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What to look for (and what not to) in a Corporate Governance Report. Massimo Belcredi Carmine Di Noia London 2006, September 28 th. CG Reports: sources. New self-regulatory code as term of reference ( Comply or explain ).
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What to look for (and what not to) in a Corporate Governance Report Massimo Belcredi Carmine Di Noia London 2006, September 28th
CG Reports: sources • New self-regulatory code as term of reference(Comply or explain) • Italian Stock Exchange listing rules (Borsa Italiana: Regulation, § IA.2.6) • the board of directors of Italian listed companies shall provide information annually on their CG systems; • companies that have not implemented the recommendations of the Code, or have implemented only some of them, shall also provide information on the reasons for such decisions(Comply or explain) • Consolidated law on Financial Intermediation (reports issued in 2007) as amended by law n. 262/05 (on protection of savings): • Italian listed companies shall annually disclose information on their adoption of codes of conduct promoted by companies managing regulated markets or by trade association of market participants… • … and on their compliance with the subsequent obligations, explaining the reasons for any failure to comply (Comply or explain) • … see also amended 4th and 7th Company Law EU Directives
CG Reports: roadmap • CG reports show: • level of compliance with best practices • level of disclosure about deviations from the code • CG reports are NOT tools for the identification of frauds • “comply OR explain” not “comply AND explain” • CG reports contain relevant information on a number of items, but they are not all-embracing • One should not look for information CG reports cannot provide
The past experience: Cirio • Virtually no disclosure to the market • No corporate information on website • Comply or explain rule + absence of adequate disclosure: • Silence may be a (bad) signal in itself • High risk of bad corporate governance practices • (incentive to conceal the real situation)
The past experience: Parmalat • CG structure disclosed in detail to the market • However: CG not in line with best practices • Comply or explain rule + disclosure of bad governance: • CG transparency is achieved • (“comply or explain” approach); • Full disclosure (bad) CG: who read the report? • Disclosure of (bad) CG and accounting frauds
The past experience: Bpl • Detailed disclosure to the market • How effective were internal and external controls? • Comply or explain rule + fair disclosure: • Fair evaluation of executive/non executive directors • Internal controls apparently aligned with best practice… but how effective?
Information available in CG Reports • Governance structure: • one tier/two tier; board of auditors; committees • power of each board and committee • directors’ classification (executive, non exe, independent) • Quantitative data: • board activity (N. of meetings per year) • members’ activity (attendance to meetings) • number of other positions held
Information available in CG Reports Assonime –Emittenti Titoli standard Table (1 of 3):
Information available in CG Reports An Example: Trevisan Cometal S.p.A
Some data (2005) • Virtually all companies disclose • directors’ classification and info on other offices; (info on remuneration/stock options is mandated by law/Consob) • board and committee composition, N.meetings, data on attendance to meetings • info on the structure of delegated powers(e.g. value limits, approval of important transactions, especially those carried out with related parties)
Some data (2005) • 70% of the companies (virtually all the S&P-Mib issuers) report the Assonime Tables • on average, no significant compliance problem arises from “hard” data… • …although red flags may appear for single topics from single CG Reports (e.g. no meetings; Attendance =Ø): • the market is the judge • a red flag is a stimulus to gather further info • it does NOT necessarily mean non-compliance or a bad CG practice (e.g.: a newly appointed committee/director)
Information NOT in CG Reports • Efficiency and effectiveness of internal audit function andinternal controls • Activism of board and committees members outside meetings CG ratings cannot rely only upon CG reports
A staggered implementation? • 1st step: the new Code as a term of reference • CG report 2006, issued in 2007 • 2nd step: “comply or explain” rule • CG report 2007 • Procedural aspects will be implemented first (comply…) • Structural aspects (e.g. board composition) (… or explain) • may take longer • 3rd step: “comply or explain” rule • Following CG reports
How will CG Reports look like? • A further increase in quality of Reports is expected • qualityand detail, rather than mere quantity of info • especially among smaller firms (outside S&P-Mib) • Some of the most important changes • role of the Board (powers delegated to executives, transactions with related parties) • directors’ classification • appointment of directors/statutory auditors • chairman-CEO and lead independent director (LID) • They should generate additional infoin the CG Reports
The Role of the Board • The crucial point of the Code of Conduct • Goals and modus operandi of the Board are spelled out more clearly • Directors shall pursue the priority of creating value for the shareholders • Consistent with this goal, they shall also take into account group’s directives and policies, as well as the benefits deriving from the issuer being a member of a group
