Corporate Governance

Corporate
Governance
Chapter 1: the scope of governance
Meaning
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Corporate governance is the system by which companies are directed and controlled.
Governance should not be confused with management.
Management is concerned with running the business operations of a company.

Governance is about giving lead to the company and monitoring and controlling
management decisions, so as to ensure that the company achieves its intended purpose
and aims.
Professor Bob Tricker, 1984:

If management is about running business, governance is about seeing that it is run properly
The term corporate governance means governance of companies.
What CG is not?
Corporate governance is not about management activities, and management skills and
techniques.
Corporate governance is not about formulating business strategies for the company.
When the problems for corporate governance arises

o
o
The separation of ownership and control.

Company has many different shareholders, and there is no majority shareholder.
The separation of ownership from control can affect the quality of governance in noncorporate entities.
The main areas covered by codes of CG

o
o
o
o
o
o
The role and responsibility of the board of directors.

The composition and balance of the board of directors.
Financial reporting, narrative reporting and auditing.
Directors remuneration.
Risk management and internal controls.
Shareholders rights.
Governance issues in public sector entities and in government

Six core principles for good corporate governance in public sector companies:
1. Focusing on the organizations purpose and on outcome for citizens and service
users.
2. The responsibilities of executive management and governing body (board)
should be clear.
3. Integrity and ethical behaviour.
4. Risk management and responsibility of the governing body for the internal
controls.
5. Composition and balance of the board.
6. Engaging stakeholders and making accountability real.
o Constructive dialogue should exist between the governing body and
the general public and particular interest group.
Concepts of good governance
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1. Fairness
o
o
All shareholders should receive fair treatment from directors.

One vote per share and the right to receive same dividend per share.
2. Openness/transparency
o
o
o
Openness and transparency means not hiding anything.

Intentions should be clear and information should not be withheld from
individuals who ought to have a right to receive it.
Transparency means clarity. Providing information about what the company
has done, what it intends to do in the future, and what risks it faces.
3. Independence
o
o
Independence means freedom from the influence of someone else.

A principle of the CG is that substantial number of the directors should be
independent, which means that they are able to make judgments and give
opinion that are in the best interest if the company, without bias or preconceived ideas.
4. Honesty and integrity

o
o
Honesty should be an essential quality for directors and their advisers.

An individual who is honest, and who is known to be honest, is beloved by
others and is therefore more likely to be trusted.
5. Responsibility and accountability

o
The boars is responsible for:

Setting the strategic objective of the company, and
To monitor the decisions of executive management.
With responsibility, comes accountability. The BOD should be accountable to
shareholders.
6. Reputation
o
o
A large company is known widely by its reputation or character.

A reputation may be good or bad, it depends on:
o Combination of several qualities, including:
Commercial success, and
Management competence.
7. Judgment
o
All directors are expected to have sound judgment and to be objective in

making their judgments (avoiding bias and conflicts of interest).
Nolans Seven Principles of Public Life
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These were issued in the UK by Nolan Committee (1995) on standards of public life. The committee
was formed to report on the standards of behaviour amongst politicians and in the civil service and
other public sector bodies.
1.
2.
3.
4.
5.
6.
7.
Selflessness
Integrity
Objectivity
Accountability
Openness
Honesty
Leadership
Chapter 2. Agency relationships and theories
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Agency Theory:
1.
The law of agency

An agent is a person who acts on behalf of another person, the principal, in dealing with
other people.
The agent acts on the name of the principal, and commits the principal to agreement and
transactions.
In company law, the directors act as agents of the company. The board of the directors as a
whole, and individual director, have the authority to bind the company to contractual
agreements with other parties.
Directors set the objectives and strategies of the company.
Fiduciary duties of directors

A fiduciary duty of the director is a duty of trust.
A director must act in on behalf of the company in total good faith, and must not put his
personal interest before the interests of the company.
In case of breach he could be held liable in law. Legal action by company would normally be
taken by the rest of the bods, or possible, a majority of shareholders acting in the name of
the company.
Agency law and challenging the actions of the directors

It is very difficult for shareholders to use the law to challenge the actions and decisions of
the companys directors. Their ability to challenge them is restricted.
The shareholders can vote to remove any director but this requires majority of votes
by shareholders, which might be difficult to obtain.
In the court of law it is up to the shareholder to demonstrate that director is in the
breach of his duty.
In summary, although there is the legal relationship between the BODs and their company,
the shareholders cannot easily use the law to control the decisions or actions of the
directors take on behalf of the company.
2.
Concepts in agency theory: the agency relationship

The theory of agency deals with the relationship between:
a companys owners and

its managers (directors).
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Agency is based on the idea that when a company is first established, its owners are usually
also its managers. As a company grows, the owners appoint managers to run it.
The owners expect the managers to run the company in the best interest of its owners; the
agency relationship arises.
Major lenders also have interest in the activities of the company; how the company is being
managed, because they have concerns about the ability of the company to repay the debt
with interest.
The agency relationship
This theory was developed by Jensen and Meckling (1976). They suggested how the
governance of the company is based on the conflicts of the interest between:
3.
o the companys owners(shareholders)

o its managers
o and major providers of debt finance.
Shareholders
Increase their income and wealth
Dividends and capital growth
Concerned about long-term profitability and financial prospects
Managers (Directors)
They are employed to run the company on behalf of the shareholders.
Managers have an employment contract and earn a salary.
Their main interests are likely to be the size of their remuneration package and their
status as company managers.
Major providers of debt finance
1. Have interest in sound financial management by the companys managers.
Agency Conflicts
Agency conflicts are differences in the interests of a companys owner and managers.
Moral Hazards. Interest of manager in receiving benefits from his status. Car, chauffer,
company airplane and so on.
Jenson and Meckling: Managers incentive to obtain these benefits is higher if he has no
shares, or only few shares.
Effort level. Managers may work less hard than they would if they were the owners of
the company. This problem exists in the middle as well as senior level of management.
Different pay incentives to senior and middle management.
Earnings retention. Remuneration of directors is related to the size of the company,
rather than its profits. In order to grow the company managers might invest in the
projects where the expected profitability is quite small, rather than pay out dividends.
Risk aversion. Executive directors and senior management usually earn most of their
income from the company they work for. They are therefore interested in the stability of
the company. This means that management might be risk averse, and reluctant to invest
in higher-risk projects.
Time horizon. Managers might only be interested in the short-term. This is partly
because they expect annual bonuses based on short-term performance and partly
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because they might not expect to be with the company for more than a few years. They
want the ROI and ARR to increase while shareholders have greater interest in long-term
value as measured by NPV.
4.
Agency costs
Agency costs are the costs of having an agent to make decisions on behalf of a principal.
Agency costs are the costs that the shareholders incur by having managers to run the
company instead of running the company themselves.
Agency costs are potentially very high in large companies, where there are many different
shareholders and large professional management.
Agency costs can therefore be defined as the value loss to shareholders that arises from
the divergence if interest between the shareholders and the companys management.
There are three aspects of agency costs:
1. Monitoring costs are costs of measuring, observing and controlling the behavior of
management. Sometimes are imposed by law (annual accounts, annual audit) and
some arise from compliance with codes of corporate governance.
2. Bonding Costs are costs of arrangements that help to align the interest of the
shareholders and managers. For example, agency costs arise when a companys
directors decide to acquire a new subsidiary, and pay more for the acquisition
than it is worth.
3. Residual losses are losses occur for the owners, such as the losses arising from a
lower share price, because the managers take decisions and actions that are not in
the best interest of the shareholders. Monitoring costs and bonding costs will not
prevent some residual loss from occurring.
5.
Reducing the agency problem
Incentives should be provided to management to increase their willingness to take

value-maximizing decisions.
Align the interest of directors through:
I.
PRP (performance related pay)
Their salaries and commission are dependent on profit. They work for ROCE.
Example; teacher hired on per hour basis.
II.
Share option schemes
Offer shares to managers. They will not only be the employees of the company,
they would become the shareholders of the company. Sense of ownership will
force them to work for the share price, EPS etc.
III.
Executive share option scheme (ESOS)
Members of BOD are offered shares with certain conditions of time.
For e.g. After 3 years X number of shares.
Choosing between agency cost and alignment of interest is based on cost benefit
analysis.
Providers of debt
The problems of the agency relationship are bigger in companies that are profitable but
have low growth in profits. these companies generate a large amount of free cash flow.

