Corporate Governance – Principles, Policies and Practices 3e

1. Corporate Governance – Principles, Policies and Practices 3e Chapter 4 The governance partnership

2. The governance partnership • In which we consider: - shareholder rights - shareholder stewardship and activism - shareholder information - different types of director - directors’ legal duties and rights - the board leadership role of the chairman - the corporate officers.

3. The governance partnership Shareholder rights • determined by company law and a company’s articles of association, • share ownership typically gives the right • to receive notice, attend and vote at shareholders’ meeting • to inspect the shareholder register and the register of directors and officers • to regular information • But, having elected directors to govern the company, shareholders do not have the right to be involved in the day to day management of the business, nor to inspect company records or management accounts.

4. The governance partnership Shareholder stewardship and activism • Advocates of shareholder democracy equate rights of share ownership with responsibilities • Shareholders, particularly institutional shareholders, they argue, have a duty to be a watchdog over corporate activities and possible excesses, for example: • challenging excessive director remuneration • opposing schemes to protect the company and the incumbent directors from predators • highlighting unsatisfactory performance • Some corporate governance codes call for such a commitment.

5. The governance partnership Shareholder information • Most company law and corporate governance codes encourage transparency in corporate matters and require the reporting of specific information • The OECD corporate governance principles call for timely and accurate disclosure of • all material matters regarding the company • its financial situation, performance, ownership and governance. • Such transparency requires • accurate accounting methods • full and prompt disclosure of information regarding the company • disclosure of conflicts of interest of directors or controlling shareholders.

6. The governance partnership • Under the UK CG Code (2008) companies have to: • explain the company’s business model and overall financial strategy • to report on the company’s strategy, risk management, and governance procedures. • show that remuneration incentives are compatible with the companies risk profile • Companies do not need to follow a specific template in their presentation. Their report should describe the company’s exposure to risk, explain how they are identified, and outline the risk management systems in place. • Most listed companies now use websites as well as hard-copy reports to convey shareholder information.

7. The governance partnership • Some listed companies use road shows, conference calls, webcasts and other internet opportunities to communicate with shareholders and the public • Some companies have developed on-line tools for readers to build their own reports • An on-line stock exchange announcement by a company can now trigger e-mail alerts, media feeds and possible updating of Facebook, YouTube and Twitter pages.

8. The governance partnership Regularly updated standing information about the company, its activities and personalities can be used to de-clutter and simplify the annual company report.

9. The governance partnership Different types of ‘director’ and director appointment • The appointment of directors • Cross-directorships • The chairman and chief executive roles • Board committees.

10. Directors and board architecture Different uses of the title ‘director’ • Director • executive director [ED] • non-executive director [NED] • Connected [CNED] • Independent [INED] • Outside director • Managing Director • Shadow director • Nominee director • Governing Director (Australia private company domination) • Worker or employee director • Associate director.

11. Directors and board architecture • Independent NED • a non-executive director with no relationship with the company, other than the directorship, that could affect the exercise of independent judgement • Connected NED • a non-executive director with a connection to the company.

12. Directors and board architecture • Connected NED - a non-executive director with a connection to the company such as: • retired executive of that company • relative of the chairman or CEO • nominee of a large shareholder • representative of a significant supplier, distributor or customer • representative of a major financial partner • retired partner of the firm’s auditor - there could be good reasons for appointing to board (experience, knowledge, contacts, but a connected NED is not an independent NED).

13. Directors and board architecture • Cross-directorships

14. Directors and board architecture • Chairman and Chief Executive • Should they ever be the same person? • the arguments for and against • what the codes say • the practice in the USA

15. Directors and board architecture • Board committees • Standing committees of the main board • The three committees in the codes • Audit committee • Remuneration Committee • Nomination Committee • Other board committees • Executive or General Purposes committee • Finance committee • Compliance or corporate governance committee • Strategy committee.

16. Directors’ Capabilities and Responsibilities The legal duties of a director Directors’ responsibilities derive from the nature of the joint stock limited liability company and are enshrined in statute law, case law and regulation Details vary by jurisdiction, but the essential duties are: • a duty of trust - to exercise a fiduciary responsibility to the shareholders • a duty of care - to exercise reasonable care, diligence and skill.

17. Directors’ Capabilities and Responsibilities The legal duties of a director The duty of trust • Act honestly - for the benefit of members • Show independence of judgement • Avoid conflict of interest • Act fairly

18. Directors’ Capabilities and Responsibilities The Nolan (UK) principles of public life 1. Selflessness - holders of public office should serve the public interest, not seek gains for their friends 2. Integrity – they should not place themselves under financial obligation to outsiders who might influence their duties 3. Objectivity – they should award public appointments and contracts on merit 4. Accountability –they should submit themselves to the appropriate scrutiny. 5. Openness – they should give reasons for their decisions. 6. Honesty – they should declare conflicts of interest 7. Leadership – they should support these principles by personal example.

19. Directors’ Capabilities and Responsibilities The legal duties of a director Act honestly - for the benefit of members Exercise powers honestly in line with the company’s constitution Exercise powers in good faith, for the benefit of the members in the short and long term Recognise the need to foster business, to see the impact of operations on communities and environment, and maintain a reputation for good business conduct.

