Corporate Governance: A Review Prof. Igor Filatotchev

1. Veolia Imperial Pathfinder (VIP) Programme Corporate Governance: A Review Prof. Igor Filatotchev

2. A Quick Quiz Veolia Imperial Pathfinder (VIP) Programme • If I have the word ‘director’ on my business card but am not a statutory member of the board of my organisation, do I have the same liabilities as a board member? • Do non-executive (independent) directors have fewer responsibilities than executive directors? • In a limited liability company, is the prime duty of a director to the shareholders? • If you are advising and working with a board, either as a senior manager or a consultant, how do you avoid directoral liability? • Are directors of state-owned organisations, including agencies and parastatals, exempt from normal directoral responsibilities?

3. Corporate Governance: Current Issues Veolia Imperial Pathfinder (VIP) Programme • Corporate failures and regulatory initiatives have placed corporate governance systems under closer scrutiny than ever: • Enron; Worldcom (USA) • Maxwell Group (UK) • Parmalat (Italy) • VW (Germany) • Hyundai (Korea) etc.

4. Areas of Concern Veolia Imperial Pathfinder (VIP) Programme • Concentration of power in small number of executive directors • Lack of balance in Board composition: “an executive capture of Boards” • Deficiencies in accountability and audit • Over-generous remuneration of the executives: “a reward for failure”

5. Why is Corporate Governance so Important? Veolia Imperial Pathfinder (VIP) Programme • “Good Corporate Governance” leads to better accountability and transparency • “Good Corporate Governance” prevents managers from making “wrong” strategic decisions • “Good Corporate Governance” facilitates the successful implementation of important strategies

6. Corporate Governance Veolia Imperial Pathfinder (VIP) Programme • “Corporate governance deals with the agency problem: the separation of management and finance. The fundamental question of corporate governance is how to assure financiers that they get a return on their financial investment.” Shleifer, Andrei and Robert W. Vishny (1997) 'A Survey of Corporate Governance', Journal of Finance 52, 737-783.

7. Corporate Governance Veolia Imperial Pathfinder (VIP) Programme • “…the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies… responsibilities of the Board include setting the company’s strategic aims, providing the leadership to put them into effect, and supervising the management of the business and reporting to shareholders on their stewardship…” The UK Department of Trade and Industry, 2005

8. The Regulator’s Response: UK Veolia Imperial Pathfinder (VIP) Programme • 1992 Cadbury Code • 1994 Greenbury Report • 1998 Hempel Report • 1998 Stock Exchange Combined Code • 1999 Turnbull Report • 2003 Higgs and Smith Reports • 2010 Walker Report

9. Corporate Governance in the USA: 2002 Sarbanes-Oxley Legislation Veolia Imperial Pathfinder (VIP) Programme • Increase in directorial independence • Constraints on non-audit services of audit firms; rotation of auditors • “Section 404” - directors report on the effectiveness of internal controls - auditors report on management’s assessment of the controls - potentially unlimited legal liability • Disclosure of voting records by institutions

10. SEC Rule of Proxy Access 2010 Veolia Imperial Pathfinder (VIP) Programme Under the new rule shareholders seeking access to corporate proxy materials would: • have to own at least 3% of the total voting power entitled to vote at the meeting. • be able to aggregate holdings to meet the 3% requirement. • be required to have held their shares for at least three years. • not be able to use the new rule "if they are holding the securities for the purpose of changing control of the company.“ • be able to include one nominee or a number up to 25% of the board, whichever is greater.

11. “Shareholder Activism” and the Role of Boards Veolia Imperial Pathfinder (VIP) Programme • Shareholder activism - shareholders take an active role in the firm’s operations and attempt to secure drastic changes in the organisation when performance declined. • Annual General Meeting of Shareholders • Board of Directors that include the representatives of the owners and has the responsibility to oversee the direction of the organisation chosen by the CEOs • Internal control is the process by which the Board oversees the management of a corporation • Incentive clauses in managers’ contracts (ESOs; LTIPs)

12. Principles of “Good Corporate Governance“ Veolia Imperial Pathfinder (VIP) Programme • Separate the roles of Chairman and Chief Executive Officer. • Not less than one half of the Board should be Non Executive (Independent) Directors, and their independence and effectiveness should be strengthened. • Establish committee dominated by Non Executive Directors and independent of management (e.g., nomination, audit and remuneration committees). • Short-term contracts for executive directors, etc.

