Issues and Motives

1. Corporate Governance Issues and Motives By S. Lioukas

2. Corporate Governance: definitions • The system by which companies are monitored and controlled (ΟECD, 1999) • The relationship of the company with its shareholders and the society at large (Financial Times) • Regulations for the promotion of corporate fairness, transparency and responsibility (Chairman of World Bank)

3. What is Corporate Governance about? • The system that societies use to direct and “control” the conduct of corporations • sets the rights & obligations of companies, owners (shareholders), and company obligations against other stakeholders • accountability to society and mechanisms to align the company with the “public interest” at large • Includes formal laws &regulations & codes, as well as informal customs and processes • all determine to what end a firm should be run

4. Corporate Governance is not corporate management • It is about the oversight of the corporations • It is about social control • It is an evolving theme, far from settled • Extends beyond laws and compulsory regulations • Includes voluntary codes and self regulation, conduct and habits, practices • The intersection between law, morality, and economic efficiency

5. CG and CSR • Both concerned with ethics • CG is more specific and formalized relative to Corporate Social Responsibility • There are more formal, compulsory laws and regulations in CG • CSR is more voluntary • Metrics and rating is more developed in CG • CG scoreboards • Ratings industry (agencies, investment institutions…)

6. Is Corporate Governance Important? “The governance of companies is more important for the world economic growth than the governance of countries” J. Wolfensohn (President, World Bank)

7. Does Corporate Governance Pays off? Indications • Companies with “good governance” have higher performance • earned 9.3% more profit that those with “bad governance”(HBS survey in USA,2002) • In Europe: 3% more(Deminor Rating, Amsterdam, 2003) • Investors prefer to invest in corporations with high CG standards • 75% of investors are ready to pay a higher price for good corporate governance, with premiums of 12% to more than 30%(McKinsey, 2002) • Good corporate governance leads to significantly lower capital costs(FAZ, 2002)

8. CG reforms spread worldwide • Indications of worldwide waves of reform • Committees for reform in all countries • White Papers, charters, codes • Changes in supervision, Board of Directors and management structures • Auditing and accounting overhaul • EU, OECD, WB, IMF drive the evolution • Developed countries have passed two or three waves of reform

9. CG: Motives of governments • To attract foreign capital, and also mobilize local capital • To utilize local talent in directing companies • The best people in Board of Directors • To assist companies’ internationalization • Promote compliance with CG rules worldwide – to host countries • To enhance company responsibility • Control for abuses of corporate power • Without reducing company competitiveness

10. Governance problems in practice (1) • Socially irresponsible corporate behavior • Greedy behaviour, arrogance of CEOs • High profile cases of fraud (“enronitis”) • Enormous cost to society • Weak investor protection • Unfair treatment of small shareholders • domination of blockholders • uneven information, or limited access to info • Coupled with shareholder absenteeism, …

11. Governance problems in practice (2) • Ineffective Boards • Strong executives overpower Boards • Weak representation of shareholders interests by Boards • Deficiencies of Regulatory Framework • Administrative burden • “Controlling” philosophy • may restrain innovation and investment • Compliance and enforcement

12. CG debate: main issues (1) • Responsibilities of companies, investors, regulators • How to reconcile diverging interests / views? • is self – regulation a solution? • Shareholders rights • How can shareholders be mobilized and protected? • How to apply shareholders democracy? • Transparency and disclosure • What information should companies disclose? And to whom? • What standards to apply

13. CG debate: main issues (2) • Role of the Board of Directors • Responsibilities / ability to discharge its duties • Effective oversight on CEO /management • Auditing and internal control • Credibility of financial reporting • Oversight of risk • Rights of other stakeholders • Are their interests well balanced? • Do we need extra regulations?

14. Division of responsibilities

15. Investors and governance relations Investors’ activity Company activity BoD Investment Managers Executives Trustees of Funds Managers Beneficiaries* Workforce *Pension beneficiaries included

16. Shareholders rights • Ownership structure has fundamental effects on CG • Dispersion adheres more to CG regulations • More transparent, stronger BoD, professional managers…. • But concentration may lead to better business performance • Some one is more committed to the firm eg family control

17. Dispersed & Concentrated Models “Internal Model” “External Model” Dispersed ownership Strong institutional investors Professional managers Professional Board High disclosure High internal control Concentrated ownership Strong lenders (banks) Owner manager Weak Board Low disclosure Low internal control

18. Large shareholders have advantages • Power to influence appointments of managers • Better access to inside information • Can affect decisions without informing the small shareholders • They can use complex structures to enhance their power in excess of their capital ownership • “Blockholders” obtain disproportional power

19. Examples of complex structures • Ownership by holdings, investing companies and other corporations • FIAT in Italy is controlled by a voting trust (Ifi) • Ifi controls 14.8% of the capital and 22.3% of the votes in FIAT • Agnelli and his family hold 49.95 of the capital and 100% of the votes in Ifi • Cross shareholdings and exchange of seats in companies BoD • Lead to deviations form the one-share one-vote principle

20. How to protect minority shareholders? • Need to make “shareholders democracy” functional • equitable treatment, e.g. • in voting rights (“one share one vote” principle) • rights to seek redress and to sue for unfair treatment • What measures to apply? • Transparency measures, info to all • Facilitate minorities representation in General Shareholders Meeting (GSM) • Representation in BoD

21. Transparency and disclosure • What information should companies disclose? • For performance: financial info, periodic reports, management reports ... • Major corporate events / changes: in ownership, in activities, restructuring • Disclosure to whom? • Effects on competition?

