corporate goveranance

8/12/2019 Corporate Goveranance

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Lecture Outline

What is Corporate Governance?

Internal Mechanisms

External Mechanisms

Convergence Measuring Corporate Governance

Benefits of Good Governance

What you need to remember…



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Introduction

Company founded (owned and managed) by individual,

family, partnership, government or company.

Stage 1:

Stage 2:

Company expands by issuing more equity and debt.

New equity holders also get voting rights as to who

manages the company.

Equity New Equity Debt

Equity

Voting Rights

Voting Rights Voting Rights



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Introduction

Company founder must now choose between keepingcontrol of the company or allowing the company to be

managed by professional managers.

If they keep control there is a potential conflict between

the founders and other shareholders.

If they pass management to professional managers there

is a potential conflict between owners and managers.

Equity New Equity Debt

Voting Rights Voting Rights



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Corporate governance is about minimizing the loss ofvalue that results from the separation of ownership

and control.

It deals with the ways in which suppliers of finance

to corporations assure themselves of getting a return

on their investment.

While corporate governance has been a hot issue in

recent years (Enron, Worldcomm, HIH and One.Tel)it is a problem that has been around for hundreds of

years – Adam Smith (1776).



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Good corporate governance practices involve: – The corporate governance framework should protect

shareholders rights.

– The corporate governance framework should ensure the

equitable treatment of all shareholders.

– Stakeholders should be involved in corporate

governance.

– Disclosure and transparency is critical.

– The board of directors should be monitored and held

accountable for what guidance it gives.




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Internal Mechanisms

Board of Directors Board Size & Independence

Chairman/CEO Positions

Board Committees

Executive Compensation

Ownership Structure

Concentrated versus Dispersed Ownership

Identity of Owners

Other Blockholders



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External Mechanisms

External Auditors

Debt & Equity Markets

Monitoring by debt holders

Analysts

Mergers & Acquisitions

Legal/Regulatory System

Common versus Civil Law

Extent of Law Enforcement

Recent Regulations – Sarbanes Oxley Act, Companies

Act 2013, Clause 49 of the Listing Agreement (SEBI)



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International Differences



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Board of Directors

The board of directors is responsible for overseeingmanagement and representing shareholders’ interests.

US and Australia have single-tiered boards, headed

by a Chairman of the Board. The CEO and other

executives usually also sit on the board.

Some other countries (Germany, Indonesia) have

two-tiered boards. The roles and composition of the

two boards can differ.



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Board Size

Boards should be an appropriate size – not too bignot too small.

Depending on the size of the company within the

range of 5-15 is normal.

If the board is too small, there is a lack of

monitoring.

If the board is too big, there are problems reaching a

consensus for decision making.



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Board Independence

Boards should have a majority/high proportion ofoutside/independent directors.

Outside/independent directors should have no

personal interest in the company and therefore are

more effective monitors.

But, it is also a good idea to have some company

insiders (CEO, executives) on the board to provide

the board with a better understanding of thecompany’s operations.



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Chairman/CEO Positions

The Chairman of the Board is responsible foroverseeing the board of directors.

The CEO is responsible for the day-to-day running of

the company. In family-controlled companies it is common for the

same person or relatives to hold both of these

positions. But, this concentrates power and reduces

monitoring. Therefore, the positions of Chairman and CEO

should be separated.



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Board Committees

The board of directors can delegate certain duties to board committees – this can provide increased

monitoring on specific issues.

Audit committee (AC) – responsible for internal

audit function and appointment of external statutoryauditor.

Nomination and Remuneration committee (NRC) –

responsible for finding appropriate directors andexecutives and for setting appropriate compensation

for directors and executives.

Stakeholders Relationship Committee (SRC) -

Purpose – to solve the grievances of security holders



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Executive Compensation

Compensation of top executives can be used to tie theinterests of the executives to those of shareholders.

Variable performance packages are preferred:

If they perform well, they are rewarded.

If they perform poorly, they are not rewarded or fired.

Alignment of interests is usually achieved through:

Stock ownership

Stock options



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Ownership Structure

Australian and US companies are usually owned bywidely-dispersed shareholders and controlled by

professional managers. This means that no single

party is in control of the company.

However, in other nations around the world,

ownership is usually concentrated in the hands of

family groups or government entities. This means

that one group is in control of the company and thereis very little you can do (other than sell) if you don’t

like what they’re doing.



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Ownership Structure

The identity of the controlling owner can also havecorporate governance implications.

