B.Governance

Corporate Governance

Overview of Corporate Governance

• Definition: Corporate governance is the system by which companies are directed and controlled.

• Importance: It involves a framework of rules and practices set by the board of directors to meet stakeholder expectations and protect the interests of shareholders.

• Main Components:

  • Board structures and practices

  • Shareholder rights

  • Stakeholder engagement

Areas of organization affected by issues in Governance

1. The Board

   • every company headed by effective Board which collectively responsible for the success of the company

   • Effective Board = Board should comprise directors from diversified background to ensure that decisions made are result of extensive deliberation from different perspectives.

   • Diversity of the Board can avoid ‘groupthink’ effect that caused all the directors to perceive an issue similarly and thus, are not able to think outside the box.

2. Chairman and Chief Executive

   • There should be clear division of responsibility at the head of the company between these two.

     • to avoid unfettered power of decisions that can lead to abuse

     • separation allows these 2 individuals to spend sufficient time in the role that they play

     • if these two roles are held by same individual, it is unlikely him/her (i.e. chairman) would hold himself accountable if they are the same individual

   • Chairman ;

     • focuses on running the Board

     • overseen each and every directors including CEO

     • should be an INED (i.e. not involve in operations)

     • enjoys veto power that allows him/her to overturn the Board’s decision

   • CEO ;

     • focuses on running the company business

     • oversees the resources of the company, establish control to manage it and establish strategies (i.e. business model to be used in selling the products/services)

     • the most senior person in operation

3. Board Balance and Independence

   • Board should include a balance of executive and non-executive director (especially INED)

   • Good CG practices requires INEDs to be represented by atleast ½ of the the Board so their monitoring over EDs will be effective

   • also, to avoid individual or group of individual to dominate board’s decision making.

4. Appointments of the Board

   • Procedure of appointment of new directors to Board should be formal, rigorous & transparent

   • the process should be undertaken by separate nomination committee so that no ED can involve in determining the members of the Board

   • shall promote meritocracy in the recruitment

Issues involving directors’ remuneration

• focusing only on EDs as NEDs only earn directors’ fee which is subjected to approval by shareholders in AGM.

• the amount of directors’ fee payable will be decided by the Boar as a whole with the NED combined not participating in deciding his own fee

• Issues;

  • Remuneration not linked to company’s performance

  • CEO and executive chairman are involved in deciding their own remuneration package

  • Failure to attract, retain and motivate the directors

• Short Term remuneration;

  • obj : to attract, retain and motivate the EDs

  • Basic salary

    • not performance related as it is determined before the director joined the company

    • ED will continue to earn high remuneration at the time when the company performance is poor and dividend payout to shareholders is low

    • against the principle of accountability to shareholders thus, shall only represent low % of total remuneration package

  • Bonus

    • performance related as it is determined at the end of the year when the performance of both, company and directors and are known.

    • promotes accountability to shareholders , hence, shall represent higher %

  • Perquisites

    • to reflect the ED seniority in the company

    • e.g. the company car / housing allowance / holiday / memberships

• Long Term remuneration

  • obj : to make EDs the shareholders of the company so that they can align their interest with the shareholders

  • Share option

    • grant the rights to purchase shares at specified exercise price over a time period

    • they may purchase at lower price than prevailing market price

    • to encourage the ED concerned to subscribe the company share and make themselves the shareholders of the company

  • Company shares (a.k.a. Restricted stock grant)

    • granted to EDs free-of-charge as reward for their long service with the company

    • usually rewarded with limits on its transferability for a set time but sometimes for director’s tenure with the company

• Severance Payments (a.k.a. golden handshake/ golden goodbye)

  • compensation paid to the ED for terminating his/her employment without serving the notice

Agency Theory

• Principal-Agent Relationship: Relevant primarily for larger companies where ownership (shareholders) is separate from control (directors).

• Fiduciary Duties of Directors: Directors act in a trustee capacity, owing loyalty and care to shareholders.

  • Duties: Undivided loyalty and due diligence in decision-making.

  • Related Party Transactions: Must be performed at arm's length to avoid conflicts of interest.

• Agency Costs: Expenses incurred due to the conflicts between principals (shareholders) and agents (directors).

  • Composed of:

    • Monitoring expenditures

    • Bonding expenditures

    • Residual losses due to misuse of director positions.

Stakeholder Theory

Concept and Definitions

• Stakeholders Defined: Any group or individual who can affect or be affected by the achievement of organizational objectives.

• Classification:

  • Primary vs. Secondary: Primary stakeholders are essential for the company's survival; secondary stakeholders can influence or be influenced but are not critical to operations.

  • Narrow vs. Wide: Narrow stakeholders are deeply affected by company actions, while wide stakeholders are less impacted.

Mendelow’s Matrix

• A framework to assess stakeholders based on power and interest:

  • High Power, High Interest: Key players to engage thoroughly.

  • High Power, Low Interest: Keep satisfied, manage effectively.

  • Low Power, High Interest: Keep informed, ensure no issues.

  • Low Power, Low Interest: Monitor regularly, minimal effort.

Corporate Governance Models

Rules-Based vs. Principles-Based Approach

• Rules-Based:

  • Compliance is mandatory with specific practices outlined, but can lead to a box-ticking mentality.

• Principles-Based:

  • Encourages companies to tailor practices to their individual circumstances and provide explanations for deviations.

Corporate Social Responsibility

Definition and Importance

• Corporate Social Responsibility (CSR): The obligation of companies to act in ways that benefit society as a whole.

  • Triple Bottom Line: Evaluating success based on economic, social, and environmental metrics.

Ethical Theories

• Instrumental Stakeholder Theory: Good ethics lead to good business.

• Normative Stakeholder Theory: Companies have moral obligations to all stakeholders.

Governance in Public Sector

Key Differences from Private Sector

• Ownership Structure: Public sector entities are owned and controlled by state bodies, relying on public funds rather than private investors.

• Profit Utilization: Profits are reinvested into services rather than distributed to shareholders.

• Accountability and Engagement: Higher levels of scrutiny and obligation toward public interests.

Committees in Corporate Governance

Roles and Responsibilities

• Remuneration Committee: Focuses on fair executive pay linked to company performance.

• Nomination Committee: Oversees recruitment of board members, ensuring diversity and meritocracy.

• Audit Committee: Responsible for overseeing financial reporting and compliance.

Integrated Reporting

Main Components of Integrated Reporting:

1. Organizational Overview and External Environment: This section includes information about the organization, its mission, and the environment in which it operates.

2. Governance: Details on governance structures and practices, demonstrating how governance supports value creation.

3. Business Model: A description of how the organization creates value over time, including key inputs, activities, outputs, and outcomes.

4. Risks and Opportunities: An analysis of significant risks and opportunities that may affect the organization's ability to create value and how it plans to manage them.

5. Strategy and Resource Allocation: An overview of the organization's strategic objectives, including its approach to resource allocation.

6. Performance: Reporting on the organization's outcomes in relation to its strategic objectives over