Shareholders would wish that free cash flow should be either:
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o Invested in projects that will earn a high return (+npv)

o Paid to the shareholders as dividends.
One way of reducing this problem is would be to have high proportion of debt in to the
capital structure of the company. Interest must be paid on debt, and this reduces the free
cash flow. Management must also make sure that new investments are profitable so and the
company would be able to pay interest on debt capital.
Board of Directors
A different way of reducing the agency problem is to make the board of directors more
effective at monitoring the decisions of the executive management.
The board will be ineffective if dominated by CEO.

CEO and chairman should not be the one person.
The board must consist largely of independent non-executive directors. Because they
are not the full-time employees of the company.
Non-executive directors should be responsible for the remuneration packages for
executive directors and senior management.
Jensen argued that board becomes less effective if it grows in size. Large board makes slow
decisions.
6.
Accountability of agents
Agents should be accountable to their decisions and actions. Agent should disclose every
action to the principal.
7.
Ethics and agency theory

There is an ethical aspect to agency theory. The theory is based on the view that individuals
cannot be trusted to act in any way that it is not in their own best interest.
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Transaction cost economics theory

This theory explains the relationship between the owners of a company and its management as
the resolution of a conflict of interest, although it is an economic theory. It is closely associated
with the work of Oliver Williamson.
1.
Costs of the firm: production costs and transaction costs

The operations of a business entity can be performed either through market transactions or
by doing the work by in-house.
Market Transactions:
o Obtaining raw material form external supplier (outside)
o Hiring full time employees
o Selling finished goods through retail organizations
In-house:
o Making raw material itself
o Hiring self-employed contractors to do work
o Selling finished goods directly to the end user
According to the theory of transaction cost economics, the structure of a firm and the
relationship between the owners of a firm and management depends on the extent to which
transactions are performed internally.
Total costs are the sum of production costs and transaction costs.
Production costs:
o Costs incurred in ideal economic market, to make and sell goods of the firm.
o In ideal economic market production costs are minimized.
Transaction Costs:
o Additional costs incurred whenever the perfect situation is not achieved.
For example: Unavailability of the cheap supplier, because organization was
not aware of the existence of the cheap supplier.
For example: Selling goods to the customers not knowing that the receivable
will become a bed debt.
Transaction costs are sometimes higher when transaction is arranged in the market, and
they are sometimes higher when the transaction is done in-house.
Carrying out the transaction in-house rather than arranging contracts externally is called
vertical integration.
Total costs are minimized when transition costs are minimized.
Performing transactions in-house removes all the risks and:
o
o
Uncertainties about the future prices of products and about product quality
Costs of dealing with external suppliers.
2.
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Assumptions in transaction cost economics (TCE)

Traditional economic theory is based on the assumptions that all behavior is rational and
that profit maximization is the rational objective of all businesses.
Transaction cost economics changes these assumptions, by trying to allow for human
behavior, and the fact that individuals do not always act rationally.
Williamson assumptions about behavior:
Bounded rationality, and

Opportunism.
Bound rationality
It is assumed in TCE that humans act rationally, but only within certain limits if
understanding. For example that the manger of a company will in theory act rationally in
seeking to maximize the value of the company for its shareholders, but their bounded
rationality might make them act differently.
It is impossible to predict with certainty what will happen, because there are too many
factors and too many possibilities to consider.
When uncertainty is high, or when a situation is very complex, there is a greater tendency to
carry out transaction in-house and to have vertical integration.
Opportunism
o
o
o
o
3.
People will not always be honest and truthful about their intentions.
An effort to realize individual gains through a lack of candor or honesty is
transactions. Williamson
However managers are opportunistic by nature. Given the opportunity, they will
take advantage of available ways of improving their on benefits and privileges.
Problems with opportunism:
External parties such as contractors can not always be trusted to at honestly.
There is also risk that by taking control of transactions internally, managers
will have opportunities to take decisions and actions that are in their own
personal interest.
The variables in transaction costs economics

There are three variables which determine the extent to which a firm does the work itself.
Frequency of transactions
Uncertainty
Asset specification
Frequency of transactions
when goods are purchased very frequently, or services are used frequently, there is a much
stronger case for vertical integrations and bringing the work in-house because the
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transaction costs should be lower. For example, a company will rarely ever want to establish
its own department for management consultancy.
Uncertainty
Uncertainty creates problems partly because of bounded rationality. As a general rule,
greater uncertainty makes it more likely that the transactions will be done in-house.
For example, Ski instructor for the customers on its winter skiing holidays.
Asset specification
When an asset has only one specific use, transaction costs are likely to be reduced by
vertical integration.
For example, a professional football club will use a football stadium for its football matches.
4.
Comparison of transaction cost economics with agency theory

Transaction cost economics
Management behavior is determined

by bounded rationality and
opportunism.
Due to both factors mangers will act
in their own self interest when
opportunities arise.
Self interest behavior should be
controlled.
Agency theory
Agency theory uses the

conflict of interest between
shareholders and managers.
Managers will often try to
increase the size of their
company, even though it is
not in the best interest of the
shareholders.
Managers benefit personally
from the growth in the size of
the company.
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Stakeholder theory
1.
Stakeholders approach to corporate governance

The stakeholder view is that the purpose of corporate governance should be to achieve, as
far as possible, the aims of all key stakeholders- employees, investors, major creditors,
customers, major suppliers, the government, local communities and the general public.
Govt should design its policies in such a way that it provides firms incentives and discipline
to maintain the interest of all the stakeholders.
The OECD Principles themselves recognize the role of stakeholders in corporate governance
and state that the corporate governance framework should:
Recognise the right of stakeholders that are recognized in law or through mutual
agreements, and also
Encourage active co-operation between corporation and stakeholders in creating
wealth, jobs and the sustainability of financially sound enterprises.
2.
Definition of stakeholder theory

Company managers should take decisions that take into consideration the interests of all the
stakeholders, not only shareholders.
Stakeholder theory can be seen as a mix of a variety of discipline which provides a blend of
sociological and organizational ideas.
3.
Rights for stakeholders

According to the stakeholder approach of corporate governance, significant power within
the framework of CG is held by senior management, directors and shareholders.
A stakeholder approach to CG can therefore be implemented only by:
Negotiation and co-operation between management and employees, and
Legislation giving to stakeholders or protecting stakeholder rights.
4.
Stakeholder theory and agency theory

Stakeholder theory
Company has obligation to other

stakeholders in addition to
shareholders.
Agency theory
Manager should act in the best

interest of the shareholders.
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Both the approaches to CG (or ethical theory) are not necessarily inconsistent.
Companies and their managers can act in the best interest of the shareholders and at the
same time attempt to satisfy the interest of other stakeholders. For example, society and
environment concerned stakeholder.
In other words, best practice in corporate governance and corporate social responsibility
might be consistent with each other
Chapter 3. The board of directors
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The role of the board

1.
Introduction
The BOD is an executive committee with governing powers and administration. They attract
investment, raise finance from the public/shareholder.
When a country has a code of CG, the code applies only to major stock market companies.
Private companies or subsidiaries within a group might choose voluntarily to comply with.
2.
Delegation of power within a company

The delegation of power within a company may vary form company to company.
The role of the board of directors is not to manage the company. This is the role of the
management.
3.
Corporate governance codes on the role of the board

The combined code in the UK states that every company should be headed by an effective
board, which is collectively responsible for the success of the company. It then goes on to
state that the board is responsible for:
4.
Strategy setting or strategic decisions

Acquisition of assets
Borrowing loans
Raising finance
Any special transaction (forex)
Appointment of CEO
Monitoring of CEO
Risk management
Decision making and monitoring roles

