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Lecture 5 - Corporate Governance-

Lecture 5 - Corporate Governance- . Dr. Lynn Barkess. Overall unit objectives 4. define corporate governance and assess the effectiveness of various corporate governance mechanisms 6. critically evaluate contemporary a external company reporting practices. Unit -Learning objectives.

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Lecture 5 - Corporate Governance-

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  1. Lecture 5 - Corporate Governance- Dr. Lynn Barkess

  2. Overall unit objectives 4. define corporate governance and assess the effectiveness of various corporate governance mechanisms 6. critically evaluate contemporary a external company reporting practices Unit -Learning objectives Dr. Lynn Barkess S2 2013

  3. 1. define corporate governance in at least two ways; 2. apply concepts from agency and stakeholder theories to explain corporate governance; 3. list various corporate governance mechanisms 4. describe the minimum corporate governance mechanisms recommended by the ASX Topic 5 -Learning objectives Dr. Lynn Barkess S2 2013

  4. 5. explain and evaluate the use of non-executive directors as means of achieving corporate governance; 6. explain and evaluate the use of executive compensations packages as means of achieving corporate governance; 7. describe the annual report and other disclosure requirements related to corporate governance; Topic 5 - Learning objectives cont… Dr. Lynn Barkess S2 2013

  5. Study learning materials 2 hrs Read supplied readings 12 hrs Undertake activities and review Activities 10 hrs 24hrs Topic 5- Study Time Dr. Lynn Barkess S2 2013

  6. Its board of directors! Basic Corporate Governance Dr. Lynn Barkess S2 2013

  7. Agency Theory Perspective “… the process of supervision and control intended to ensure that the company's management acts in accordance with the interests of the shareholders “ (Parkinson (1994) as quoted in Table 1 Solomon 2007, page 13). Definition of Corporate Governance #1 “narrow” Dr. Lynn Barkess S2 2013

  8. Adopted by Solomon “… the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity. “ (Solomon 2007 (reading 5.1), page 14). Definition of Corporate Governance #2 “broad” Dr. Lynn Barkess S2 2013

  9. ASX “the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations”. (ASX Corporate Governance Principles and Recommendations (reading 5.2), page 3) Definitions of Corporate Governance #3 Dr. Lynn Barkess S2 2013

  10. “Effective corporate governance structures encourage companies to create value, through entrepreneurialism, innovation, development and exploration, and provide accountability and control systems commensurate with the risks involved”. (ASX Corporate Governance Principles and Recommendations (reading 5.2),page 13) Definitions of Corporate Governance Dr. Lynn Barkess S2 2013

  11. Agency theory. Stakeholder theory. Solomon suggests that these frameworks share commonalities and overlap theoretically (covered in reading 5.1, Solomon 2007, chapter 1) Theories of Corporate Governance Dr. Lynn Barkess S2 2013

  12. “…competition would take care of corporate governance.” Disclosures and practices based on business reasons. However, markets are not perfectly competitive. Which has lead to the intervention by regulators and the development in Australia and internationally - policy documents - codes of best practices Agency theory Dr. Lynn Barkess S2 2013

  13. Accountability to a broad range of stakeholders. Impact of companies on : Employees, customers, suppliers, local community and environment. Stakeholder theory – ethical branch Dr. Lynn Barkess S2 2013

  14. “…may be viewed as a conceptual cocktail, concocted from a variety of disciplines and producing a blend of appealing sociological and organisational flavours” (Solomon 2007, page 23) Stakeholder theory Dr. Lynn Barkess S2 2013

  15. Normative theory Companies should have a sound system of corporate governance to ensure they uphold their responsibility to a broad range of stakeholders. Stakeholder theory – ethical branch Dr. Lynn Barkess S2 2013

  16. Agency theory – principal agent relationship is a subset of the more general Stakeholder theory where the agency relationships extend the concept To the relationships between the entity as a whole and the broader society in which it operates Agency and Stakeholder Theories Dr. Lynn Barkess S2 2013

  17. 1. powerful founder/owner- with significant influence over the board 2. Weak board authority 3. poor financial disclosures- aggressive accounting and earnings management 4. inadequate centralised management processes such as risk management and compliance issues High Risk Corporate Governance Structures (p 40 Study Guide) Dr. Lynn Barkess S2 2013

  18. Independent Directors Audit Committees Executive Compensation Corporate Governance Mechanisms Dr. Lynn Barkess S2 2013

  19. What is an independent (outside) director ? Is a non-executive director Not a member of management Free of any business or other relationship that could materially interfere with or could reasonably be perceived to materially interfere with the independent exercise of their judgement. Corporate Governance Mechanisms- independent directors Dr. Lynn Barkess S2 2013

  20. Roles Chair of the board should be an independent directors (ASX 2.2) Majority of the board should be independent directors (ASX 2.1) Pitfalls Jensen and Murphy (2004, reading 5.5) recommend to limit number of independent directors (R-15 p55) outside CEO’s bring expertise to the board May view the board through CEO eyes and not challenge the CEO on day to day issues– with the exception of serious problems Corporate Governance Mechanisms- independent directors Dr. Lynn Barkess S2 2013

  21. Board sub-committees -Nomination committee (ASX 2.4) Comprising majority of independent directors Chaired by independent director Have at least 3 members examine the selection and appointment practices of the company Charter setting out the roles and responsibilities Formal and transparent process for appointment and re-election of directors Corporate Governance Mechanisms Dr. Lynn Barkess S2 2013

  22. Board sub-committees- Independent audit committee (ASX 4.1) Focus on issue relevant to the integrity of the companies financial reporting Assess the performance of external auditors and internal audit function Examine the provision of non-audit services Have a charter, reports to the board Corporate Governance Mechanisms Dr. Lynn Barkess S2 2013

