CORPORATE

GOVERNANCE

CFS

What is Corporate Governance?

2

Deals with the problems arising fro

m the separation of ownership and
control.

Separation of Ownership and Control

3

The thousands, or more, investors who own

public corporations could not collectively m
ake the daily decisions needed to operate a
business. Therefore:
The shareholders are owners of the firm
The shareholders elect directors to act as their
agents in supervising the firm
The directors appoint officers (or executives) to
actually run the firm on a day-to-day basis

Separation of Ownership and C

ontrol
Ownership

Shareholders

Board

Control /
Management

Managemen
t
Employees

Focus of Corporate Governance

Shareholders elect directors who represent them.

Directors vote on key matters and adopt the majority decision
s.
Decisions are made in a transparent manner so that sharehold
ers and others can hold directors accountable.
Company adopts accounting standards to generate the inform
ation necessary for directors, investors and other stakeholders
to make decisions.
The company's policies and practices adhere to applicable nati

Principal-Agent Problem
6

Principal-agent problem represents the confli

ct of interest between the principal and the a
gent.

Primary principal-agent problem in corporatio

ns: Principal = Shareholders
Age
nt = Officers
If shareholders cannot effectively monitor the o
fficers behavior, then officers may be tempted t
o use firms assets for their own personal use.

Solutions to Principal-agent problem

7

Incentivesaligning executive incentives with

shareholder desires.
Monitoringsetting up mechanisms for moni
toring the behavior of managers.

Can Shareholders Influence Managers?

8

Shareholders do not directly hire/fire manage

rs so they cant vote to replace them
Shareholders can influence managers indirect
ly through the board of directors
Changing board members can be difficult as
management controls the process and some i
nactive shareholders will go along with whate
ver management wants.
Some active shareholders are large enough
to try and influence management or change t
he board, but they are often met with defeat.

Monitors
9

Monitors are called for because managers

may not act in the shareholders best inter
est.
Figure 1.1 shows that monitors exist:
inside the corporate structure
Board of directors

outside the structure

Auditors, analysts, bankers, credit rating agencies, and
attorneys

in government
SECP

Figure 1.1
10

11

Inside monitors-Board of direct

ors

Oversee management and are supposed to re

present shareholders interests.
Evaluates management and design compensa
tion contracts to tie managements salaries to
the firms performance.

Outside monitors
12

Interact with the firm and monitor manager a

ctivities

Auditors
Analysts
Bankers
Credit rating agencies
Attorneys

Government monitors
13

The SEC regulates public firms for the protecti

on of public investors
The SEC also makes policy and prosecutes viol
ators in civil courts.

14

Governance is more than just Boar

d Processes and Procedures

It involves the full set of Relationship between

a companys management
Its Board
Its Shareholders
Its other stakeholders

One size doesnt fit all. The Board Objectives and Proce
dures may be the same to all societies but when it com
es to applying them to individual countries we have to r
eckon the peculiar, socio-cultural characteristics, the hi
story of its people, their value systems, their economic
system, etc.

15

Corporate Governance Guidelin

es

Most worldwide organizations have strongly p

romoted good corporate governance by appli
cation of the following corporate governance
guidelines:

1. Rights of shareholders
2. Equitable treatment of shareholders
3. Role of stakeholders in corporate governance
4. Disclosure and transparency
5. Responsibilities of the board

16

Corporate Governance Guidelin

es

1. Rights of shareholders

All shareholders must be given their due rights i.

e. They all should have
Secured

ownership of their shares

Voting rights
Right to full disclosure of information
participation on decisions on sale or change in corpo
rate assets or new share issues
Capital structure must be disclosed
All transactions should be at transparent prices and u
nder fair conditions

17

Corporate Governance Guidelin

es

2. Equitable treatment of shareholders

All

shareholders should have equal opportunity for r

edressal of the violation of their rights
Insider trading should be prohibited

18

Corporate Governance Guidelin

es

3. Role of stakeholders in corporate governan

ce

Corporate governance framework apart from the

rights of shareholders allow
Employees

representation on BOD
Profit sharing
Creditors involvement in insolvency proceedings

19

Corporate Governance Guidelin

es

4. Disclosure and transparency

Financial details, operating results, policies, gove

rnance structure should be disclosed
Annual audits should be performed by independ
ent auditors

When in

oubt
isclose

20

Corporate Governance Guidelin

es

5. Responsibilities of the board

Board is responsible for

Protecting

the company, its shareholders and other s

takeholders
Making policies, strategies
Monitoring effectiveness

McKinseys Two-Version Governance Chain

Models
21

Model 1: Market Model

In Market Model governance chain, there are
efficient, well-developed equity markets and
dispersed ownership.
Model 2: Control Model

In Control Model governance chain is represented by

underdeveloped equity markets, concentrated(famil
y) ownership, less shareholder transparency and ina
dequate protection of minority and foreign sharehol
ders.