The role of the board of the directors is a combination of decision-making and monitoring.
A board should retain certain responsibilities, and should make decision in these areas
itself.
After delegating the responsibilities to executive management it should monitor the
performance if management. For e.g. CEO.
In addition the board should monitor the system of internal controls that management
has put in place.
The board should accountable to shareholders for its performance in carrying out these
twin roles of decision-making and monitoring.
5.
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Unitary board and two-tier board structures
In most countries, companies have a unitary board. This means there is a single board of
directors, which is responsible for performing all the functions of the board.
Two-tier boards
In some countries (such as Germany and the Netherlands), all or most large companies have
a two-tier board. A two-tier board consists of:
A management board, and

A supervisory board.
The management board is responsible for the oversight of management and business
operations. It consists entirely of executive directors, and its chairman is the companys CEO.
The supervisory board is responsible for the general oversight of the company and the
management board. It consists entirely of non-executive directors, who have no executive
management responsibilities in the company. Its chairman is the chairman of the company,
who is the most significant figure in the corporate governance structure.
The function of the chairman is to work closely with the CEO. As chairman of the
management board, CEO reports to the chairman of the company. If there is a good
relationship between the CEO and the chairman, the chairman will speak to the companys
management at meetings of the supervisory board.
Directors on the supervisory board normally include:
Representatives of major shareholders of the company
Representatives of the employees or the major trade union
Former executive managers of the company, possibly former members of the
management board who have now retired form the company.
In large companies, the supervisory board can be quite large, in order that it can represent
sufficient number of different stakeholder interest.
Comparison of unitary and two-tier boards
Unitary board
Healthy debate between NED

and ED
Faster communication
Cost effective
Better co-ordination within
members and good
relationships.
Work towards a common
purpose.
Disadvantage: minority
interest may be overlapped.
Two-tier board
Fraud chances will be reduced

Check will increase
Accountability of the board will
increase.
NED will have more time to
analyze the issues.
Disadvantage: NED will have
more powers and autonomy
situation may arise.
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Composition of the board

1.
Composition and size of the board

1.
2.
3.
4.
5.
Chairman
Deputy chairman(sometimes)
CEO
EDs
NEDs
The board should not be so large as to be unwieldy (unable to use the power).
2.
Executive and non-executive directors

(Note: UK listed companies may be required to include non-executive directors on their
board. Other companies are not required to appoint non-executive directors, but might do
so voluntarily.)
Executive Directors are directors who also have executive management
responsibilities in the company. They are normally full time employees of the
company. Examples are CEO, CFO/Finance directors.
Non-executive Directors or NEDs are directors who do not have executive
management responsibilities in the company. (They might be an executive director
in a different company.)
o NEDs are not employees of the company.
o They are not full-time employees. When they are appointed there should be
clear understanding about how much time they would spend discussing
companys affairs (monthly or yearly).
However, the status of ED and Ned, as directors, is exactly the same.
3.
Independence
Independence means reaching opinions, expressing them and not necessarily agreeing with
everything that fellow directors say.
All directors should show the independence of character.
In corporate governance, however, independence means something much more specific
than having an independent mind.
4.
Independent directors
An independent director is the one who:
has no link to a special interest group or stakeholder group. For e.g. management, other
employees of the company, major shareholder, a supplier or a major supplier or
customer of the company.
has no significant personal interest in the company, such a significant contractual
relationship with the company.
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This is impossible for an executive director to be independent, because he/she has a direct
link with executive management. Only NED can be independent. However all NEDs are not
independent.
Definitions of independent director vary between countries and codes. In Singapore the
definition is less strict than in the UK.
According to UK CCG a director is not independent when he:
1. has been an employee with in past five years.
2. has (or has had within the previous three years) a material business relationship
with the company. For e.g. shareholder, director or senior employee.
3. receives remuneration in addition the fees as NED. For e.g. participant in share
incentive scheme, PRP, pension.
4. close family ties with a director, senior employee or professional advisor the
company.
5. has significant links with the other directors through involvement in other
companies or entities.
6. Represents a major shareholder
7. Has served on the board for more than nine years since the date of his election as
director.
5.
Board balance and independent directors

A board should consist of directors with a suitable range of skills, experience and expertise.
However, there should also be a balance of power on the board, so that no individual or
small group of individuals can dominate decision-making by the board.
Example:
The Maxwell Communication Corporation (Robert Maxwell). Misappropriated 900

million form pension fund, using the fund in the expansion of the company and to
support the group companies that were in financial difficulty in 1992.
Polly Peck International (Asil Nadir)
Both the companies collapsed in the early 90s.
The UK CC states: The board should include a balance of EDs and NEDs (and in particular
independent NEDS) such that no individual or small group of individuals can dominate the
boards decision-taking.
Further it states that: To ensure the power and information are not concentrated in one or
twp individuals, there should be a strong presence on the board of both EDs and NEDs.
The CC specifies that:
o
o
o
At least 50% of the board, excluding the chairman, should consist of independent
NEDs, except for smaller listed companies. (It is usual for the chairman of a UK listed
company to be independent.)
In smaller listed companies, there should be at least two independent NEDs.
In Singapore CCG states that independent directors should make up at least onethird of the board. Because codes vary form country to country.
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The role of chairman, CEO and NEDs

1.
Separation of the roles of chairman and CEO

The UK CC states that:
The roles of chairman and CEO should not be held by the same person.
CEO should not go on to be the chairman of the company.
However, there should be a good working relationship between the chairman and the CEO.
The idea behind the provision of the Code that the CEO should not go to be the chairman is
that a CEO who sets up to become the company chairman might seek to dominate or
influence his successor as CEO. However, sometimes CEO is offered a part-time role as
chairman, this happens when the CEO decides to do something different, a company might
be able to retain his experience and knowledge in that case..
2.
Role of the CEO

o
o
o
o
3.
The CEO is responsible for the executive management of the companys operations.
He is the leader of the management team, and all senior executive managers report
to the CEO.
If there is an executive management committee for the company, the CEO should
be the chairman of this committee.
Other executive directors may sit on the board of directors, the CEO reports to the
board on the activities of the entire management team, and is answerable to the
board for the companys operational performance.
Role of the board chairman

If the companies comply with the CC, a chairman will therefore be both independent and
NED.
o
o
o
He is the leader of the board of directors.

He is responsible for managing the board.
The UK CC identifies the following are the responsibilities for the chairman:
Setting the agenda for the board discussions.
Ensuring that all directors receive accurate, timely and accurate information.
This is important for NED particularly, because he relies on the information
provided by the chairman.
Communication between company and shareholders.
Ensuring that NEDs contribute effectively to the work of the board.
Ensuring co-operative relationship between the NEDs and Eds.
Higgs Suggestions:
Run the board and set the agenda (agenda for strategic matters not details
of management).
Makes sure that enough time is allowed for the full discussion of complex
and controversial issues.
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Arranges the induction programmers for new directors with the assistance
of the company secretary.
Organize the performance evaluation of the board, its main committees and
its individual directors.
Encourage the active participation in the boards affairs by all directors.
The chairman represents the company in its dealings its shareholders and (usually) the
media. He is the public face of the company.
Comparison of the roles of CEO and chairman
4.
CEO
Chairman
1) Executive Director. Full time

employee.
2) All executive managers report,
directly or indirectly to the CEO.
3) The CEO reports to the chairman (as
leader of the board) and to the board
generally.
4) Head of the executive management
team.
5) To draft proposed plans, budget and
strategies for board approval.
6) To implement decisions of the board
1) Part time. Usually independent.

2) No executive responsibilities. Only the
company secretary and the CEO report to
the chairman directly, on matters relating to
the board.
3) The chairman reports to the companys
shareholders, as leader of the board.
4) Leader of the board, with responsibility for
its effectiveness.
5) To make sure that the board fulfils its role
successfully.
6) To ensure that all directors contribute to the
work of the board.
Role of NEDs
The reason for having the NEDs on a board:
o
o
To give the board the better balance.

