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The Code of Best Practices and the Board of Directors. Professor Florencio L o pez-de-Silanes Yale University School of Management International Institute for Corporate Governance April 9 th , 2002. Corporate Governance and the Code of Best Practices.
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The Code of Best Practices and the Board of Directors Professor Florencio Lopez-de-Silanes Yale University School of Management International Institute for Corporate Governance April 9th, 2002.
Corporate Governance and the Code of Best Practices • Corporate governance is the system through which companies are directed and controlled. • Good corporate governance implies: • Efficient Board of Directors. • Adequate investors’ protection. • International experience has shown that improved transparency and disclosure of corporate practices increase investors’ trust in the companies. • Different countries have found that a way to improve the corporate governance of their companies is through the development of Codes of Best Practices (CBP).
The Code of Best Practices • Although the Codes have common factors, each one emphasizes the problems or characteristics of each country. • In general terms, the Codes establish basic principles, of voluntary adherence, to improve corporate governance. • The CBPs make recommendations in five areas: • Board of Directors • Auditing and Accounting • Board’s Compensation • Selection of the Members of the Board • Shareholder rights
Code of Best Practices SUSPENDED 33 Companies DEFERMENT 15 Companies MISSING 13 Companies SUBMITTED 178 Companies The companies that requested a deferment have already submitted the requested information Total number of companies that answered the questionnaire: 239
Composition of the Board of Directors 1) The number of directors is between 5 and 15 89% 2) There are not substitute Directors 33% 3) At least 40 % of the directors are independent 83% 4) At least 20 % of the directors are independent 75% Total of companies that commented on best practices: 178
Structure of the Board of Directors • The Board performs functions of compensation and evaluation, audit, • planning and financial management 72% • 2) The audit committee is chaired by an independent director 26% Total of companies that commented on best practices: 178
Committees and the Board’s Functions • It is considered important that the Board is properly informed and that the Directors participate in the discussion of the topics of relevance. • Recommendations: • The creation of intermediate entities, committees, to support the Board in the execution of its functions • These committees are extensions of the Board • There are at least three functions in which the Board should be involved. These are: • Evaluation and Compensation • Audit • Financial and Planning
Compensation and Evaluation Function 1) The evaluation and compensation committee revises the selection of the company’s executives 58% 2) Information (structure and form) about compensation packages for directors and executives is disclosed 33% Total of companies that commented on best practices: 178
Audit Function 1) The external auditor’s fee is less than 20% of the audit firm’s revenue 83% 2) External auditor is different than the “comisario” 67% 3) The committee submits accounting policies to the approval of the board 41% 4) The board approves guidelines of the internal control system 57% 5) The committte verifies the compliance with applicable dispositions 54% Total of companies that commented on best practices: 178
Financial and Planning Function The Financial and Planning Committee evaluates the viability of the investment and financing 63% Total of companies that commented on best practices: 178
Disclosure of Information to Shareholders 1) Miscellaneus topics are omitted during the annual meeting 76% 2) Information needed for the annual meeting is available 15 days in advance 90% 3) Shareholders with enough information and voting alternatives can instruct their agents 31% 4) Relevant aspects of the committees’ performance are included 22% Total of companies that commented on best practices: 178
Benefits and Limits • Benefits of CBP • Provides a guideline for shareholders for some reforms • Gives investors more information to sort good from bad • Market push to institutionalize and professionalize companies • To improve the image of companies that uphold the principles recommended by the CBP • Limits • Only guideline, not forcing anybody • Some principles need more bite • Big missing point: director’s responsibilities • Need other forces (the press) to excersice some monitoring
Board of Directors • The Board of Directors must be committed to its function, be functional and make informed decisions. • The CBP suggests: • The separation of the CEO and the President’s roles • To define more concretely the functions of the Board • To limit the Board’s size • That substitutes are not included in the Board • Principles about the Directors’ duties • It is considered as an essential element for the good operation of the Board that it has plurality of ideas and that it acts with objectivity. • The Code suggests: • The appointment of independent Directors • Minimum percentages of representation of the different categories of directors
Evaluation and Compensation Function • It is necessary that the Board supervises the administration of the company, the execution of the goals, as well as to make sure that the Directors’ compensation is not disproportioned. • The CBP recommends: • That the board is informed about the policies on evaluation and to compensation of Directors • That information is disclosed
Audit Function • The Board should guarantee that the financial information is revised and that external auditors participate in this process so that the information that is disclosed is accurate and has a high degree of transparency. • Recommendations: • To assure the objectivity in the selection of the auditors • That the Chairman of the audit committee is independent • Consistency in the company’s accounting policies • To have an internal control system • To make sure that the company fulfills all the legal dispositions that are applicable
Financial and Planning Function • The Board should establish the company’s investment and financing policies, guaranteeing that these are consistent with the strategic planning of the company. • It is recommended: • That the Board approves the company’s investment and financing policies, as well as the annual budget • That the strategic position of the company is periodically revised
Disclosure of Information to Shareholders • Shareholders, especially the minority shareholders, should have access to all the necessary information to be able to participate in the annual Shareholders meeting. • The CBP recommends that: • The topics that will be discussed during the annual meeting are well defined. • The disclosure of all necessary information • The existence of policies and mechanisms that facilitate the communication between the shareholders and the company