Navigating Complexity: The Unrelenting Speed of Change

Sydney 14 October

Thomas Clarke Centre for Corporate Governance

UTS Sydney “Boardroom Dynamics-

What Boards Expect From Their CEO

Copyright: Thomas Clarke, International Corporate Governance: A Comparative Approach, London;Routledge (Second Edition 2015)

Governance and Corporate Life Cycle

Diversity and Internationalisation

Institutional Investor Influence

From Long Term Investing to Short Term Trading

Cycles of Crisis and Regulation

Reshaping Regulatory Regimes

Cycles of Governance Crisis and Regulation

Board Reform

CEO Pay

Alternative Institutional Systems

Governance of the Global Value Chain

The word governance is from the Latinised Greek gubernatio meaning management or government, and this comes from the ancient Greek kybernao to steer, to drive, to guide, to act as a pilot.

19th C Entrepreneurship

20thC Management

21st C Governance

(R.I. Tricker circa 1992)

Maturity Governance challenges

Growth Governance challenges:

Launch Governance Challenges:

• Maintain alertness • Board assessment •Advance value commitments

•Risk management •Develop board directors. • Engage stakeholders.

• Raise capital • Recruit board of directors • Establish accountability

Time

Corp

ora

te

Develo

pm

ent

Founding Entrepreneurs

Private Company

IPO (Initial Public Offering)

Public Corporation (Majority Shareholders)

Public Corporation (Diffuse Shareholders)

Source: Clarke T. (2006)

National, regional and cultural differences

Ownership structure and dispersion

The industry and market environment of the corporation

Firm size and structure

Life cycle variations including origin & development, technology & periodic crises and new directions

3

Percentage of United Kingdom Shares

Held by Individuals and Foreign Investors, 1963-2008

0

10

20

30

40

50

60

1963

1969

1975

1981

1989

1990

1991

1992

1993

1994

1997

1998

1999

2000

2001

2002

2003

2004

2006

2008

%

Foreign Investors

Individual Investors

Sources: U.K. Office for National Statistics, 2010; Federation of European Securities Exchanges, 2008.

3

Percentage of Value of Japanese Shares

Held by Individual and Foreign Investors, 1950-2009

0

10

20

30

40

50

60

70

1950

1970

1975

1980

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2009

%

Foreign Investors

Individual Investors

Source: Tokyo Stock Exchange, 2010

High

Low

None

Years

Imp

ort

ance o

f

Susta

inable

Valu

e C

reati

on

Hedge Funds

Mutual Funds Private

investors

Life Assurers

Pension Funds

Time Horizons

Source: Adapted From Morley Fund Management (2003).

Institutional Investor Concern for Sustainable Value Creation

Not Australian Super Funds!

Active Managers

Advances in financial, computing and communications technologies have facilitated the dramatic reduction of the average holding period of equity: on the NYSE this has diminished from 7 years in the 1950s to 6 months today. More worryingly as much as 60% of trading volume on the NYSE is measured now in milliseconds, and other exchanges are similarly overwhelmed.

The more impact short-term traders have in the market, the more volatile prices will be as these become less rooted in the fundamentals of the value of corporations traded, as Andrew Haldane of the Bank of England has documented.

Long term innovation and investment performance requires attention to more than short term financial metrics.

Today strategies using algorithmic trading and HFT play a central role on financial exchanges, alternative markets, and banks’ internalized (over-the-counter) dealings.

Although there have always been occasional trading errors and

episodic volatility spikes in markets, the speed, automation and interconnectedness of today’s markets create a different scale of risk. These risks demand that exchanges and market participants employ effective quality management systems and sophisticated risk mitigation controls adapted to these new dynamics in order to protect against potential threats to market stability arising from technology malfunctions or episodic illiquidity

Exchanges are committed to protecting market stability and promoting orderly markets, and understand that a robust and resilient risk control framework adapted to today’s high speed markets, is a cornerstone of enhancing investor confidence.