To reduce the possibility of dominance of once individual or small group of
individuals.(one man show= Robert Maxwell, Asil Nadir)
The four roles for NEDs identified by Higgs Guidance:

1) Strategy. NEDs should challenge constructively and help to develop proposals
on strategy.
2) Performance. Monitor the performance of executive management.
3) Risk. NEDs should satisfy themselves about the integrity of the financial info
provided by the company and should also satisfy themselves about the
companys risk management system and internal controls.
4) People. NEDs should be responsible for deciding the remuneration of the EDs
and other senior managers, and should have a major role in the appointment of
new directors and in the succession planning for the next chairman and CEO of
the company.
These roles suggest that NEDs have complex tasks in unitary board. They act as
colleagues of the EDs and at the same time they are monitoring them also. They act as
Page 20 of 50
colleagues in discussing the strategies and helping to develop strategy. However they act
as policeman on monitoring their performance.
Note: the function of the independent NEDs is to reduce the agency costs arising from
the conflict of interests between shareholders and management.
Senior Independent Director (SID)
The UK CC suggests that one of the independent NEDs should be appointed as senior
independent director (SID).
Roles of the SID:
o
o
5.
Act as a leader for the other independent NEDs. For e.g. calling meetings for
NEDs away from EDs.
Expected to act in usual circumstances, when corporate governance is not
functioning. For example:
A disagreement between major shareholder and chairman.
The SID might be required to argue with the chairman or CEO in a
situation where the company is failing to apply proper standards of
corporate governance.
The appointment of non-executive directors

It is generally accepted that the board of directors should collectively possess a suitable
combination of experience and skills. The Tyson Report (2003) reached several conclusions.
The effectiveness of the board would be improved by having a board consisting of

directors with a range of experiences, knowledge and backgrounds, rather than a
aboard whose NEds all come from the same type of background.
Companies should have a formal system of appointing new NEDs to the board.
NEDs should be recruited from wider range of different backgrounds.
Other sources of NEDs should be individuals in private sector companies,
professional (accountants, solicitors) and business consultants, and individuals
working on the public sector or the non-commercial private sector.
Keeping the board refreshed
There is a need to keep a board refreshed by appointing new directors regularly, to

bring fresh experience and skills to the board.
As a company grows the experience required by the directors might change.
Over time, the independence of a NED is likely to diminish. Tats why NEDs should be
replaced after the certain number of years.
Changes to the board, to keep it refreshed, affect NEds rather than EDs. This is
because EDs are the employees of the company. They remain EDs as long as their
job is retained.

6.
Criticism of NEDs
Lack of knowledge
Insufficient time with the company
Accepting the views of EDs.
Page 21 of 50
Page 22 of 50
Directors and the law

Corporate law varies between countries. Directors have certain right and duties; if they fail
to carry out their duties they could become liable for their failure.
1.
The powers and rights of directors

In UK law, individual company directors have implied power to make legally bound contracts
for the company, even if their powers have not been specified actually (actual authority).
Service contracts
A service contract for an executive director is a legally-binding contract of employment. It
includes:
o entitlement to remuneration
o pension rights
o a minimum notice period for termination of office.
The service contract of an ED should specify his role as an executive manager of the
company, but might not include any reference to his role as a company director. If the
director is asked to resign from the board, it is generally accepted practice that he is
dismissed from the post of executive manager. Director is given rights by law to wrongful or
unfair dismissal by the company.
Fixed term contracts
2.
NEDs are usually appointed for fix period.

In UK, normally Ned is appointed for 3 years.
After 3 years, reappointment might be renewed with the approval of S/H.
This cycle of 3 years continues till the NEDs retirement.
Appointment, election and removal of directors
When a vacancy occurs during the course of the year, BOD nominates an individual
and then appoints him.
At the next AGM (also called shareholders meeting), the directors stands for
election. In UK, the director is elected if he obtains 50% votes of the s/h.
As the appointment of NEDs is for three years.
o In UK, most companies include in their AOA a requirement that one-third of
directors should retire each year by rotation.
o And stand for re-election.
It is usual for directors who retire by rotation and stands for re-election to be reelected by a very large majority.
Directors are removed from the office when they have failed. Chairman removes
them. Their removal is based on their bad performance.
UK company law allows shareholders (with at least a specified minimum holding of
shares in the company) to call the company meeting to vote on the proposal to
remove the director/ a director can be removed by a simple majority vote of the s/h.
Page 23 of 50
When a director is removed form office, he retains his contractual rights, as
specified in his contract of employment. This could involve a very large payment.
3.
Duties and legal obligations of directors

In the UK, the Companies Act 2006, statutory duties for directors are to:
act within their powers

promote the success of the company for the benefit of its shareholders
exercise independent judgment
executrices reasonable skill, care and diligence (show care and effort)
avoid conflicts of interest
not to accept benefits form third party
declare any interest in a proposed transaction with the company
Conflicts of interest
A director would be in breach of his fiduciary duty to the company, for e.g. if he puts his own
interests first, ahead of the interests of the company.
Disclosure of interests
A breach of fiduciary duty would also occur if a director has an interest in a contract with the
company but fails to disclose this interest to the rest of the board and obtains their
approval. For e.g.
o
o
o
o
o
David is a director in company A and also a major share in another company (say
company B)
And company A is going to enter into a supply contract with company B.
Then David must disclose his interest as soon as possible to the rest of the board of
company A, and obtain their approval.
In case of failure he would become liable and all his secret profits will be handed
over to the company A.
In the UK, it is criminal offence (not to disclose an interest), punishment is FINE.
Share dealings by directors

It is common practice that directors of listed companies have some shares in their company.
They work inside the company and this is common for them to have information about
company (or other company). That information is confidential and if it is made public, it is
likely that it will affect the share price.
Taking advantage of price-sensitive information about a company to buy or sell shares, or to
encourage anyone else to buy or sell shares, is a criminal offence, known as insider dealing.
If the director is found to have carried out insider dealing or insider trading, he has
committed a criminal offence and face a fine/imprisonment or he might be found liable in
civil law to the individual at whose expense he has made profit.
In UK all listed companies are required to apply THE MODEL CODE, or a code that is no less
strict.

THE MODEL CODE:
5.
Page 24 of 50
Directors must not deal in shares of their company during a close period.
CLOSE PERIOD means the period before the announcement to the stock market of
the companys interim and financial results.
A director must not deal in shares of the company that he has the price-sensitive
information.
A director must obtain the prior permission from the chairman before dealing in the
companys shares at any time.
Disqualification of directors
In the UK the law allows a court to disqualify an individual from acting as a director in a
variety of circumstances. These include:
when a director is bankrupt

when a director is suffering from mental disorder
when a director is found guilty of crime such as the misappropriation of company
funds).
Page 25 of 50
Induction, training and performance evaluation of directors

1.
Induction for new directors
2.
Induction is a form of training.

Its purpose is to make a new person familiar with what the company does, how it
operates, how it is organized, who the senior managers are and so on.
NEDs and EDs both need the induction training.
EDs should know more about the company than the EDs.
Knowing more does not mean that they know everything about the company that
they should know.
The UK combined code recognizes the importance of induction and states that all
directors should receive induction on joining the board, and the chairman with the
help of company secretary should ensure that new directors receive a full, formal
and tailored induction on joining the board.
Induction to gain familiarity with company
induction to gain familiarity with being a director of the company
An induction programme might therefore include:
o visits to important sites/locations of operations
o demonstrations of the companys products
o meetings with senior managers and staff
o possibly, meetings with professional advisers of the company
o possibly, meetings with major shareholders(if shareholders wish to)
a new director should be given:
o information about what the board does
o guidance on insider dealing/trading
o copies of minutes of recent board meetings
o a schedule of dates for future board meetings
o details of the committees of the board, and their responsibilities.
Training and professional development for directors

The UK combined states that:
All directors should regularly update and refresh their skills and knowledge.
The chairman should ensure that directors regularly update their skills and the
knowledge.
The company should provide the necessary resources for developing and updating
its directors knowledge and capabilities.
Subject areas for training and development might include formal training in business
strategy, corporate governance issues or developments in financial reporting.