20. Directors’ Capabilities and Responsibilities The legal duties of a director Show independence of judgement A director has a duty to exercise independence of judgement and not restrict his thinking or action.

21. Directors’ Capabilities and Responsibilities The legal duties of a director Avoid conflict of interest A director must disclose a personal interest in any company transaction and abide by the board’s decision on that interest A director must not make a secret profit out of the company A director must not use any property, information or opportunity from the company for his own benefit unless allowed by the company’s constitution and disclosed.

22. Directors’ Capabilities and Responsibilities The legal duties of a director Act fairly A director’s duty is to act fairly between all the members of the company A director must recognise the interests of minority Shareholders.

23. Directors’ Capabilities and Responsibilities The legal duties of a director The duty of care Exercise care, skill and diligence A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person - with the knowledge, skill and experience expected of a director - and the knowledge, skill and experience which that director has.

24. Directors’ Capabilities and Responsibilities Codification of Directors’ Duties UK Company Act 2006 • Duty to act within powers • Duty to promote the success of the company • Duty to exercise independent judgement • Duty to exercise reasonable care, skill, and diligence • Duty to avoid conflicts of interest • Duty not to accept benefits from third parties • Duty to declare interest in proposed transaction or arrangement.

25. Directors’ Capabilities and Responsibilities A related party transaction is one between a company and a party closely related to it, such as a director or a major shareholder • for example, the purchase by the company of a property from one of its directors Related party transactions provide good examples of the requirement to disclose personal interests The listing rules of most stock exchanges and securities regulators require related party transactions to be disclosed and, often, approved by the other shareholders.

26. Directors’ Capabilities and Responsibilities Insider trading, that is trading in a listed company’s shares on the basis of privileged, share-price sensitive insider information is a breach of a director’s fiduciary duty It is also illegal in almost all countries Japan, Hong Kong and Germany were among the last countries to make insider trading a criminal offence The United States has the most severe penalties for insider dealing.

27. Directors’ Capabilities and Responsibilities • Directors have to be careful not to trade in their company’s shares when they are in possession of inside or privileged information such as the company results just prior to publication and before the stock market has that information • The company secretary will often inform directors when the window of opportunity for trading in the company’s shares is open and, more importantly, when it is closed.

28. Directors’ Capabilities and Responsibilities s.9(1) Securities (Insider Dealing) Ordinance Insider Dealing Tribunal (Hong Kong) Insider trading takes place: When a person concerned with a corporation who is in possession of information which he knows is relevant information in relation to that corporation deals in any listed securities of that corporation or their derivatives (or listed securities of related corporation) or counsels or procures another person to deal in such listed securities knowing or having reasonable cause to believe that such persons would deal in them.”

29. Directors’ Capabilities and Responsibilities The US Sarbanes-Oxley Act 2002 (SOX) • To strengthen corporate governance and restore investor confidence following Enron, WorldCom and others • SOX imposed new accountability standards, with criminal penalties, on directors. • CEOs and CFOs must certify under oath that their financial statements neither contain an ‘untrue statement’ nor omit any ‘material fact’. • Audit committees must be comprised totally of independent outside directors.

30. Directors’ Capabilities and Responsibilities The US Sarbanes-Oxley Act 2002 (SOX) • SOX also established new independence standards for external auditors • Areas of lucrative non-audit work by audit firms prohibited • A Public Company Accounting Oversight Board (PCAOB) created to oversee public accounting (auditing) firms and to issue accounting standards • Rules regulated by the SEC and apply to all companies quoted in the United States, including overseas companies listed there • Sarbanes Oxley Act differentiated the United States from many other countries by enshrining corporate governance practice in law rather than voluntary codes.

31. Directors’ Capabilities and Responsibilities The US Sarbanes-Oxley Act 2002 (SOX) • SOX has proved expensive to operate, particularly section 404 • Some overseas companies have complained about the potential extra-territorial legislation • Others have withdrawn from listing in the United States.

32. Directors’ Capabilities and Responsibilities UK Companies Act 2006 • Clarified directors' duties for the first time in statute law • Made clear that directors have to act in the interests of shareholders • But added that in acting in the shareholders' interests, they must pay regard to the longer term interests of employees, suppliers, consumers, and the environment.

33. Directors’ Capabilities and Responsibilities UK Companies Act 2006 • Encouraged narrative reporting by companies calling for them to be forward-looking, identifying risks as well as opportunities • Quoted companies have to provide information on environmental matters, employees and social and community issues • This business review must include information on any policies relating to these matters and their effectiveness, plus contractual and other relationships essential to the business.

34. Directors’ Capabilities and Responsibilities UK Companies Act 2006 • Promotes shareholder involvement in governance by enhancing the powers of proxies • Makes it easier for outside investors to be informed and exercise governance rights in the company • Allows shareholders to limit the auditors' liability to the company to what is fair and reasonable • Requires institutional investors to disclose how they used their votes • Introduces a new offence for recklessly or knowingly including misleading, false or deceptive matters in an audit report.

35. The governance partnership We have considered: - shareholder rights - shareholder stewardship and activism - shareholder information - different types of director - directors’ legal duties and rights - the board leadership role of the chairman - the corporate officers.