Corporate Governance

1. Corporate Governance Week 1

2. Have you heard about! • NICL Scam (Pakistan) • Mehran Bank (Pakistan) • Enron • Satyam Computers

3. Corporate Governance – An Introduction • Corporate – related with corporations • Governance- derived from Latin ‘gubernare’- meaning to ‘steer’ • The way in which companies are directed and controlled (Cadbury Report 1992) • Recent examples of massive collapses resulting from weak systems of CG have highlighted the need to improve and reform CG at international level.

4. Corporate Governance – An Introduction • Some recent reforms: • USA issued Sarbane-Oxley Act (2002) • Higgs and Smith Reports (2003) UK • SECP guidelines in Pakistan • OECD guidelines in European continent.

5. Corporate Governance – An Introduction • There are different perspectives of CG and the same is evident from the definitions as well. • One approach of CG adopts a narrow view, where CG is restricted to the relationship b/w a company and its shareholders. • In an other approach, CG has broader spectrum beyond shareholders extending that to stakeholders such as employees, customers, suppliers, governments etc.

6. Corporate Governance – An Introduction Some Definitions of CG are: “the process of supervision and control intended to ensure that the company’s management acts in accordance with the interests of shareholders (Parkinson 1994) “the governance of an enterprise is the sum of those activities that makeup the internal regulation of the business in compliance with the obligations placed on the firm by legislation, ownership and control. It incorporates the trusteeship of assets, their management and their deployment (Cannon 1994)

7. Corporate Governance – An Introduction Some Definitions of CG are (Contd): According to Solomon & Solomon (2004: 14) CG is “the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity.” • This definition perceives that companies can maximize value creation over the long term by discharging their accountability to all of their stakeholders and by optimizing their system of CG

8. Corporate Governance – An Introduction The same outcome was identified by different independent researches such as the reports of UK Investment Institute of the Higgs report found that: Companies that demonstrate a commitment to a broad range of stakeholders are likely to show better management skills and increase in accountability can maximise the sustainable wealth creation. • Body shop, Tesco, Patagonia

9. Governance andManagement • How do these terms differ? • Does Governance include Management? Or • Does Management include Governance?

10. Governance & Management

11. What is a Corporate Body? • Any Company is a corporate body. However, in a broader sense only public limited companies are taken to be the subject matter of CG. • So far the thrust of CG is only on listed companies. • What about family businesses, private companies? • In USA and Europe, companies are frequently run by minority shareholders. Hence, they require even greater degree of CG. • Please refer to Butt, S (2011), Pages: 16-18

12. Corporate Governance – Theoretical Frameworks • A number of different theoretical frameworks have evolved to explain and analyze CG such as: • The Agency Theory (Finance and Economics) • Transaction Cost Theory (Economics and Organizational Theory) • Stakeholder Theory (Social-oriented perspective)

13. Corporate Governance – Theoretical Frameworks The Agency Theory: • Owners (shareholders) delegate the running of the company to management • Owners: Principals • Management: Agents • The problem is that sometime the agents take decisions which are not in the best interests of the principals. • Due to managers ego-ism or personal objectives leading to short term profits but ignoring the long term sustainable profit maximisation or in other words ignoring the long term consequences.

14. Corporate Governance – Theoretical Frameworks The Agency Theory (Cont’d): • Same is in case of risk sharing • Again the monitoring of agents by principals is a difficult and expensive task. • Usually contract (agreements) are performed to solve this problem. • As well as the voting power of the shareholders and their power for “Take-over” vote is useful for the balancing of powers.