3.
Performance Evaluation
Page 26 of 50
The board is accountable to the shareholders, and it might therefore be argued that the
performance of the board should be judged by the shareholders. However, in practice this
would be difficult to achieve.
In some countries codes of corporate governance include a requirement that the
performance of the board and its individual directors should be reviewed regularly, and the
review should be carried out by the board itself. The chairman should have the responsibility
for the performance evaluation.
Chapter 4. Board committees
Page 27 of 50
The need for the board committees

1.
The nature of the board committees

The board committee is a committee set up the board, and consisting of selected directors,
which is given responsibility for monitoring a particular aspect of the companys affairs for
which the board has reserved the power of decision making.
A committee is not given the decision making powers. Its role is to monitor an aspect of the
companys affairs, and:
Report back to the board, and

Make recommendations to the board.
Board committee is not a substitute for executive management and board committee does
not have executive powers.
2.
The main Board committees

1.
2.
3.
4.
3.
A remuneration committee
An audit committee
A nomination committee
A risk management committee
The reason for having board committees
Saves time of the board and effective utilization of resources.

To avoid a conflict of interest between EDs (management) and its shareholders.
Board committee should consist wholly or largely of independent non-executive directors.
Page 28 of 50
The audit committee

Audit committee is a sub committee of board comprises of NEDs or sometimes majority of NED. In
large listed companies there should be at least three members of the committee (and in smaller
companies at least two members).
Singapore CCG states that the audit committee should consist of at least three members, all of them
should be NEDs. There should be 1 financial expert in the committee. Singapore recommendation is
2 financial experts
Role and function:
Advisor to the BOD

Appraisal of the board
Liaison between internal and
external auditor
To review and monitor the
independence and objectivity of
the external auditor
Review F/S before authorization
of board.
Review the companys internal
financial controls
Review the companys internal
control and risk management
systems(if there is no risk
management committee)
Review the effectiveness of the
IA dept
Review the effectiveness of the audit process
Develop and monitor the use of the external auditor to perform non-audit work for the
company
Approve the remuneration and terms of the engagement of the external auditor
In USA (NYSC) all the listed companies must have an audit committee as per SOX
The audit committee reports to the board, and board takes the decision. If case of conflict
between board and committee, committee report to shareholders.
Advantages
Financial statements become more reliable

Provide check on the risks of misleading reporting
Reduce the possibility of fraud
Management letter by external auditor is provided to audit committee then board.
Disadvantages
Delay in issuance of F/S

If not expert, wastage of time and resources.
The remuneration committee
Page 29 of 50
A remuneration committee comprises of independent NEDs negotiates and recommends

remuneration packages for executive directors or senior managers. Independent NEDs do not have a
personal interest in the remuneration structure for senior executives, because they are not
remunerated in the same manner as executives. They receive a fixed annual salary.
The need for remuneration committee:

o
o
o
o
In the past directors set their own salaries. This was a misuse of shareholders
resources. They rewarded themselves fat cat salary (inequitable salaries).
It was required by means of good corporate governance that there should be
equitable salaries.
Equitable salary means salary on the basis of talent/ competence of directors.
Good corporate governance required REMUNERATION COMMITTEE. Let the salary
be set by neutral people (independent NEDs).
Composition of Remuneration Committee:

o
Remuneration committee is comprises of solely independent NEDs.
Remuneration of NEDs
o
o
o
Remuneration of Ned is set by board and approved by shareholder in AGM. Their

salary is set according to the felt rate normally. This should be disclosed in the
annual report. This enhances the degree of transparency.
Disclose the salary of EDs in annual report also.
Describe the salary of NEDs in the constitution of the company (AOA). This enhances
the degree of openness.
How to motivate EDs

o
o
o
o
All the directors should not be treated in the same way. Good corporate governance
emphasizes the point of fairness. Treatment should be equitable.
Remuneration packages should be attractive to attract knowledgeable, skilled and
competitive persons.
The remuneration should be set in such a way that keeps the existing directors
attracted in order to retain them and it has the ability to attract new directors.
The directors contract or remuneration should be limited to one year (combined
code), sometimes two years, or 3 years; it depends upon the relationship b/w
Company and directors or past history of the directors.
Main duties of the remuneration committee

The Higgs Guidance suggested the following duties:
o The committee should agree with the main board, chairman, CEO and other
executive directors on the policy for remuneration. The role of the CEO is advisory.
o For PRP, committee should decide the target for performance.
o Committee should decide the pension arrangements for each ED.
o Committee should design approve the design of any new share incentive plan.
The nominations committee
Page 30 of 50
A nomination committee makes recommendations about new appointments to the board. It

Comprises of NEDs and Sets the desirable size and the balance of the board.
The need for nomination committee

o The process for filling the vacancy on the board or succession planning takes time.
The board should delegate the task to a committee to save the time and resources.
o The UK Combined Code states that there should be a formal, rigorous and
transparent procedure for the appointment of new directors to the board. Such
transparency can be established by setting up a nomination committee.
Main duties of nomination committee

o
o
o
o
o
o
To consider skills and knowledge of the members

To consider the diversity (age, sex and skin) of the board
To consider the need of leadership in the company
To consider the need of induction programmes, contracts between directors
To consider the need of succession planning
It has specified role.
Succession planning
o
o
Planning in advance for the eventual replacement of key members of the board
when they eventually retire (or in the event of dismissed).
Succession planning applies in particular to:
the board chairman
the CEO, and
possibly, the finance director.
Page 31 of 50
The risk committee

The work of the risk committee should be to satisfy itself that executive management have a suitable
system of risk management and internal control in place, and that these systems function
effectively. This is another check on executive management.
Risks that a company faces:

o
o
Business risks, strategic risks, operating risks

Errors, frauds, losses
Responsibility of board for risk management and risk control:

o Make sure that internal controls exist and they are working effectively
o Protecting the company and its resources from the risk of external events
Such as damage to assets from fire, flooding, theft, natural disasters etc.
Risk management and internal control should therefore be:

o
o
Planned and implemented by management

Monitored by the board
The role of the board and board committees on risk:

The board should:
>conduct review of
internal controls at least
once a year.
>report to shareholders
about review
> review should include:
--all material controls,
financial, operational and
compliance controls.
--risk mgt system
Accountable
Executive
mgt
Planned and
implemented
Accountable
Board
Monitored/Maintained
Internal
controls
INTERNAL CONTROLS
Compliance
controls
Operational
controls
Internal controls
>In addition to the internal controls:
Shareholder
Financial
controls
Risk
management
Page 32 of 50
Board responsibilities for the internal control system and risk management:
o The responsibility to review the companys internal controls and risk management
should be carried out by:
the audit committee, or
the full board, or
risk committee, consisting of independent NEDs entirely.
o The Combined Code does not suggest the specific way to way to review the internal
controls and risk management.
o The guidelines in the Singapore code of corporate governance are similar to the
provisions in the UK Code:
The audit committee should review the adequacy of internal controls and
risk management of the company.
The audit committee should ensure that review is carried out at least once a
year.
The board should include the comment on the adequacy of the internal
controls and the risk management system in its annual report and accounts.
Chapter 5. Directors remuneration
Page 33 of 50
Principles of directors remuneration

NEDs are paid an annual fee for their services.
o
o
Usually a fixed amount.

Based on the estimated number of days that the director will spend with the
company during the year. E.g. attending board and board committees meetings.
Components of remuneration package of EDs:

o
o
o
o
o
o
Remuneration package for ED is part of the directors service contract.

