Corporate Governance

There are have been various definition s of corporate governance but for the purpose of this essay ,‘Corporate governance refers to the way in which companies are governed, and to what purpose it is concerned with practices and procedures for trying to ensure that a company is run in such a way that it achieves its objectives this could be to maximize the wealth of its owners its shareholders subject to various guidelines and constraints and with regard to other groups with an interest in what the company does’ . Sound corporate governance may therefore be said to exist where the conflicting interest of all stakeholders in a company are ethically balanced

The importance of corporate governance cannot be over emphasised as it is ‘one key element in improving economic efficiency and growth as well as enhancing investor confidence…as a result, the cost of capital is lower and firms are encouraged to use resources more efficiently, thereby underpinning growth.’ Corporate governance also helps to ensure that assets of the firm are secure and not subject to expropriation by individual groups within a firm who could wield excessive power . Corporate governance may therefore be an instrument of checks and balances in the administration of a company.

Before delving into the fundamental issue of corporate governance

It is vital to discuss the theoretical justification (another word for this) for a system of rules or guidelines on corporate governance there are 3different views namely ;the agency theory , the transaction cost theory ,and the stakeholder theory however for the purpose of this essay the agency theory will be a focal point as it is ‘the dominant academic view of the corporation’ ‘it rest on the premises that markets … provide the most effective restraints on managerial discretion , and that the residual voting rights of shareholdersd should ultimately commit corporate resources to value maximizing ends ,. It sees a firms existing corporate governance arrangements as the outcome of a bargaining process which has been freely entered into by corporate insiders and outsiders .’ the separation of ownership and control is important in as much as it may allow managers to deviate from their shareholder value –ie profit maximization . however, such behaviour is widely predicted and following Jensen and Meckling (1976), is expected to be fully anticipated when an owner –manager sells equity to outsiders .’

According to coyle ‘Agency theory’ may be summarised as follows:

_ In large companies ownership is separated from control. Professional managers are appointed to act as agents for the owners of the company.

_ Individuals are driven by self-interest.

_ Conflicts of self-interest arise between shareholders and managers.

The fundamental issue of corporate governance in companies lies in the potential conflict of interest between the board of directors and other stakeholder groups especially shareholders and employees . ft note.

The directors of a company may be more interested in boosting the companies performance on a shaort term basis in other to gain their performance related rewards , they may resort to aggressive accounting (ft note…) measures or may even take risk s or decisions aimed at tachieveing short term goals which would not help the companies performance on the long run . on the otherhand , shareholder most often are more concerned with company performance on the long run , continued existence of the company and an increase in the value of their investments so if the company runs into financial problems the shareholders suffer a greater financial loss This fundamental issue of conflict of interest between directors and stakeholders can occur in such as

Structure of the board of directors

The effective communication between shareholders and directors

Internal control and risk management

Directors remuneration and its relationship with performance

financial reporting and auditing

Ethical and social issues, corporate social responsibility( CSR)

Company – stakeholder relation.

STRUCTURE OF THE BOARD OF DIRECTORS

The board of directors in a company appears to be a very important part of a company as they are essentially the decision making organ of a company. They are the link between the shareholders and the managers. The strength of a company will therefore depend on the balance power between those who own the company and those who run it. the powers of directors in accompany will usually be provided for in the articles of association of the company. A board consists of executive and non executive directors who are expected to devise business policies approve strategic plans approve key transactions , declare profits and approve the sale of further securities subject to limitations as provided for in the articles of incorporation. In UK and US, companies are mostly characterized by unitary boards unlike the German and Japanese companies where there exists a two –tier board structure which is allows employee representation on the supervisory board.

The power of the board of directors to act on behalf of the company are largely unrestricted by the shareholders the ability of the directors to act in their selfish interest regardless of the interest of shareholders and other stake holders,

The board of directors is a collection of individuals, each with his or her personal views, interests and concerns. Some individuals, notably the CEO and the chairman, carry more influence than others and this may tilt the balance of power on the board .A central issue in corporate governance is therefore the balance of power and influence among individuals on the board. In a poorly governed company, there will be no checks and balances to prevent one individual, or group of individuals, from dominating the board and its decisions. And in such a company, there will be an opportunity for autocratic leadership.Autocratic leadership may be enlightened and even good for the company, but there is a risk a company will be used to serve the purpose of that individual an example of this in the uk is Mr Asil Nadir, who was both CEO and chairman. Of polly peck The company collapsed without warning in October 1990. As a result of loose internal controls system at the company’s London head office, Mr Nadir was able to transfer money from the company’s UK bank accounts to his personal accounts with a bank in Northern Cyprus, without anyone questioning his actions .