  23. Board sub-committees- Remuneration Committee (ASX 8.1) Review and recommendations to board on Remuneration, recruitment, retention, and termination policies and procedures for senior executives Senior executives remuneration and incentives Superannuation arrangements Remuneration framework for directors Remuneration by gender Corporate Governance Mechanisms Dr. Lynn Barkess S2 2013

  24. ASX Principle 8 – Remunerate fairly and responsibly, states “Companies should ensure that the level and composition of remuneration is sufficient and reasonable and that its relationship to performance is clear.” Executive Compensation Dr. Lynn Barkess S2 2013

  25. Executive Compensation Dr. Lynn Barkess S2 2013 There are numerous examples in Australia and elsewhere of excessive executive remuneration that has no correlation with the long-term value of companies. Shareholders, tax payers and other stakeholders are wearing the costs of executives’ risky behaviour.

  26. The purpose of remuneration is to: - attract the right executives (at the lowest cost) - retain the right executives and - motivate executives to maximise long-term firm value Executive compensation (reading 5.5) Dr. Lynn Barkess S2 2013

  27. Types of remuneration Cash as salary Risky performance related cash Shares Restricted shares of share options Retirement benefits Non-pecuniary benefits…. (page 19) Executive compensation Dr. Lynn Barkess S2 2013

  28. The effects of remuneration systems on performance and corporate governanceis an area that has received much attention. It has long been recognized that remuneration systems that correlate management’s salary with financial performance can motivate them to increase financial performance. Executive compensation Dr. Lynn Barkess S2 2013

  29. However, remuneration systems can motivate incompetent and opportunistic managers to use their power to fake the earnings of the firm they manage. Refer to “agency costs of over-valued stock” for example, (p 46). Executive compensation Dr. Lynn Barkess S2 2013

  30. Forging the accounts is not possible in the long-term and because management is assumed to be incompetent in the long-term there is unlikely to be a positive correlation between financial performance and compensation. It is naïve to think that a performance measure can correct deficiencies in corporate governance, judgement or decision analysis. Executive compensation Dr. Lynn Barkess S2 2013

  31. Not prescriptions merely guidelines “if not why not” system (ASX) Disclosure in a separate CG statement in the annual report All ASX Principles and Recommendations ASX principles and recommendations Dr. Lynn Barkess S2 2013

  32. Principle 1- Lay solid foundations for management and oversight Principle 2- Structure the Board to add value Principle 3- Promote ethical and responsible decision making Principle 4- Safeguard integrity in financial reporting Principle 5- Make timely and balanced disclosure Principle 6- Respect the rights of shareholders Principle 7- Recognise and manage risk Principle 8- Remunerate fairly and responsibly ASX principles Dr. Lynn Barkess S2 2013

  33. Directors Name, Positions held, Tenure Changes (new and retired) Directors Cash salary, fees and commissions Bonuses (incl. long-term incentive plans) Post-employments benefits (e.g. pensions and superannuation) Equity compensation (e.g. value of share and options) Termination benefits (AASB 1046) Director and Executive, Disclosures Dr. Lynn Barkess S2 2013

  34. Directors Remuneration (AASB 1046) Cash salary, fees and commissions Bonuses (incl. long-term incentive plans) Post-employments benefits (e.g. pensions and superannuation) Equity compensation (e.g. value of share and options) Termination benefits Disclosure – (AASB 1046) Dr. Lynn Barkess S2 2013

  35. A related party transaction is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged. To enable users of financial statements to form a view about the effects of related party relationships on an entity, it is appropriate to disclose the related party relationship when control exists, irrespective of whether there have been transactions between the related parties. AASB 124- Related Party Disclosures Dr. Lynn Barkess S2 2013

  36. How can shareholders influence CG practices and disclosures voting at AGMs; calling other meetings with senior management; and campaign by a shareholder or a group of shareholders to achieve change. Shareholder activism Dr. Lynn Barkess S2 2013

  37. The Australian Shareholders' Association (ASA) was established as a not-for-profit organisation in 1960 to protect and advance the interests of investors. improvements in transparency and accountability company performance executive remuneration treatment of minority shareholders, risk management and dividend policy Shareholder activism-ASA Dr. Lynn Barkess S2 2013

  38. liaises regulators, lawmakers, industry groups and accounting bodies. represents its members' views on a number of accounting and financial industry bodies holds regular members' meetings conducts adult education workshops aimed at improving members' financial literacy. Directors and other volunteers draw no fee or other remuneration for their services. Shareholder activism-ASA Dr. Lynn Barkess S2 2013

  39. Legal compliance - corporate governance, trade practices, fair trading. Instances of organised shareholder activism or complaints on behalf of shareholders. Governance awards. CEO Remuneration. Non Executive Director remuneration Auditor's remuneration for services other than auditing Board committee structures and independence Concentrated shareholdings Corporate Governance Ratings – Corporate Monitor- Dr. Lynn Barkess S2 2013

  40. How would you rate a company on its corporate governance practices and disclosures? Corporate Governance Ratings Dr. Lynn Barkess S2 2013

  41. This corporate governance quotient was developed by the Institutional Shareholders Service (ISS) to rate publicly traded companies on the quality of their CG Correlations have been found between good CG practices and increased shareholder value. Global Corporate Governance Quotient- Dr. Lynn Barkess S2 2013

  42. •  board structure and composition; •  charter and bylaw provisions; •  audit issues; •  anti-takeover practices; •  executive and director compensation; •  progressive practices such as board performance review; •  director and officer stock ownership; and •  director education. Global Corporate Governance Quotient- eight core topics (p. 39 Study Guide) Dr. Lynn Barkess S2 2013

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