Remuneration is reviewed regularly each year.
Package is set through the negotiation between individual director and
remuneration committee.
Negotiation occurs when the director first join the company.
Package might be re-structures subsequently at any time.
Package includes:
Salary
Bonuses
Share option Schemes
Pension right
Often:
Free medical insurance
A company car
A company aero plane, helicopter and so on.
The amount that a company must offer its directors depends on:
o
o
What other companies are paying, and

How many suitable candidates are available.
Remuneration package structures:

1.
2.
3.
4.
Basic salary
Short- term incentives: bonus
Long- term incentives: shares plans
Pensions
1. Basic Salary:
The purpose of basic salary is to give a director a guarantees minimum amount of
pay.
The size of the salaries varies between companies, and directors.
A lower salary might be acceptable to a director who expects to receive large
amount cash bonuses or equity awards.
2. Short-term incentives:
Bonus:
An annual cash bonus for meeting or exceeding target performance levels.
The nature and potential size of annual bonuses can drive the behavior of senior
executives.
Executives will possibly be much more concerned about short-term targets and
annual cash bonuses than about longer-term share incentives and bonuses.
Page 34 of 50
3. Long-term incentives:
Share plans:
Long-term incentives schemes usually are:
o Share options or
o Fully-paid shares in the company.
Share options:
o A share option gives its holders the right, at a future date, to buy shares in
the company at a fixed price.
Buy 20,000 shares in the company at an exercise price of
$6.40.
o Share option schemes for senior executives might be the responsibility of
the remuneration committee.
o In the UK, the earliest time for that share option can be exercised is three
years after they have been awarded; this is why share options are long
term incentives.
o The exercise price for the share options should not be lower than the
market price of the shares at the time the share options were awarded.
Under water share options
If the share price falls below the exercise price of the, the options are said
to be out-of-the-money or under water.
However share options are replaced when they are under water.
Arguments:
If the share options are awarded, with the rise in share price both
the directors and shareholders benefit. And if it goes down both
suffers at the same time. If share options are replaced when they
are under water, the directors benefit from the rise in the price but
do not suffer when the share price goes down. Conflict of interest
arises. The executives are protected against the bad situations.
Fully-paid shares in the company:
o An alternative to share options is the award of fully paid shares in the
company.
o This avoids much of the problem of a fall in the share price.
o Whereas share options under water have no value at all, fully-paid share
retain some value, even when the share price falls.
o In order to award free fully-paid share to executives, the company will buy
its own shares.
Share plans and performance targets
o The award of share options should be conditional on the director or senior
executive meeting certain performance targets.
4. Pensions:
Executives may be members of a company pension scheme. In addition, there may
be unfunded pension arrangements for individual directors.
Page 35 of 50
Performance- related incentive schemes

Incentives should link rewards for executives with benefits for the company and its
shareholders.
Problems:
o
o
o
o
o
Profits in the current year might be improved by deferring much-needed capital

expenditure, or by deciding not to invest in new research or development work.
An executive might have much less concern for the long term performance of the
company, partly because short-term incentives are usually paid in cash and partly
because the director might not expect to remain with the company for the long
term.
Executive are often protected against the downside. For e.g. under water share
options.
Reward for the new executive might be due to the decisions taken in the past by the
executives predecessor. Or vice versa.
Incentives are criticized for rewarding an executive for doing something that ought
to be a part of his normal responsibilities. (Executive recommending the successor
to the nominations committee).
A proposed new long-term incentive scheme should be submitted to the shareholders for
approval. <The UK Combined Code>
Performance Targets:
o
Annual Bonuses:
An annual bonus scheme may be the award of a bonus on achieving or
exceeding an annual target.
Higher profits do not necessarily mean higher dividends or a higher share
price.
If profits are obtained, but investors consider the company to face much
higher risks, the share might fall.
The remuneration committee might recommend that bonus should be
based on TSR.
TSR (Total shareholder return) is simply the sum of the dividends to the
shareholders plus the increase in the share price during the period (or minus
the fall in the price of the share.
Personal Targets:
Within an incentive scheme for senior executives, each individual may be
given personal non-financial targets for achievement.
Long-Term Incentives:
Long-term incentives schemes for executives may set a target for
profitability, possibly over a period of three years.
Why share options an expense:

o
o
o
The award of fully-paid shares in the company is an expense because the company
pays the money to buy the shares, and this spending is for the benefits of its
executive directors.
This is an employment cost.
Employment cost should be reported as an expense in the income statement.
Legal Issues:
o
o
o
Page 36 of 50
It should be a principle of corporate governance that the shareholders of a company

should be given full information about the remuneration of the companys directors.
The requirement to publish remuneration details varies between countries.
In the UK quoted companies are required by law (the Companies Act) to prepare a
directors remuneration report each year.
Chapter 6. Different approaches to corporate governance
Page 37 of 50
Rules-based and principles-based approaches

The main reason for codes of good corporate governance is to help and protect investors.
o
o
Investors need reliable information about companies to decide whether to invest in

shares or to sell them.
Investors need to be protected against unethical or dishonest behavior by company
management.
Countries have developed corporate governance codes and practices because they want to
attract and keep investment capital, especially from global institutional investors.
o Investment capital helps the countrys economy to develop and its companies to
prosper.
o Pressure for better corporate governance has come mainly for two reasons:
The collapse of major stock market companies in a major financial centre.
Pressure form the institutional investors in the countries with well
developed corporate governance codes or rules.
ICGN The International Corporate Governance Network:

o
o
o
o
Formed in 1995
Members are major institutional investors, companies, banks and other interested
groups.
Its aim is to encourage the development of good corporate governance worldwide.
ICGN commented that governance of a corporation is the key factor which investors
consider when they decide to invest.
Ethics and company performance:

o
o
Good corporate governance practices are an application of good business ethics.

Good corporate governance contributes to the efficiency and effectiveness of the
company.
Codes of CG:
o
o
o
Are applied to major stock market companies.

Laws and regulations on CG issues are also mainly applied to stock exchange
companies.
Other companies can normally decide what system of CG they want to comply with,
but they are not required to comply with any established principles or rules.
Rule-based approach:
o
o
A rule based approach to CG is based on the view that companies must be required
by law to comply with established principles of good CG.
ADVANTAGES:
Companies dont have choice of ignoring the rules.
All companies are required to meet the same minimum standards of CG.
Confidence of the investor might be increased.
DISADVATAGES:
Same rules might not be suitable for every company.
Some aspects of CG cannot be regulated easily. E.g. negotiating the
remuneration of directors.
UK is associated with principles-based approach to CG.
Page 38 of 50
Examples of statutory rules in the UK:

Mainly small and medium sized companies are required to submit
directors report and FS to the shareholders each year.
Audit of FS
Quoted companies must prepare a directors remuneration report
each year and present to shareholders.
USA is most associated with rules based approach.(Sarbanes Oxley Act 2002)
SARBANES OXLEY ACT (2002) SOX:

o
o
o
The SOX introduced corporate accountability legislation.

It required the financial markets regulator and SEC to issue rules to implement some
parts of legislation.
PROVISIONS:
PCAOB
Law set up a regulator (public company accounting oversight
board). The role of the regulator is to inspect and monitor the
accounting firms.
It can take disciplinary action against the accounting firms. For
example. Working papers: a firm should maintain W/P for at least 7
years.
CEO/CFO certification (sec 302 of the Act)
All listed companies in the US are required to include in their annual
and quarterly accounts a certificate to SEC. This certificate should be
signed by CEO and CFO.
CEO and CFO should certify the appropriateness of the FS. In case of
material misstatements (inaccuracy) all the bonuses awarded to
CEO/CFO will be forfeited.
Assessment of internal controls (sec 404 of the Act)
Management and directors are responsible for establishing and
maintaining adequate internal controls.
Auditors are required to prepare an attestation report on the
companys assessment of its internal control system.
Companies must disclose any material weakness in their internal
control system. If more than one material weakness exists, a
company is not allowed to conclude that its internal control system
is adequate.
A report on internal control must be included in the companys
annual report to shareholder.
Loans to executives
The Act prohibits companies (other than banks) from lending money
to any directors or senior executives.
Insider dealing
Very strict on insider dealing.
Directors or senior executives are not allowed to trade in shares of
their company during any black-out period.
Audit committees
Listed companies must have an audit committee, consisting entirely
of independent NEDs.
Page 39 of 50
Non-audit work by auditors

