diagnosing Your Board…

7. Do compensation consultants report to your compensation

committee rather than to the company’s human resources
officers?
8. Has your compensation committee shown the courage to
establish formulas for CEO compensation based on long-term
results – even if formulas differ from industry norms?
9. Are the activities of your executive committee sufficiently
contained to prevent the emergence of a ‘two-tier’ board?
10. Do outside directors annually review succession plans for
senior management?
11. Do outside directors formally evaluate your CEO’s strengths,
weaknesses, objectives, personal plans and performance every
year?
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 22 Questions for Diagnosing Your Board…

12. Does your nominating committee rather than the CEO direct the
search for new board members and invite candidates to stand for
election?
13. Is there a way for outside directors to alter the meeting agenda set
by your CEO?
14. Does the company help directors prepare for meetings by sending
relevant routine information, as well as analyses of key agendas
ahead of time?
15. Is there sufficient meeting time for thoughtful discussion in addition
to management monologues?
16. Do the outside directors meet without management on a regular
basis?
17. Is your board actively involved in formulating long-range business
strategy from the start of the planning cycle?
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 22 Questions for Diagnosing Your Board…

18. Does your board, rather than the incumbent CEO, select the
new chief executive – in fact as well as in theory?
19. Is at least some of the director’s pay linked to corporate
performance?
20. Is the performance of each of your directors periodically
reviewed?
21. Are directors who are no longer pulling their weight
discouraged from standing for reelection?
22. Do you take the right measures to build trust among directors?

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 The Dangers of a Corporate
Governance Checklist
Enron had all their governance boxes checked:
• They separated the roles of Chairman (Kenneth Lay) and
Chief Executive Officer (Jeffrey Skilling) – at least until
Skilling’s surprise resignation.
• They maintained a roster of independent directors with
flawless résumés.
• They maintained an Audit Committee consisting
exclusively of non-executives.

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 The Dangers of a Corporate
Governance Checklist
The true picture of Enron’s Corporate
Governance:
• Many of the ‘independent’ directors were affiliated with
organizations that benefited directly from Enron’s
operations.
• They also enjoyed substantial ‘benefits’ that continued
to grow as Enron’s fortunes grew.
• Their role as directors of Enron, guaranteed them
positions as directors for other companies – a career
package that would be placed in jeopardy if they chose
to ask too many awkward questions and gain reputations
as troublemakers.
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Effective Corporate Governance
“No system of corporate governance can be totally
proof against fraud or incompetence. The test is how
far such aberrations (kesilapan)can be discouraged
and how quickly they can be brought to light. The
risks can be reduced by making the participants in the
governance process as effectively accountable as
possible. The key safeguards are properly constituted
boards, separation of the functions of chairman and of
chief executive, audit committees, vigilant
shareholders, and financial reporting and auditing
systems which provide full and timely disclosure.”

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