Corporate governance

Definition (MCCG 2012)

 “The process and structure used to direct and
manage the business and affairs of the
company towards enhancing business
prosperity and corporate accountability with
the ultimate objective of realising long-term
shareholder value, whilst taking into account
the interests of other stakeholders.”
TYPES OF COMPANIES

 concept of company structure i.e. unlimited

liability, limited liability, no liability, limited by
guarantee, public co., proprietary co., private co,
partnership co, GLC and so forth.

  legal entity, legal right and responsibility

 separate and distinct entity from its

owners/members/shareholders, directors and
officers
AGENCY THEORY
 
 Adverse selection and moral hazard are two types of
agency problems.
  
 Agency theory analyzes conflicts of interest between
an agent who makes decisions which affect a principal.
  
 E.g of principal-agent relationship
 shareholders (principals) and management (agents)
 firms (principal) and employees (agents)
 bondholders (principals) and shareholders (agents)
Agency Costs
  The total costs of administering and
enforcing the principal-agent relationship are
called agency costs. They include:
 out-of-pocket cost to develop and enforce

contracts
 costs incurred when the agent behaves

differently than the principal would have if he

had the same information
Ways to reduce agency problems:

 Monitor agents’ behavior

 Set up contracts with incentives to induce the

desired behavior on the part of the agent

 Place constraints on the agents’ behavior
CG mechanisms
 Board of Directors
 Audit committee
 Ownership
 Executive/Directors remuneration
 Institutional /Block shareholder
 Audit of financial statement
 The Market for Corporate Control (takeover)
Effective Board of Director
 leadership by the board chairman separate from
the chief executive to provide critical review

 majority of independent non executive directors to

promote arms length oversight

 recruitment for expertise in financial services

industry, relevant functional area and governance

 initial induction and continuing education to

maintain level of expertise
Effective Board of Director
 sub committees of independent directors for
nominations, remuneration and audit committee

 regular meetings with sufficient time and

information needed to perform duties

 interaction with senior management, internal and

external auditors, stakeholders

 disclosure statements to show board activities and

transactions in transparent manner
Role and Responsibility of Board
 Role of the Board is collectively responsible for the
success of the company. It is ultimately responsible
for the strategic direction and decisions of the
company.

 protecting the interests of the stakeholders (investors

including shareholders and customers) in accordance
with the standards for the financial services sector.

 directing the organization to enhance effective

performance and foster a culture of propriety
appropriate for a financial provider.
Role and Responsibility of Board
 setting the strategy of the company and monitoring
the key performance indicators
 overseeing the risk identification, assessment and
management processes
 establishing the policy framework for governing the
organization, from which all operational policies and
actions are developed
 monitoring the performance of the senior management
team and planning for succession
 ensuring reliability of financial statements
 compliance with regulatory requirements
 evaluating its effectiveness as a board
Members in BOD

 Chairman
 Chief Executive Officer
 Executive Director
 Non-executive

◦ Non-independent
◦ Independent
Role of Chairman

 Leader of the board of directors

 Responsible for the functioning of the Board
 Sets the agenda of the Board meeting
 Responsible for ensuring the effectiveness of the

Board.
 Chairs general meetings of the company
 Represents the company externally, particularly in

dealings with shareholders

 Runs the Board - organizes, with Company

Secretary, the Board committees etc.

Role of CEO

 Leads the executive team.

 Responsible for the executive management of the
company’s operations.
 Runs the company’s business
 Responsible for operations and financial performance
 Provides clear leadership
 Executive Directors report to CEO
 Prepares strategy, plans, objectives etc. and implements
 Submits acquisition / investment proposals and implements
 Develops organization structures, succession planning
 Together with Chairman, communicates to investors etc.
 Submits proposals on Non-Executive fees to the Board
Role of Non-Executive Director

 Independent (+ Non-Executive) Directors are primarily valued

for their objective judgment of corporate affairs.  they need
knowledge of the technical and legal aspects of directorship
and may have a specific skill that can be exercised from time
to time. But for the most part, their contribution will be rated
by their overall knowledge and wisdom.

 Judgment cannot be learned from reading a book or attending

a course - neither can wisdom.  The best course for anyone
wishing to become an independent Director is to build on
their own business experience and develop judgment by
exposing and testing this knowledge and experience in many
different situations and learning from a wide cross-section of
individuals.
Role of Non-Executive Director

 An independent Director legally bears the same

responsibilities as the Executive Directors, but
achieves effectiveness by influencing decisions rather
than controlling operations.

 The field of independent directorship is in no way

risk free; it should not be entered lightly.  It carries
significant exposures, of financial liability, possible
disqualification, and consequential damage to future
careers.
  
  
Audit Committee

 The distinguishing feature of an Audit Committee is its

independence. An Audit Committee is independent of
the activities of management and this independence
assists in ensuring that an Audit Committee acts in an
objective, impartial manner free from any conflict of
interest or inherent bias or undue external influence.

 Be independent, in fact and appearance as

relationships, whether personal, business, political or
philanthropic, may compromise their independence
and therefore their ability actively to challenge
management.
Ownership Concentration

 Another form of internal control

 Ownership concentration can either be by managers or

by investors.

 Theory suggests that when managers hold equity in the

firm, their interests are aligned with equity holders and
they are more likely to maximize shareholder value.

 However, if their equity holdings get too large, they

may garner enough power to guarantee their
employment. This is known as entrenchment.
Executive Compensation
  A form of internal control -tie managers' interests to those of
shareholders.

 Concept of pay-performance

 Issue in performance measures (ROA or RET)

 Incentive in term of bonus or share option or long term share plan.

 However, the current sentiment is that the executive compensation

changes implemented in the 1990's not only have been ineffective,
but may have made things worse.
  
Institutional Shareholders

  Shareholder activism – Institutional investors pursue good

corporate governance when managing long-term
investments and often take an active role in bringing
under-performing companies to task. Calpers, MSWG.

 Recent new legislative and self-regulatory corporate

governance requirements have helped to instill global
market confidence. This includes improved integrity and
oversight of audit firm, management, scrutiny over board
composition and independence, effective use of internal
and external audit functions, higher levels of disclosure
and transparency and greater engagement with investors.
The Market for Corporate Control (Takeover)

 During the 1980's there was a very active market for

corporate control using hostile takeovers

 Indication of some degree of failure in internal control

mechanisms 

 Individuals and firms buy or take over undervalued

corporations
 Ineffective managers are usually replaced in such takeovers
 Threat of takeover may lead firm to operate more efficiently
 However, changes in regulations have made hostile take
overs difficult