22. Role of Board of Directors • To whom the BoD should be accountable? • To all shareholders – equally • To other stakeholders, balancing their interests? • Company Law: basically sees BoD are stewards of owners interests • but is the supremacy of shareholders under question? • the “company’s interest” is rising as a separate concern • Supervise and control CEO and management • Check on management • Has the rights of investigation

23. Board’s composition • CG debate has focused on BoD composition and independence • E.g. boards’ responsibility in high profile company failures • Board needs to operate independently of management • Must have the power to monitor management • Must be competent to scrutinise managers’ activities

24. Split Chair and CEO? (1) • Current CG debate promotes split of roles • To counterbalance executive power • Companies prefer to combine the roles • To promote strong unified leadership? • Or just to extend the power of strong executives? • Many companies move half way • E.g appoint a “lead director” or “presiding director”

25. Split Chair and CEO? (2) • Separation may bring benefits • May question the “dominant logic” • May restrain executive arrogance • May enhance transparency • Empirical studies show rather neutral results • Split has no significant effect on company value

26. Outside members in the Board • Makes Board more diverse • Bring in outside expertise, more points of view • Make it more representative, more sensitive • Diverse Boards are • More likely to focus on real value creation than financing & asset manipulation • More likely to monitor one another

27. What about Board’s Role in Strategy • The BoDs has to provide direction, strategic guidance • But the strategic role varies across companies /countries • Three styles for the Board: • “Detached”, passive Board • Strategy delegated to management • The Board is simply “rubber stumping” • “Supervisory” Board • Monitors management performance • Gives only general strategic direction • “Proactive”, involved Board • Leads strategy development

28. Committees controlled by outside members of the Board • Auditing Committee • Refers to a non executive director • Nominations Committee • For new Board members • Remunerations Committee • For executives & directors

29. How to make Board Committees more independent • Appoint independent members in the BoD with experience and strong personalities • Difficult, such members are rare or not willing to take responsibility • No incentives for outsiders to stand out against strong CEOs • Establish nomination procedures • Restrict the ability of CEO to influence the selection of members

30. External Audit • Safeguard auditor independence and accountability • Select auditor with no conflicting interests • Rotate auditors • Procedures to selects external Auditors • Audit Committee controlled by independent Board members • Monitoring and supervision of auditors • Dependencies • Standards applied: International Accounting Standards

31. Internal Audit • Establish internal auditing function • Minimum audit procedures • Direct internal auditing so as to assess business risks • Safeguard auditor independence and accountability • Internal auditor reports to an independent director • Monitor internal auditor compliance against rules and procedures

32. Internal Audit best practice • Focus on risks facing the business • rather than focus solely on financial reporting risks (which are the main focus of the external auditor) • Risk based audit plan, taking a broad view of risks • reputational, operational, financial, legal, information technology, and compliance risks • Focus on high risk areas, in forming the audit plan • Collaborate with operational team to validate risks

33. Internal auditors versus external auditors • Internal auditors • Internal procedures • Conformity with company’s policies • Assessment of risk areas • External auditors • Financial accounting for external users • “True and fair” view

34. Other Stakeholders • Whose interests to consider / balance? • Creditors /Bondholders • Managers • Employees • Other • CG debate has not advanced much in this area

35. Creditors / bondholders versus Shareholders • Creditors /Bondholders get a fixed rate • they are “first” claimants • Shareholders are residual claimants • get what is left after loans are served • Are less interested in the company • Depending on assurances • Longer term association with company if loans are linked to business plans

36. Managers as stewards of Owners’ wealth • Managers areresponsible to shareholders? • “stewards” of others’ wealth? • in practice managers areresponsible to other stakeholders also • even in USA • Also they look after their own self interest • Managers’ interests are not aligned with owners interests • The “principal-agent” problem • Shareholders are principals, managers are agents • There are costs from misalignment : “agency” costs

37. Aligning Managerswith Owners • Structure appropriate incentives, e.g • move managers into ownership, stock option plans • profit sharing • do they work? • Owners move into management, e.g • Owners take Board and management positions • Overlapping structure of ownership and supervision • Does it blur managers accountability.

38. Dilemmas in current CG debate (1) • Does it elevate monitoring & control against strategy and direction? • Does it degrade the strategic role of the BoD and other bodies? • Does it degrade the roles of trusting and management? • Adversarial / divided Boards, no team play, no trust • Can shareholders democracy be enhanced in other ways?

39. Dilemmas in current CG debate (2) • How to enhance company leadership and entrepreneurship in a tight CG environment? • performance linked CG? • How to select the best talent in the Boards and make them devote time? • Can we establish a market for BoD members • How to reconcile the interest of other wider Stakeholders with those of Shareholders ? • are existing regulations sufficient?

40. Are there alternatives to CG regulations? • Use market control rather than “internal” CG controls, e.g. • enhance controls exercised thought the market (competition) • facilitate the market for corporate control: threat of takeovers • Use non market controls, such as media pressure, or government intervention • These “external” controls can substitute for “internal” CG controls