Market Model Governance Chai

n
22

More common in US, UK, Canada & Australia

Shareholder environment

Institutional
Context

Dispersed
Sophisticatownership
ed
institution
al
ownership
Active
equity
market
Active
takeover
market

Capital Market Liquidity

Independence & Performance

Nonexecutive
Majority
Aligned
Boards
incentive
s
High
disclos
ure

Corporate
Context

Sharehold
er equality

Transparency & Accountability

Control Model Governance Cha

in
23

More common in Asia, Latin America, parts of Europe

Shareholder environment

Institutional
Context

Concentrat
ed
Reliance
ownership
on family,
bank,
public
finance
Under
developed
new issue
Limited
market
takeover
market

Capital Market Liquidity

Independence & Performance

Incentives
aligned
with core
shareholde
rs
Limited
disclos
ure
Inadequat
e minority
protection

Insider
boards

Corporate
Context

Transparency & Accountability

Corporate Governance Concerns

24

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Management Accountability
Providing Adequate Incentives To Management
Disciplining & Replacement Of Bad Management
Enhancing Corporate Performance
Transparency
Shareholder activism
Enhancing Protection
Improving Access To Capital Markets
Promoting Long-Term Investment
Encouraging Innovation

Issues in Corporate Governanc

e

25

Corporate Governance conveys different meanings to different people. But

to all, corporate governance is a mean to an end, the end being long-term s
hareholder value and more importantly stakeholder value. All authorities h
ave identified some governance issues being crucial and critical to achieve
these objectives. These are:
1.

Distinguishing the role of Board & Management

2.

Composition of Board & related issues

3.

Separation of the roles of CEO & chairperson

4.

Should the board have committees?

5.

Appointments to the board & directors re-election

6.

Directors and executives remuneration

7.

Disclosure & audit

8.
9.
10.

Protection of shareholders rights & their expectations

Dialogue with institutional shareholders
Should investors have a say in making a company socially responsible corporate
citizen

Issues in Corporate Governance

1. Distinguishing the role of Board & Management
26

Board of the company has following functions:

Select, decide the remuneration & evaluate on regular basis and when necessary
change the CEO.

Oversee indirectly the conduct of companys business

Review and approve the companys financial objective if necessary

Render advice & counsel to the top management

Recommending candidates to the shareholders for electing them to BOD

Review the adequacy of systems to comply with all laws and regulations

All other functions required by law to be performed

Issues in Corporate Governance

2. Composition of Board & related issues
27

BOD is a committee elected by shareholders. Sometimes, full-t

ime functional directors are appointed, each being responsible
for some particular branch of the firms work.

Issues in Corporate Governance

3. Separation of the roles of CEO & chairperson
28

Combining the role of chairperson with that o

f the CEO leads to conflict in decision making
and too much concentration of power in one
person resulting in unhealthy consequences.
The role of CEO is to lead the senior manage
ment team in managing the enterprise, while
The role of chairperson is to lead the board to
evaluate the performance of senior executive
s including the CEO.

Issues in Corporate Governance

4. Should the board have committees?
29

Following committees if made would lessen t

he burden of the board and enhance its effec
tiveness:

Nomination
Remuneration
Auditing

Issues in Corporate Governance

5. Appointments to the board & directors re-electi
on

30

The board or its specially constituted committ

ee selects and appoints the prospective direct
or and gets the person formally elected by th
e shareholders at AGM.

Issues in Corporate Governance

6. Directors and executives remuneration
31

Shareholders are entitled to a full and clear st

atement of Directors recent and future benef
its and how they have been determined.
Remuneration committee must be appointed
for this task.

Issues in Corporate Governance

32

7. Disclosure & audit

8. Protection of shareholders rights & their exp
ectations
9. Dialogue with institutional shareholders
10. Should investors have a say in making a co
mpany socially responsible corporate citizen

Need & Importance for Corporate Governan

ce
33

Corporate governance is needed to create a c

orporate culture of consciousness, transparen
cy and openness.
It refers to the combination of laws, rules, reg
ulations, procedures and voluntary practices t
o enable companies to maximize shareholder
s long-term value.
It should lead to increasing customer satisfact
ion, shareholder value and wealth

Governance & Corporate Performance

34

There is a positive relationship between corpo

rate governance and corporate performance.
Improved corporate governance is linked with
improved corporate performance either in ter
ms of rise in share price or profitability.

Investors Preference for Good Govern

ance

35

Majority of investors (institutional) consider g

overnance practices to be at least as importa
nt as financial performance, when they evalua
te companies for potential investment.
They are prepared to pay a premium for shar
es in a well-governed company as compared t
o a poorly governed one exhibiting similar fin
ancial performance.