Another instance in the UK of a company dominated by atyrannical leader is that of of Robert Maxwell. At one time, he owned Pergamon Press, which was the object of a failed takeover bid in 1969. after the failed bid, the Department of Trade and Industry carried out a report (1971)which stated: ‘We regret having to conclude that, notwithstanding Maxwell’s acknowledged abilities and energy, he is not in our opinion a person who can be relied on to exercise proper stewardship of a publicly quoted company.’ Maxwell finally revived his business , buying the British Printing Corporation in 1980 and building up a publishing and media empire in the 1980s that eventually included Mirror Group Newspapers, US publisher Macmillan and the New York Daily News. . In spite of the 1971 DTI report, Maxwell received enthusiastic backing and funding from investment institutions and bankers. , after his death In 1991it was found that he had misappropriated about £900 million from the pension funds of his companies, using the funds to finance his corporate expansion and support his ailing private companies. A subsequent DTI report stated that ‘there were no proper corporate or financial controls to prevent this’.

In most uk companies the board of directors are usually dominated by executives in terms of numbers and access to and control of information and this is a cause for concern as many of the recent and well publicised corporate failures whether in the uk or elsewhere have stemmed from lack of countervailing influence on boards dominated by executives only

Since the executives have more access to information they can decide which information to pass on to the non executive directors who most often do not spend enough time in the company to know what really goes on . the executives may also decide to withhold sensitive information or even manipulate information to suit their positions and this willl result in neds inability to make informed contributions in board deliberations and decisions making The appointment of people who are acquitances or executive from other boards many of whom have a pre existing relationship with the firm , as non executive directors is clearly widespread and to be independent of the executives that appointed them may not be possible as such NEDs can not be expected to perform monitoring n control roles required to protect shareholders interest

It may then be said that it’s structure as it relates to size, composition, in a way determines the role played by each individual director and by the board as a whole. In recent times the size of the board of directors have changed slightly from what it used to be in the past where there were a higher number of directors than necessary it may even be better to have less number of directors so as to reduce remuneration expenses. The size of the board will vary from one company to another.The ideal size is one that balances: _ the need to avoid the board being so large as to be unwieldy; and _ the need to have a board that is large enough so that it has individuals with a balance of skills and experience appropriate for a company of its size and business.

The siz of the board is an A common board structure in the US is for the board to consist of NEDs, with only the CEO and the chairman representing executive management. The Financial Times suggested that this structure is potentially vulnerable to manipulation by the chairman and CEO, who are able, if they wish, to control the flow of information to their fellow directors. A better structure would therefore be a board with more executive management representation, but with a majority of NEDs led by a senior independent director.This structure should improve the knowledge NEDs have about the company.

Another example is that of Enron in 2002 which help to illustrate failures of the board of directors, both collectively and as individuals. _ The board was ineffective in supervising the actions of its senior executives. _ The board ignored the complaints of whistleblowers. 74 DIRECTORS AND SHAREHOLDERS case example 4.1 The dangers of a dominant personality There are many examples, of which the case of the UK company Polly Peck International is just one. Polly Peck, a FTSE 100 company, was effectively run by a single individual, Mr Asil Nadir, who was both CEO and chairman. The company collapsed without warning in October 1990. On administration, the system of internal controls at the company’s London head office was found to be virtually non-existent. As a result, Mr Nadir had been able to transfer large amounts of money from the company’s UK bank accounts to personal accounts with a bank in Northern Cyprus, without any questions being asked. After the company collapsed, Mr Nadir fled to Northern Cyprus, where he lives in exile outside the Individual directors should be suitable to hold their position on the board of a public company.‘Suitability’ refers to character, experience, skills and other individual qualities. Taken as a group, the board should possess a breadth of experience, skills and knowledge, and each individual should be able to contribute to the decision-making capabilities of the board.There would be little value in having two individuals on the board with a similar background. The