The Role of the Board • The BoD shall (inter alia): • examine and approve the company’s strategic, operational and financial plans, and the corporate structure of the group, if any • delegate powers (to managing directors/executive committee) and specify the limits to delegated powers • examine and approve in advancetransactions carried out by the issuer and its subsidiarieshaving a significant impact on the company’s profitability/assets & liabilities/financial position, paying particular attention to transactions where one or more directors hold an interest and to transactions with related parties • adopt measuresaimed at ensuring that such transactions are performed in a transparent manner and meet criteria of substantial and procedural fairness • issue guidelinesregarding theMAX number of officescompatible with a director’s duties • evaluate board composition and performance
Transactions with related parties • The Board shall, in particular: • establish evaluation and approval procedures for transactions carried out by the issuerand its subsidiaries • define thespecific transactions(or determine thecriteriato identify such transactions) which must be approved: • afterconsulting with the Internal Control Committeeand/or • with the assistance ofindependent experts
The role of the board: disclosure • Additional info expected from future CG Reports: • A more widespread disclosure (especially among smaller issuers) of precise info about: • powers delegated/retained by the Board • timing of Board approval (for transactions carried out by the issuer and its subsidiaries) • Measures and procedures adopted by the Board
Directors’ classification • A general principle:prevalence of substance over form • improveddefinition of executive/non executive/independentDirectors • periodic evaluation by the Board (at least once a year)according toanumber of detailed criteria(covering the main problematic issues) • such criteria arenot binding; • BUT usingdifferent/additional criteriarequires anexplanationas to why they yield a better picture according to the general principle • evaluation process controlled by the Board of Statutory Auditors (BoSA)(Code of Conduct AND art. 149 TUF; therefore indirect control by Consob) • theBoSAwill disclose the result of such controlsto the market (in the CG Report or in its annual Report to the general meeting)
A connected point: Statutory Auditors • Statutory Auditors should meet thesame independence criteriarecommended for independent directors • Statutory Auditors must already meet “independence” criteria established by the law • The Code of Conduct recommends Statutory Auditors meet more stringent independence criteria (on a comply or explain basis)
Appointment of Directors • Slate voting mandated by law for the appointment of BOTH Directors and Statutory Auditors • The usual “rational apathy” argument does not seem to apply to the appointment of Directors • Majority shareholders and significant blockholders (sometimes, participating to shareholders’ agreements) are active • so are (increasingly) mutual funds • while pension funds are still small • Although it may apply to the appointment of Statutory Auditors • Average threshold to present a list of candidates: 2.7% (in 2005) • however, only 72 companies (29.5% of the total) had minority Statutory Auditors
Appointment of Directors • A transparent procedure • Lists to be deposited 15 daysbefore the general meeting • Timely adequate information on personal and professional qualifications of the candidates (including eligibility to qualify as as independent directors according to the Code of Conduct) • Lists and info to be timely published through the Internet site of the issuer • Info on the appointment/voting and disclosuresystem to be published in the CG Report • Boards shall evaluate whether to establish a Nomination Committee (not a comply-or-explain provision) • Functions limited to independent directors’ candidatures/ replacement and/or general issues (e.g. board size and composition)
Chairman-CEO: the issue • Average Board structure in Italy • Non-financial companies (2005): 9.3 directors • 2.7 executives; 6.6 non-execs (3.6 of which are independent) • powers delegated to one (or more) executives (the CEO is not always easily identifiable) • frequently, BOTH an executive chairman AND a separate CEO • Banks/Insurance: 15.3 directors • 1.7 executives; 13.6 non-execs (9.3 of which are independent) • Quite often, no CEO • executive committee + a powerful general manager (not necessarily a member of the board)
Chairman-CEO: the solution • Chairman-CEO separation is NOT mandated • Chairman-CEO situations should bemade explicit • Ifthe Chairmanis also theCEOor the personcontrollingthe issuer, a Lead Independent Director(LID)should be appointed • TheLIDwill: • collaborate with the chairman in order to ensure that directors receivecomplete, timely information flows • convene appropriate meetings of independent directors(at least once a year, without the presence of the other directors) • No CEO + Executive Committee? See revised criteriato identify executive/ non executive/ independent directors
Conclusions • CG reports are useful: • They show the level of compliance with best practices AND disclosure about any deviations from the code • However, one should not look for information CG reports cannot provide • In particular, CG reports are NOT tools for the identification of frauds • New CG reports will improve transparency
Enjoy your reading and… Arrivederci!
Contacts Massimo Belcredi Professor of Corporate Finance Dipartimento di Scienze Economiche e della Gestione Aziendale Università Cattolica del S.Cuore Via Necchi, 5 20123, Milano Tel. +39 0272342457 massimo.belcredi@unicatt.it Carmine Di Noia Assonime Deputy Director General Head, Capital Markets and Listed Companies Via S. Maria Segreta, 6 20123, Milano Piazza Venezia, 11 00187, Roma Tel. +39 0286997450 +39 06695291 carmine.dinoia@assonime.it