Non audit services are prohibited.
For example, book keeping for the client, valuation services or any
management functions for the company.
Protection for whistleblowers
A whistle blower is an employee of the company who reports,
through a channel of communication other than his direct
supervising manager, suspected fraud or illegal activities in the
company.
The Act provides protection for that employee preventing company
from taking action against employee, such as terminating his
employment. For e.g. Enron
Rotation of partners (audit firm) at least 5 years. Firm should ensure quality
of audit (quality control procedures).
MAJOR DRAW BACKS OF ACT
It is very rigid. Major draw back is its nature as rules based
approach.
Many companies moved to LSE except other companies which were
attracted by its discipline. On the whole it ended up in loss.
Relationship between auditor and client got worse. Due to the
limitation of non audit services provided by the audit firm.
Overcame only some rules based on ENRON scandal, other fraud
situations were not covered.
Controls over financial reports only.
Code of ethics especially for finance directors.
Principles-based approach
o
o
o
It is based on the view that a single set of rules is inappropriate for every company.
Circumstances and situations differ between companies. The circumstances of the
same company can change over time.
It is therefore argued that CG should be applied to all major companies but code
should consist of principles not rules.
This approach is sometimes called comply or explain. Either the company has
complied with all the provisions or explains their non-compliance with any specific
provision.
ADVANTAGES
Flexibility
Differences can be
understood. There is no
o DISADVANTGES
best way. Contingency
Companies do not follow
approach.
because not mandatory.
Bureaucracy reduces
Subjectivity issues
Effective utilization of
Lack of comparability
resources
unavailability of
Requires no revision
benchmark.
Room for explanation
Directors are not matured.
Insider system and outsider system
Page 40 of 50
Insider system
Company is owned and controlled by a small number of major shareholders.

Family companies are perhaps the best example of insider structures.
Agency is not really an issue with families because of their direct involvement in management.
Family companies also depends on family unity, this breaks down, governance may become very
difficult.
Advantages
No agency problems. Agency cost will be reduced.

Immediate decisions.
Better understanding due to less diversification.
Disadvantages
Lack of accountability (self review, apna ehtisab khud karna)

Poor corporate governance
Lack of skills
Violation of rights of minority
Outsider system
Where shareholding is widely dispersed and there is the manager-ownership separation.
Advantages
Shareholders have voting rights that they can use to exercise control.
More governance, minority shareholders are protected.
Disadvantages
Agency problems and significant cost of agency.

More diversification
It takes time to make decision
Page 41 of 50
Brief history of corporate governance in the UK

THE CADBURY CODE (1992)
Best practices
The Cadbury committee in the UK was set up because of:
o Lack of the trust of shareholders in FS

o Globalization (trading in local and international stock markets)
o Scandals and collapses
o Difficulties in the relationship between auditors and board of directors.
Cadbury focuses on:

o BOD
o Auditors
o Shareholders
o Other stakeholders (indirectly)
Corporate governance responsibilities

o The directors are responsible for the preparation of FS.
o Auditors provide a check on particular FS, in short provide external objective check
on FS
o Shareholders are informed/linked with company via FS(direct link)
o Other stakeholders are indirectly linked with company via FS
o CCCG encourages directors to adopt these provisions/ rules in the company.
Provisions
o The board should meet regularly.
o There should be at least three NEDs on the board, a majority of whom should be
independent.
o The major matters (acquisition and disposals of assets, mergers) should be referred
to the board.
o Responsibility and powers of CEO and chairman should be separated.
o Audit committee (key board committee) should be formed. It provides liaison
between internal/external auditor and the board. The committee should also review
half yearly and annual statements.
o Directors service contract should be disclosed in the annual report.
o Balance and understandable assessment of the companys going concern and the
effectiveness of its internal controls should be disclosed and mentioned in the
annual report.
THE GREENBURY CODE (1995)
Best practices
It puts a more emphasis on principles based approach.

There should be a room for explanation in case of any non-compliance with the
code/principle.
Every company should disclose/present/report its corporate governance structure in the
annual report.
THE TURNBULL REPORT (1999)
Directors remuneration
The directors remuneration should be set by the remuneration committee, comprises of

solely independent NEDs, and it should be disclosed in the annual report.
Directors service contract should be limited to one year. It is advisable.
Salary of ED is set by remuneration committee (NEDs).
Salary of NEDs should be decided by full board through flat rate and should be subject to
shareholders approval.
THE HAMPEL REPORT (1998)
Page 42 of 50
Risk mgmt & internal controls
Established by ICAEW
Risk management and effective internal controls are the responsibility of the board.
The board should take measures for the future significant risks
Risk and controls should be reviewed regularly
Shareholders should be informed about risks and the system for managing risk (i.e. risk
management)
The internal controls should be:
o embedded in the operations of the company and should form part of its culture
o Should be able to respond quickly to changing risks to the business from factors
within the company and its business environment.
The sound system of internal controls reduces, but cannot eliminate, the possibility of:
o Poor judgment in decision making
o Human error
o Management overriding controls
o Unforeseen events and circumstances
o Control processes being deliberately circumvented by employees and others.
Chapter 7. Governance: reporting and disclosures
THE HIGGS REPORT (2003)
Non-Executive Directors
Its title was review of the role and effectiveness of the NEDs
At least one half of the board should consist of independent NEDs
The chairman should be independent at the time of his appointment
A CEO should not go on to become chairman of the company
One independent NED should be appointed as senior independent director
NED should have suitable skills and experience
NED should spend the proper time at the board as required by them
All new NEDs should be given induction after their appointment.
THE SMITH REPORT (2003)
Page 43 of 50
Audit committee
Established by FRC (financial reporting council)

Purpose was to make audit committees effective
Liaison b/w internal auditor and external auditor
Review FS before the authorization of the board
One or two members in the audit committee should financial expert.
THE REVISED COMBINED CODE (2003)
UK (LSE)
The code is consisting of:

1)
2)
3)
4)
5)
6)
Cadbury
Greenbury
Hampel
Turnbull
Higgs
Smith
The Higgs report and Smith report early in 2003, a revised version of the Combined Code
was published later in the same year.
The Code now consists of:
1) Main principles
2) Supporting principles
3) Detailed provisions
The code is now reviewed regularly by the financial reporting council.
(1992)
(1995)
(1998)
(1999)
(2003)
(2003)
Best practices
Directors remuneration
Best practices
Risk management and internal controls
NEDs
Audit committee
Page 44 of 50
International codes and principles of corporate governance

1) The OECD Principles of Corporate Governance
2) The ICGN Statement of Global Corporate Governance Principles
The main aim of the international statements of principles is to raise standards in the worst country
towards the standards that already exist in the best country.
The result of encouraging better standards of corporate governance should be that:
Better governance will attract more investment form global investors

Companies will benefit from more investment finance, to increase their profits
National economies will benefit form having strong and profitable companies.
The OECD Principles
The OECD Principles are published by the Organization for Economic Co-operation and
Development
Members of the OECD are governments of 30 economically-developed countries
Objectives:
To develop the world economy

To assist government of countries to improve the legal and regulatory and institutional
framework for corporate governance
To provides guidance to stock exchanges, investors and companies on how to
implement best practices
Contents:
1)
2)
3)
4)
5)
Rights of the shareholders

Equitable treatment of shareholders
Rights of stakeholders
Disclosure and transparency
Responsibilities of the board
1) Rights of the shareholders

Right to transfer the ownership of their shares
Right to receive regular and relevant information about the company
Right to vote at general meetings
Right to receive share in the companys profits
Right to remove the directors from the board.
2) Equitable treatment of shareholders
Equitable treatment of all shareholders, including minority and foreign
shareholders
Within the same class of shares, all shares should carry the same rights
Page 45 of 50
Minority shareholders should be protected against unfair actions taken by

majority shareholders
Insider trading should be illegal
Restrictions on cross-border voting should be eliminated
Directors should disclose their personal interests in the transactions with
company.
3) Rights of the stakeholders
Shareholders interest should be protected and they should have right to access
relevant information.
There should be co-operation between companies and their stakeholders in
creating wealth, jobs and the sustainability of the financially sound enterprise.
4) Disclosures and transparency
Openness
Financial, non-financial, relevant and material information should properly be
disclosed (voluntary or mandatory) in the annual report.
5) Responsibilities of the board
To take the strategic decisions, direction of the company (to set the vision) and
making policies
To protect the rights of shareholders and other stakeholders
To provide relevant information to shareholders and stakeholders.
OECD is not solely the corporate governance; it is the one of the pillars of the corporate
governance.
The ICGN Principles
Page 46 of 50
It is the voluntary association of major institutional investors, companies, financial

intermediaries and other organizations
Its aim is to improve corporate governance practices around the world.
It is consistent with the OECD but it is more specific about the issues that investors will take
into account in deciding how (and where) to invest
It gives more emphasis than the OECD to the right of investor to participate actively in
corporate governance in the companies they invest.
Contents:
1)
2)
3)
4)
Role of the board