It almost goes without saying that an individual appointed to the board of a public company should possess personal qualities such that investors should trust his or her honesty and integrity. Individual directors should have a sense of what is right and wrong, and act in an ethical way in business. In practice, this is often overlooked. 3.1 Collective Integrity The requirement for personal integrity applies not just to individual directors, but to the board of directors as a body. governance. Investigations following the collapse of Enron revealed examples of poor governance by the directors. A Senate subcommittee, reporting in 2002, found that: _ In one financial year, the company paid out cash bonuses of almost $750 million to senior executives when the reported total net income of the group was only $975 million. _ Executives were permitted to run off-balance sheet partnerships with the company, which earned hundreds of millions of dollars at Enron’s expense. _ NEDs had financial ties with the company, including payments for consultancy services in some cases. 76 DIRECTORS AND SHAREHOLDERS The The 4 Size and balance of the board 4.1 Composition of a board of directors A board consists of: _ a chairman; _ there may also be a deputy chairman; _ the CEO; _ the senior independent director (who may also be the deputy chairman); _ executive directors; _ NEDs. The board is supported by the company secretary. The size of the board will vary from one company to another.The ideal size is one that balances: _ the need to avoid the board being so large as to be unwieldy; and _ the need to have a board that is large enough so that it has individuals with a balance of skills and experience appropriate for a company of its size and business. This should seem common sense, but it is also included as a supporting principle in the Combined Code. 4.2 Balance: objective decision-making The UK’s Combined Code typifies corporate governance guidelines by stating that, in order to have an effective board, ‘all directors must take decisions objectively in the interests of the company’. It is important that the directors should contribute constructively to board decisions, and in doing so should give their well-considered views. Although the board should aim to reach agreement on all issues, there might be some on which the directors disagree.A director should have the strength of character to back what he or she believes in, and should certainly not agree with the rest of the board simply to avoid argument. Where necessary, individuals should be prepared to disagree with the majority of the board, and let their views be known. This is supported by the Combined Code, which states that if directors have concerns about a matter that cannot be resolved, they should ensure that those concerns are recorded in the minutes of the board meetings at which the matter is discussed. If a NED resigns as a result of any concern, he or she should provide a written statement to the chairman, for circulation to the board. To achieve balance and objectivity at board level: _ no one individual should have excessive powers; and _ there should be a significant number of independent directors on the board: independence is provided by NEDs. Principle A.3 states: ‘The board should include a balance of executive and non-executive directors (and in particular independent non-executive directors) such that no individual or small group of individuals can dominate the board’s decision-making.’ This principle is concerned more generally with achieving a suitable balance on the board. It also introduces the idea that independent board members (independent NEDs) are important to prevent the domination of a board by one individual or clique. However, the Code also argues that executive directors bring an important element of balance to the board, and a supporting principle is that: ‘to ensure that power and information are not concentrated in one or two individuals, there should be a strong presence on the board of both executive and nonexecutive directors.’

Directors’ remuneration

Remuneration of directors became a cause for concern in the early 1990 in th uk and 2002 in the us when some top executives were critizised for being paid higher than their merit and especially during periods when their companies performed badly

Directors remuneration seems to rise at an alarming rate regardless of company performance and there are some cases where the ceo and chairman fix their own remuneration package (an example of this is the Nigerian case of wema bank ceo Anderson case ) In the us the ‘corporate library’s 2006 directors survey found that the median year on year increase in board pay was 19.62%’. According to monks and minnow these pay schemes rarely relate to the performance of the company or that of the individual director and in addition to retainers, meeting fees,chairmanship fees,and stocks or option grants most companies also give huge discounts on whatever they produce . A rather intresting example is general motors where directors received a new car every 90 days. It can be particularly damaging to the capital markets when public anger is stirred against directors who continue to pay themselves more when their companies are performing badly The trouble emerged in the UK, largely as a consequence of the privatisation of state-owned industries, like water and electricity supply companies.The same people who had run the former state-owned enterprises were selected as directors of newly established companies, with an improved pay. .The media led a fight against ‘fat cat’ directors, like the leaders of British Gas and United Utilities. Financial Times (31 July 2002) into the pay-outs to the directors of the 25 largest US corporations that had gone bankrupt since January 2001.The investigation found that the top executives of these companies had obtained about $3.3 billion in pay-outs and share sale proceeds, almost irrespective of company performance. The executives concerned were reaping the benefit of remuneration packages that had been agreed when the economy was booming and there was no foreseeable end in sight to the good times.When their company’s profits fell and the share price tumbled, the executives were still receiving rewards under their contractual agreements.To the investment community, it appeared that the executives were being rewarded for failure