13. The UK Companies Act 2006:Section 171 (“the Seven Non-Exhaustive Duties”) Veolia Imperial Pathfinder (VIP) Programme • To act within their powers – the company’s constitution • To promote the success of the company • To exercise independent judgement • To exercise reasonable care, skill and diligence • To avoid conflicts of interest • Not to accept benefits from third parties • To declare interests in proposed transactions

14. Role and Scope of Remuneration Committee Veolia Imperial Pathfinder (VIP) Programme • Set overall policy and framework for remuneration of Chairman, CEO, other EDs and Company Secretary • Appoint remuneration consultants to provide specialist advice, and set their TOR • Determine appropriate market comparators, and target relative position for total remuneration and all elements • Devise and recommend appropriate incentive schemes, both cash and share-based • Set performance conditions and targets for all incentive schemes

15. The UK 2011 Stewardship Code Veolia Imperial Pathfinder (VIP) Programme Shareholder Engagement to ensure good practice standards of Corporate Responsibility & Corporate Governance • The process through which investors seek to improve a company’s corporate governance (in its widest sense) and therefore performance • Dialogue with companies, exercising voting rights to enhance or protect shareholder value • Does not reduce investment universe

16. UK Stewardship Code Veolia Imperial Pathfinder (VIP) Programme • Institutional Investors (IIs) should disclose their stewardship policy • IIs should have a robust policy on managing conflicts of interests in relation to stewardship • IIs should monitor their investee companies. • IIs should have clear guidelines on when and how they will escalate their activities. • IIs should be willing to act collectively with other investors. • IIs should have a clear policy on voting and disclosure on voting activity • IIs should report periodically on their stewardship and voting activities

17. New Perspectives on Corporate Governance Veolia Imperial Pathfinder (VIP) Programme • Monitoring and control • Strategy/Service • Resources and ‘legitimacy’ Monitoring and control Strategy/Service Resources and ‘legitimacy’

18. Corporate Governance and ‘Entrepreneurial Leadership’ Veolia Imperial Pathfinder (VIP) Programme • “Wealth protection” and “wealth creation” roles of corporate governance • Resource and strategy roles of corporate boards • Boards as a “knowledge pool” • The new roles of non-executive directors • Individual entrepreneurship, corporate venturing and innovation

19. Stakeholder Model of Governance Veolia Imperial Pathfinder (VIP) Programme • The roles of stakeholders in the governance process • “Responsible” corporate behaviour • Business ethics • Sustainability as a longer-term governance objective

20. Corporate Stakeholders Veolia Imperial Pathfinder (VIP) Programme • Shareholders • Managers • Employees • Banks and other lenders • State • Customers • Suppliers • Local community ...

21. Stakeholder Model of Corporate Governance Veolia Imperial Pathfinder (VIP) Programme • Although top managers are technically stakeholders, their primary role is one of contracting on behalf of the firm (directly or indirectly) with other stakeholders as well as with themselves. • Top managers are at the centre of a ‘hub and spoke’ stakeholder model because they contract with all other stakeholders. • Corporate Governance is the means by which other stakeholders control the decisions of a firm’s senior managers.

22. Corporate-level Response Veolia Imperial Pathfinder (VIP) Programme Corporate Social Responsibility debates prompted a number of corporate responses: • “Ethical CSR” -compliance with the firm’s economic, legal and ethical functions. • “Altruistic CSR” - philanthropy that have no position within the domain of business. • “Strategic SCR” - the potential to increase the social performance of business by translating the identified social needs into a business case.

23. Business Ethics and Corporate “Code of Conduct” Veolia Imperial Pathfinder (VIP) Programme • Organisational level - the role of business in the national and international organisation of society. • Individual level- the behaviour and actions of individuals within the organisation, in particular the role of managers in the strategic management process.

24. Corporate Response Veolia Imperial Pathfinder (VIP) Programme The heads of McDonald’s, Diageo, UBS, Merk and other blue-chip companies are among those who develop specific measures and targets for their leadership teams on CSR and business ethics. Assessment targets include: • Employee safety and diversity • “Corporate citizenship” • Company’s reputation • “Triple bottom line” These criteria are often incorporated in formal governance systems

25. International Patterns of Corporate Governance Veolia Imperial Pathfinder (VIP) Programme • UK/USA models of “shareholder activism” • “Relationship Governance” in Germany and Japan • South-East model of family control • Governance in transition and emerging market economies

26. Questions? Veolia Imperial Pathfinder (VIP) Programme