Improving the Substance of Corporate Governance

1. Improving the Substance of Corporate Governance Mak Yuen Teen SIAS Corporate Governance Conference, 8 October 2008

2. Redefining Corporate Governance? Corporate governance refers to having the right people, structure and processes to direct and manage the company, in order to enhance its long-term value, through enhancing performance, accountability and risk management. It is about empowering management, while ensuring that there is adequate oversight and accountability.

3. Redefining Corporate Governance? • Having the right people is as (more?) important as structure and processes • Robust risk management is critical to good corporate governance (and may be undermined by design of “pay for performance” schemes) • The board should not micro-manage

4. Keys to Improving Substance • To improve substance, the board must: • believe in accountability • take responsibility for governance • seek continuous improvements • incorporate good governance principles into everything it does

5. 1. Setting the Tone at the Top • Hold directors and senior management to the highest ethical standards • having a code of conduct or ethics for directors and senior management is a good start • enforcing ethical standards on directors and senior management is critical

6. 2. Building an Effective Board • Rigorous processes should be followed in: • recruiting the right directors, which involves assessing current mix of skills and backgrounds of directors against the desired mix, and having a robust process for identifying and selecting candidates • diversity in competencies and backgrounds is valuable provided it’s not “tokenism” (e.g., specialists/generalists, CEOs/non-CEOs, local/foreign directors, gender, races, private/public/non-profit, etc.)

7. Foreign Directors: Pros and Cons • Pros: • knowledge of overseas market in which company has a listing or significant business • not part of “old boys’ network” so better able to express dissenting views • influence the board to adopt international good practices • Cons • lack of knowledge of local laws and practices • difficulty in actively contributing to board and committee work • difficulty in paying them adequate fees or may lead to fee escalation for entire board if no policy on differential fees for foreign directors

8. 2. Building an Effective Board • Rigorous processes should be followed in: • inducting and developing directors • assessing independence of independent directors to ensure that they are independent in substance, continue to be so, and likely to be perceived to be so • assessing board and director performance to ensure that the board and individual directors are in fact adding value

9. Induction of Directors • In the UK, the Institute of Chartered Secretaries and Administrators (ICSA) has published a guidance note on “Induction of Directors” (http://www.icsa.org.uk), divided into: • essential information to be provided immediately (directors’ duties, company’s business, board issues); • additional material to be provided within the first few months • additional information which the company secretary might consider making the director aware of

10. Assessing Director Independence • “Principles-based” approach to assessment of independence by the NC: • determines whether the director is caught by one of the 4 relationships in guideline 2.1 • considers whether there is any other relationship or factor which may influence the director’s ability to act independently (e.g., long tenure, interlocks) • considers the director’s actual behaviour • carefully explains why director is deemed independent where threats to independence exist

11. Assessing Board and Director Performance • A typical board assessment questionnaire may cover: • board structure, roles and responsibilities • board meeting processes • board culture and relationships • board’s access to information and management • board’s involvement in strategy and planning • board’s involvement in monitoring • Committee performance should also be assessed

12. Assessing Board and Director Performance • Some key issues: • Feedback from management • Feedback from key shareholders • Use of external party • Simple annual, plus more comprehensive less regular, evaluations • Quantitative vs qualitative • Benchmarking to other boards • Using the results of assessment

13. 3. Board-Management Relationship • Board and management must have a good working relationship but without becoming too close • Board and management must have clear understanding of their respective roles and responsibilities • Board should delegate clearly, have clear reserved powers and supervise its delegation

14. 3. Board-Management Relationship • Supervising delegation requires the board to be pro-active in asking questions and seeking information • Certain reserved powers can be delegated to board committees but this should be explicit • Beware of board committees over-reaching into management

15. Examples of Reserved Powers of the Board • Approval of vision, mission, values statement, code of ethics and strategic plan • Recommendation to appoint/change auditors • Recommendation on the remuneration of auditors • Approval of auditors’ engagement letter • Review of auditors’ recommendations and observations • Approval of all circulars and other documents, including those required by the stock exchange to be sent to shareholders • Approval of press releases on matters decided by the Board • Approval/review of interested party transactions

16. Examples of Reserved Powers of the Board • Approval of interim and final accounts and reports • Approval of interim dividends and recommendation of a final dividend • Approval of all significant changes in accounting policies and practices • Approval of budget • Approval of all changes to the organisation of senior management • Approval of CEO remuneration and policy • Approval of individual items of expenditure in excess of a stated amount

17. 4. Internal Control and Risk Management • An internal control system should include at least the following: • explicit assignment of responsibilities for internal control • procedures for assessing the effectiveness of internal controls • reporting of significant risk and internal control matters to the Board and CEO • whistleblowing arrangements

18. 4. Internal Control and Risk Management • According to the ASX recommendations, a sound risk management system should include: • policies on risk oversight and management, which clearly describe roles and accountabilities • policies which cover oversight; risk profile; risk management; compliance and control; and assessment of effectiveness • the board’s oversight of establishment and implementation of the risk management system, and review of its effectiveness at least annually

19. 4. Internal Control and Risk Management • risk profile should cover material financial and non-financial risks, and should be regularly reviewed and updated • management’s responsibility for establishing and implementing a system for identifying, assessing, monitoring and managing material risk throughout the organisation • means of analysing the effectiveness of its risk management system and effectiveness of implementation

20. 5. Executive and Director Pay • There is often an over-reliance on cash bonuses based on annual profits and stock options to “pay for performance” • Such “pay for performance” schemes encourage senior executives to take on more risk without bearing the full consequences (they have asymmetric payoffs) • Relative TSR also does not properly account for risk

21. Annual Cash Bonuses

22. 5. Executive and Director Pay • Is it time for risk-adjusted measures to be used for rewarding CEOs? (but CEOs have considerable power in influencing pay level and policy) • Different pay for performance schemes may be appropriate for different types of companies and for different senior executives within the company • Stock options are generally inappropriate for NEDs

23. 5. Executive and Director Pay • May need to consider raising premiums for chairmen relative to NEDs in Singapore • NED fees are too low for some companies but may be reaching competitive levels for larger companies • Attendance fees may be starting to create dysfunctional incentives in some companies

24. Questions? Slides can be downloaded from www.cgfrc.nus.edu.sg email: yuenteen.mak@watsonwyatt.com; bizmakyt@nus.edu.sg