Family-controlled companies use cross-holdings and

pyramidal structures to gain effective control of the

company with the least cash ownership. The market

recognizes this and prices the increased risk of

expropriation into the share price.

Government-owned and widely-held companies aremore likely to follow the rules.



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Ownership Structure

The presence of an non-management related blockholder of shares can increase monitoring of the

firm.

A blockholder usually holds at least 5% of the

outstanding shares, therefore has a significant interest

in the future performance of the company.

Blockholders can be governments, financial

institutions, individuals or other companies.



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External Auditors

Stock exchange listing requirements usually make itmandatory for companies to employ an external

auditor to audit their financial statements (and

internal controls).

External auditor should be independent of

management, but ….

Tenure of auditor

Tenure of audit partner



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Monitoring by Debt holders

Debt holders provide capital to the company usuallywith conditions:

Debt covenants

Secured on assets

Therefore debt holders actively monitor management

to ensure that companies are meeting debt conditions

and that they won’t default.



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Analysts

Securities analysts are professionals employed byinvestment banks / brokers / asset managers to

monitor companies and provide stock

recommendations (buy/sell), earnings forecasts, long-

term growth forecasts, target prices etc.

Provides an extra level of monitoring for investors.

But, analysts incentives/conflicts of interest meanthat not all of their output is trustworthy.



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Takeover Market

The merger and acquisition (M&A) market stands asa ‘court of last resort’ for assets that are not being

utilized to their full potential.

If management are underperforming there is a good

chance that this will be noticed by the market and

other players will want to take control of the

company.

There are active takeover markets in Australia, US,UK, New Zealand, but few other countries.



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Legal Systems

Each country’s legal system has built in a certaindegree of investor protection. However, there is a

wide variation in protection and enforcement of these

rules around the world.

Common law countries provide highest protection

and French civil law countries provide the least

protection.

Low investor protection seems to result inconcentrated ownership and underdeveloped equity

markets.



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Legal Systems

Country Legal System Protection Rule of Law

Australia Common law 4 10

France French Civil law 2 8.98

Germany German Civil law 1 9.23

India Common law 5 4.17Japan German Civil law 4 8.98

Korea German Civil law 2 5.35

Philippines French Civil law 3 2.73

Netherlands French Civil law 2 10

UK Common law 5 8.57

USA Common law 5 10



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Recent Regulations

In response to the Enron crisis in the US, theSarbanes Oxley Act was passed in 2002. This has

significantly increased governance practices and the

personal liability of directors in the US.

Most other nations have issued Corporate

Governance Best Practice Guidelines to assist

companies in improving their governance – ASX

Corporate Governance Guidelines & Best PracticeGuide (on OLT site). But these are voluntary!

BHP website BHP Annual report

http://www.bhpbilliton.com/bb/home.jsp

http://www.bhpbilliton.com/bb/investorsMedia/reports/2006/2006BhpBillitonAnnualReportPage.jsp











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Convergence?

Originally there were market-based, family-based, bank-based, government-affiliated systems.

In recent years, most nations have started to promote

US and UK best practice corporate governance

guidelines. But not all companies are adopting these

measures.

There is evidence that family-controlled companies

in particular are refusing to improve their corporategovernance practices.

Asian Corporate Governance Association

http://www.acga-asia.org/










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Measuring Corporate Governance

Understanding what good corporate governance isabout is quite easy. However, it is difficult tomeasure whether companies are really committed togood governance.

All we can do is measure if they have certaincorporate governance mechanisms in place – wedon’t know if they are effective or not!

Organizations such as Standard and Poors and Credit

Lyonnais Securities Asia have started providingcorporate governance ratings in recent years.

S&P

http://www2.standardandpoors.com/portal/site/sp/en/ap/page.article/2,1,1,0,1021558139012.html?vregion=ap&vlang=en

http://www2.standardandpoors.com/portal/site/sp/en/ap/page.article/2,1,1,0,1021558139012.html?vregion=ap&vlang=en



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Benefits of Good Governance

Researchers have shown that companies with goodcorporate governance practices are valued more

highly and run more effectively.

So the benefits of good governance include:

Higher share price

Lower cost of funds

Greater international following



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What you need to remember…

When investing it is worthwhile keeping in mindwhether a company has committed to good corporate

governance or not. You can use the mechanisms

highlighted in this lecture or corporate governance

ratings as a guide.

Corporate governance becomes most important

during stock market crashes and bad economic times.

But, it is not a perfect science. Managers will alwaysfind a way to circumvent monitoring to achieve their

own goals!

corporate goveranance

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