Shareholders
Audit and accounts
Ethics and stakeholders
1) Role of the board

The board structure should be dependent on national model
o National model: according to the law and culture of the country. Principles
based approach.
Chairman and CEO should be separated
Former CEO should not become chairman immediately
Rotation of directors after every 3 years
Relevant skills, knowledge and experience of the directors
Formal appraisal of the board.
2) Shareholders
Rights to remove or/and elect directors
Right to receive the information
In case of inequitable treatment they can take actions.
3) Audit and accounts
They must excel and foster. They should move towards more truth and fairness
They should compare the financial statements with the industry benchmark
Audit committee should review accounts.
4) Ethics and stakeholders
Rights of the stakeholders should be protected
Company should maintain a long term and productive relationship with its
stakeholders
Code of ethics (there should be statement of code of ethics for company
employees).
Limitations of international codes or principles:
It is not mandatory, then why to waste resources

Based on the development of the society and not easy to implement in developing
societies
Culture specific (UK and USA have different cultures).
Page 47 of 50
General principles of disclosure

1) Transparency and disclosure
Transparency
Transparency in stock markets and other financial markets mans that information about
conditions in the markets is clear and well understood.
Disclosure
Disclosure means making information available, so that there is transparency.
2) Principles of disclosure and communication
The information should be :

o reliable
o understandable
o timely
o equally available to all investors
o made available by convenient channels of communication
The opportunities for exploiting confidential information to make a personal profit should be
minimized.
Corporate governance reporting

There is no best practice of corporate governance which suits all companies. Its a principle based
approach and vary from organization to organization and country to country.
Every company describes its corporate governance style in its annual report under the statement of
compliance.
Statement of compliance includes:
The board
o Size
o Balance
About the directors
Vision and mission
Internal audit
Audit committee
o Size
o Balance
Training programmes
Meetings
o Regularity
External auditors
Reporting
Corporate social responsibility
Page 48 of 50
CSR
Definitions:
CSR is the Obligation of the organization to satisfy the expectations of the society.
CSR is a commitment to improve community well being through discretionary business
practices and contribution of corporate personnel.
CSR is based on the concept that company is a citizen of the society in which it exists and
operates.
As a corporate citizen of society, it owes the same sort of responsibility to society at

large that other citizens should owe.
There is social contract between a company and society in which it operates.
Principles:
CSR has five main aspects.
1) A company should operate in an ethical way and with integrity.
2) A company should treat its employees fairly and with respect.
3) A company should demonstrate respect for the basic human rights.
o Non-tolerance for Child labour
4) A company should be a responsible corporate citizen in its community.
o Invest in local communities, such as local schools or hospitals
5) A company should do what it can do for the sustainability of the environment for future
generations.
o Reducing pollution of air, land or rivers and seas
o Recycling waste materials.
CSR and stakeholders

A company has responsibilities not only to its shareholders, but also to its employees, all its
customers and suppliers, and to society as a whole.
CSR impact on company strategy

There has been a significant increase in public awareness if environmental problems, such a global
warming, pollution, energy consumption and the potential for natural disasters. To remain
successful in business, companies must respond to changes in the expectations of its customers.
Companys steps to implement CSR:
1)
2)
3)
4)
5)
6)
It should:
decide its code of ethical values, and possibly publish these as code of ethics.
establish the current CSR position and future CSR position.
develop realistic targets and strategies of CSR.
implement these strategies
identify key stakeholders (employees, pressure groups, customers)
communicate the CSR achievements to the key stakeholders. This is the main purpose of CSR
reporting.
Page 49 of 50
CSR reporting / Social and environmental reporting / Sustainability reporting
In some countries, listed companies have published annual reports on their CSR.
These reports have been voluntary.
Published separately from annual report and accounts.
The purpose is to inform key stakeholders about CSR policy achievements.
CSR reports includes:
o Health and safety issues
o Environmental issues
o Employee issues
o Social issues
o Educational issues
o Investments by company in local community projects
CSR and institutional investors

There are some ethical investor, including some investment institutions that choose to invest only
in companies that meet certain minimum standards of social and environmental behavior.
In UK, the National Association of Pension Funds (NAPF) stated that CSR is not the part of CG but it is
issue for the management of a company rather than its governance.
Why to be socially responsible?
Increases sales and market share

Strengthen brand positioning (how customer sees our product)
Enhance corporate image (how labour sees our organization)
Increase ability to attract, motivate and retain employees
Decrease operating cost (govt reliefs, tax reliefs, advertising expenses reduce due to open
marketing)
Increase appeal to investors and financial analysts.
Arguments against CSR
It is the responsibility of directors to act in the best interest of the shareholders.

If the directors are not acting in the best interest of the shareholders it is the theft of agency
cost.
The company pays corporation tax, rest of the things are the responsibility of govt.
Company has to reduce its profitability and sometimes company has to shut down its
profitable operations.
o For e.g. raw material changed due to marine life/health problems.
Accountability problems
CSR activities are non-profit activities. Managers/directors are not accountable for expenses
incurred in CSR activities. Accountability of directors is reduced. It can arise the chances of
manipulation.
Strategies of CSR
Page 50 of 50
Different companies have deferent strategies.
Pro-active
It always starts with the person who is standing in the mirror. Taking step by own before
complain of society.
Reactive
Taking steps after complain of society. Sometimes society claims, sometimes govt. (so motto
actions)
Defense
Justify actions wrong actions. What you have done, society is not benevolent.
Accommodation
Compensating for what we have done wrong by providing alternatives.

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Corporate

Chapter 1: the scope of governance

Management is concerned with running the business operations of a company.

Professor Bob Tricker, 1984:

The term corporate governance means governance of companies.

When the problems for corporate governance arises

The separation of ownership and control.

The main areas covered by codes of CG

The role and responsibility of the board of directors.

Governance issues in public sector entities and in government

Chapter 1: the scope of governance

Concepts of good governance

All shareholders should receive fair treatment from directors.

Openness and transparency means not hiding anything.

Independence means freedom from the influence of someone else.

4. Honesty and integrity

Honesty should be an essential quality for directors and their advisers.

5. Responsibility and accountability

The boars is responsible for:

A large company is known widely by its reputation or character.

All directors are expected to have sound judgment and to be objective in

Chapter 1: the scope of governance

Nolans Seven Principles of Public Life

Chapter 2. Agency relationships and theories

The law of agency

Fiduciary duties of directors

Agency law and challenging the actions of the directors

Concepts in agency theory: the agency relationship

a companys owners and

Chapter 2. Agency relationships and theories

o the companys owners(shareholders)

Chapter 2. Agency relationships and theories

Reducing the agency problem

Incentives should be provided to management to increase their willingness to take

Chapter 2. Agency relationships and theories

o Invested in projects that will earn a high return (+npv)

The board will be ineffective if dominated by CEO.

Ethics and agency theory

Chapter 2. Agency relationships and theories

Transaction cost economics theory

Costs of the firm: production costs and transaction costs

Chapter 2. Agency relationships and theories

Assumptions in transaction cost economics (TCE)

Bounded rationality, and

The variables in transaction costs economics

Chapter 2. Agency relationships and theories

Comparison of transaction cost economics with agency theory

Management behavior is determined

Agency theory uses the

Chapter 2. Agency relationships and theories

Stakeholders approach to corporate governance

Definition of stakeholder theory

Rights for stakeholders

Stakeholder theory and agency theory

Company has obligation to other

Manager should act in the best

Chapter 2. Agency relationships and theories

Chapter 3. The board of directors

The role of the board

Delegation of power within a company

Corporate governance codes on the role of the board

Strategy setting or strategic decisions

Decision making and monitoring roles

Chapter 3. The board of directors