Benefits of Good Corporate to a Corporation

36

1. Creation & enhancement of a corporations compet

itive advantage
2. Enabling a corporation perform efficiently by preve
nting fraud & malpractices
3. Providing protection to shareholders interest
4. Enhancing the valuation of an enterprise
5. Ensuring compliance of laws and regulations (BCCI)

37

Theoretical Basis of Corporate Gov

ernance
1.

Agency Theory

2.

Stewardship Theory

3.

Stakeholder Theory

4.

Sociological Theory

Agency Theory
38

1.
2.

Owners (shareholders) / Principals

Management / Agents
Agency Problem
Agency Cost
Agency Loss
Problems with The Agency Theory
Mechanisms to Reduce Agency Cost
Fair & Accurate Financial Disclosures
Efficient & Independent Board of Directors

Agency Theory
39

1.
2.
3.

4.

5.

Problems with Agency Theory

Limited success
Complexities of Investor - board relationship
Shareholders should have correct and adequate
information to wield effective control
Shareholders rarely make clear their exact targe
t returns and yet delegate authority to meet the
target
Shareholders hardly have sanctions over board
s.

Stewardship Theory
40

Stewards whose motives are aligned with the objectives

of their principals.
A stewards behavior will not depart from the interests o
f his / her organization.
Control can be potentially counter productive, because i
t undermines the pro- organizational behavior of the ste
ward, by lowering his / her motivation.
Stewardship refers to the responsibility of the board to ov
ersee the conduct of the business and to supervise ma
nagement which is responsible for the day-to-day condu
ct of the business. In addition, as stewards of the busine
ss, the directors function as the catch-all to ensure no is
sue affecting the business and affairs of the company fa

Stakeholder Theory
41

Stakeholders = Shareholder Group

+
Non-shareholder Group
Employees
Customers
Dealers
Government
Society at Large

42

Criticism of the Stakeholder Theor

y

Not applicable in practice by Corporation

Comparatively little empirical evidence

Difficulty of defining the concept

Leading to chaos

Opening doors to corruption

Sociological Theory
43

Power & Wealth Distribution

Board Composition
Financial Reporting
Disclosure
Auditing
Equity & Fairness

Corporate Governance Systems

44

The Anglo-American Model Unitary Board Model

The German Model Two-Tier Model

The Japanese Model Business Network Model

The Anglo-American Model

Unitary Board Model (Anglo-Saxon)
45

Shareholders

Elect

Board of Directors
(Supervisors)

Stakeholders

Appoints &
supervises

Officers
(Managers)
Creditors

Lien on
Own

Manage Monitors
&
Regulates

Regulatory/
Legal system

Company
Stake in

The Anglo-American Model

Unitary Board Model (Anglo-Saxon)
Major Features

46

1.

2.

3.
4.

5.
6.
7.

8.

A single board comprising both executive and non executive direct

ors in varying proportions.
The ownership of companies is more or less equally divided betwe
en individual shareholders and institutional shareholders.
Directors are rarely independent of management.
Typically managed by professional managers who have negligible o
wnership stakes.
There is fairly clear separation of ownership and management.
Most institutional investors are reluctant activists.
The disclosure norms are comprehensive, the rules against insider
trading strict, & the penalties for price manipulations stiff, all of wh
ich provide adequate protection to the small shareholders and pro
mote general market liquidity.
Incidentally, the rules against insider trading also discourage large i
nvestors (institutional) for taking active role in corporate governanc

47

The German Model

Two-Tier Board Model
Appoint 50%

Supervisory Board

Appoint 50%

Appoints &
Supervises

Employees &
Labor Unions

Management Board
(Including Labor
Relations Officer)

Shareholders

Manage

Company

Own

The German Model -Two-Tier Board Model

48

Main Features
1.

2.
3.

4.

5.

6.
7.

Corporate Governance is exercised through boards: Supervisory & Manage

ment Boards
The upper board supervises the executive board on behalf of stakeholders.
Corporate Governance approach is typically societal-oriented (Continental
European approach).
Shareholders own the company, they do not entirely dictate the governanc
e mechanism.
50% of members of supervisory board is elected by the shareholders & re
maining 50% is appointed by labor unions
The supervisory board appoints and monitors the management board.
The management board independently conducts the day-to-day operations
of the company but reports to the supervisory board.

The Japanese Model Business Network Model

49

Monitors & Acts in

Emergencies
Appoint

Supervisory Board
(Including President)
Ratifies the
Presidents decisions

Shareholders

Provides
Managers

President
Consults

Main Bank

Executive Management
(Primarily Board of Directors)
Manages
Provides Loans
Own

Company

Owns

The Japanese Model Business Network Model

50

1.

2.

3.

4.

5.

Main Features
Boards tend to be large, predominantly executive and of
ten ritualistic.
The reality of power in the enterprise lies in the relation
ship between top management in the companies (keiret
su network or Korean chaebol)
The financial institution plays a crucial role in governanc
e.
The shareholders and the main bank together appoint t
he board of directors and the president.
The president who consults both the supervisory board
and the executive management.