In September 2002, the President of the Federal Reserve in the US, Bill McDonough,attacked the high levels of remuneration for chief executives as ‘morally dubious’. He commented that the average chief executive now earned more than 400 times the average employee’s income, compared with 42 times more than the national average twenty years before, but they were not ten times better.one may suggest at this point that the higher executive remuneration become the lower the profit shareholders enjoy from their investments Another concern has been the problem of who decides a director’s remuneration.An individual who decides the remuneration of another will inevitably have an influence (conscious or not) over that person. If the chairman or CEO has the power to decide the remuneration of the other executive directors, or the fees and other rewards for NED directors, there could be a serious threat to the independence of the board members. It is therefore a well-established principle of corporate governance that there should be a formal procedure for deciding on remuneration for directors and senior executives and that no individual should be involved in setting his or her own remuneration.

In the UK during 2002–3, there was institutional investor concern, supported by widespread media coverage, about large severance payments to outgoing senior executives who had been ousted from their job following poor company performance it could be said at this point that an executive who performs poorly would even be in a beteer position since he /she would be given a fixed severance pay and could take up another executive position in another company for a higher pay package.The issue for corporate governance here will then be how to link pay with performance

The Combined Code states as a principle that: ‘Levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully, but a company should avoid paying more than is necessary for this purpose.A significant proportion of executive directors’ remuneration should be structured so as to link rewards to corporate and individual performance.’

A good remuneration package is one that aligns the interests of the individual directors with those of the company and its shareholders. _

The Code suggests the following: 4.1 Short-term incentives The remuneration committee should consider whether the directors should be eligible for annual bonuses. If so, performance criteria should be ‘relevant, stretching and designed to enhance shareholder value’.There should be upper limits to annual bonuses, and these limits should be disclosed. There may be a case for an annual bonus to be part-paid in shares which the director is required to hold for a ‘significant period’. 4.2 Long-term incentives The committee should consider whether the directors should be eligible for benefits under long-term incentive schemes. Traditional share option schemes should be weighed against other types of long-term incentive scheme. In normal circumstances the benefits under such schemes should not be receivable in less than three years (for example share options should not be exercisable within three years, and the granting of fully-paid shares should not be within three years). Directors should be encouraged to hold their shares for a further period after they have been granted or share options have been exercised (subject to the need to finance any costs of purchase or any associated tax liabilities).Awards of share options and shares should normally be phased over time rather than granted in a single large block. 4.3 Any proposed new long-term incentive scheme should be approved by the shareholders

The Combined Code contains two provisions about service contracts and compensation for termination of office: 1 When negotiating the terms of appointment of a new director, the remuneration committee should consider what compensation commitments the company would have in the event of early termination of office. More specifically, the aim should be to avoid rewarding poor performance. The committee should ‘take a robust line’ on reducing the amount of compensation to reflect a departing director’s obligation to mitigate losses. 2 Notice periods in a contract should be set at one year or less. If it is necessary to offer a longer notice period to a director coming into the company from outside, the notice period should subsequently be reduced to one year or less ‘after the initial period’. The reference to taking a robust line on a director’s duty to mitigate losses is a suggestion that a director’s contract should provide for a payment of compensation in stages, and which would be halted in the event of the director finding employment elsewhere. The UK Combined Code states that: ‘There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration.’ It goes on to make a provision that ‘the board should establish a remuneration committee … [which] should make available its terms of reference, explaining its role and the authority delegated to it by the board’.

Shareholder involvement, however, is desirable, and there are two ways in which this might happen: 1 disclosure; 2 shareholder voting on remuneration.

In the UK, companies are required (Companies Act 2006, s. 228) to keep a copy of all written service agreements with directors. Each written service contract should be available for inspection by shareholders free of charge, and a copy should be kept at the company’s registered office, or its principal place of business, or in the same place as its register of shareholders

. The Combined Code states that notice periods or contract periods should be for one year Should it be necessary to offer a director joining from outside the company a notice period or contract period in excess of one year, the period should be reduced to one year or less after the initial period. The views of the ABI/NAPF on two-year contracts are that as a general rule, they should not be offered to incoming senior executives as an inducement to join.The notice period for contracts should be one year or less. If all companies take this line, executives will stop asking for contracts with a notice period in excess of one year. Two-year deals should only be acceptable for struggling companies.The ABI’s guidelines for remuneration structure go into some detail

References