15. Corporate Governance – Theoretical Frameworks Transaction Cost Theory (Caose, R) • Talks about cost of transactions for a company and its relationship with the management’s opportunism • Bounded rationality of managers • Cost of transactions • Managers try to organize the transactions in their best interests. • Transaction cost theory suggests that shareholders should have control (influence) in the decision making and managers should pursue the best interests of the shareholders rather than their own personal interests and there should be some institutions to mange this sort of transactions

16. Corporate Governance – Theoretical Frameworks Stakeholders Theory • Freeman (1984) proposed that corporate accountability to a broader range of stakeholders. • Today you can see availability of Co information, annual reports on different medium such as newspapers, websites • The role of companies in societies has received increasing attention over time, with their impacts on employees, the environment, local communities as well their own shareholders. • A basic thing is that Cos are now so large and they have impact on the society. Imagine even in KPK the role of PTC, Lakson on Tobacco growers!!! • Some BS!!

18. Corporate Governance – Theoretical Frameworks Stakeholders Theory (Cont’d) • linked to stakeholders theory is the concept of corporate Social Responsibility (CSR) as well. • While researches have found a positive relationship b/w revenues and CSR. • However, it is very difficult to balance the interests of different stakeholders. • However, it is expected of today’s enterprises that they will have to cater to the needs and wants of the different stakeholders rather than a single stakeholder in term of shareholders. • Look at Apple’s initiative or Dell and HP initiatives, Tesco etc

19. Corporate Governance – Theoretical Frameworks To Conclude we can say that: • Ignoring the stakeholders can result in corporate failure while concern for stakeholders attracts investors in the current times. • And to survive companies has to look beyond share holders to a broader range of stakeholders as well as companies should have more accountability (not mere financial but all encompassing) and more control on its internal processes.

20. The CG Framework

21. Essential Principles of CG • Discipline • Transparency • Independence • Accountability • Responsibility • Fairness • Social responsibility

22. Is there some global uniformity • Converging • Diverging

23. Governance is more than just board processes and procedures • Rights of the shareholders • Equitable treatment of shareholders • Disclosure and transparency • Role of stakeholders in CG • Responsibilities of the board

24. Stakeholders in a Company • Management and Employees • Lenders • Suppliers and Clients • Shareholders • Society at large (this includes government)

25. Opportunity to protect individual interests • Managers and Employees have the greatest opportunity to protect their interest(s) • Suppliers and Clients essentially go by each transaction or contract. • Lenders and Shareholders are most vulnerable. • Society depends entirely on law

26. Shareholders • Controlling Groups (Internal Equity) • Outsider Shareholders (External Equity)

27. Outsider Shareholders Institutional Investors • Have some means of protecting their interest but still require protection Individual or General Public • They require the greatest degree of protection, as they have virtually no means of protecting their interest.

28. Lenders Institutional lenders • Have some means of protecting their interest through legal documentation, are relatively at lower risk but still require protection

29. Society at Large • Government (Taxes, Law and Order) • Clients (Value for money) • Community (Social Rights) How do we ensure that these stakeholders get their dues?

30. Corporate Hierarchy • Shareholders • Board of Directors • Management • CEO • Executive Directors • Senior Managers • Employees

31. Key Players • Shareholders (Voting power) • Board of Directors (Represents interests) • CEO (Delegated executive powers) • Senior Managers (Delegated executive powers)

32. Scope of Corporate Governance Individual Interests

33. Issues in CG • Distinguishing the role s of the board and mgt • Composition of the board and related issues • Separation of the roles of the CEO and chairperson • Boards functioning • Directors and executive remuneration • Disclosure and audit • Protection of shareholders rights and their expectations

34. Benefits of CG • Creation and enhancement of a corporation’s competitive advantage • Enabling a corporation perform efficiently by preventing fraud and malpractices • Providing protection to shareholders interest • Enhancing the valuation of an enterprise • Ensuring compliance of laws and regulations • Benefits to society at large

35. References • Solomon, J. and Solomon, A. (2004). Corporate Governance and Accountability. Chichester: John Wiley & Sons – Pages 1-30 • Butt, S. (2011). Corporate Governance (Second Edition). Azeem Academy, Lahore – Pages 15-29 • Fernando (2012)- Chapter 1