(WFE 2013:4)

Ben Bernanke

Chairman

US Federal Reserve

Mervyn King

Governor of the

Bank of England

Jean-Claude Trichet, President

of the European Central Bank

The Power of …Prayer

Bernard Madoff (Chairman of NASDAQ), right, in 1993 at a House hearing with David S. Ruder, (Chairman ofS.E.C.), center, and Richard Grasso (CEO of the NYSE).

The US Regulators: If these are the good guys..?

“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.” Alan Greenspan in 2004

“Authorities should not interfere with the pollinating bees of Wall Street” Alan Greenspan in 2007

PRINCIPLES OF REGULATION OF INTERNATONAL FINANCIAL MARKETS

Transparency Capital Adequacy Corporate Governance

Prudential Regulation

Risk Management

Reshaping International Regulatory

Regimes

Avoiding regulatory policies that exacerbate the ups and downs of the business cycle;

Reviewing and aligning global accounting standards, particularly for complex securities in times of stress;

Strengthening transparency of credit derivatives markets and reducing their systemic risks;

Reviewing incentives for risk-taking and innovation reflected in compensation practices; and

Reviewing the mandates, governance, and resource requirements of the International Financial Institutions (CRS 2009b:7).

“Corporate Governance crisis and reform is essentially cyclical”.

“Waves of corporate governance reform and increased regulation occur during periods of recession, corporate collapse and re-examination of the viability of regulatory systems”.

“During long periods of expansion, active interest in governance diminishes, as companies and shareholders become again more concerned with the generation of wealth, than in its retention”.

(Clarke, T. (2004). Theories of Corporate Governance)

The cyclical pattern of stock market booms encouraging and concealing corporate excesses will continue

When recession highlights corporate collapses statutory intervention invariably occurs

Avoiding mandatory restrictive over-regulation requires active self-regulation and market regulation – particularly in times of expansion

There will never be a “perfect” system of corporate governance

Market systems are competitive and volatile and dynamic systems of governance will reflect this

But corporate governance is about risk-management

The drive to make corporate governance both improve corporate performance, and enhance corporate accountability will continue

The reason corporate governance standards and reforms will increase in future as a matter of public concern is that more of the public will have more of their wealth invested in companies they will insist should behave responsibly

Out of the Darkness

Into the Light

Reporting to Shareholders, Ensuring statutory/

Regulatory compliance, Reviewing audit reports

Reviewing key executive performance

Reviewing business results

Monitoring budgetary control and

Corrective actionsR

Reviewing and initiating strategic

analysis/ Formulating strategy

Setting corporate direction

Approving budgets

Determining compensation policy

For senior executives

Creating corporate culture

Outward looking

Inward looking

Providing accountability

Strategy formulation

Monitoring and supervising

Policy making

Approve and work with And through the CEO

Past and present focused Future focused

F.

Outward looking

Inward looking

Providing accountability

Strategy formulation

Monitoring and supervising

Policy making

Approve and work with And through the CEO

Past and present focused Future focused

er

Tricker 1991

OUTWARD

LOOKING

INWARD

LOOKING

Providing Accountability Strategy Formulation

Monitoring and Supervising Policy Making

PAST AND PRESENT FOCUSED FUTURE FOCUSED

CONFORMANCE PERFORMANCE

Framework for Analyzing Board Activities

Corporate Governance Without Strategy Leads to Paralysis....

S

Strategy Without Corporate Governance Leads to Recklessness...

Trcker 1991

CULTURE

An adversarial atmosphere in the

boardroom or an unmotivated board

with a tendency to group-think

COMPOSITION

Skill deficits or lack of genuine

independence on the board

CHARACTERISTICS

Conflicts of interest or factional interests

on the board, perhaps due to a dominant

shareholder

PROCESS

Poor chairmanship – a chair who is too

weak, too autocratic or too close to the

CEO. Poor processes leading to

inefficient use of time

Chair

CEO

CULTURE

Honest, Respectful

Transparent

Constructive challenge

COMPOSITION

Diversity

Experience

CHARACTERISTICS

Engaged

Non-adversarial

Independent

PROCESS

Secretarial support

Information

Committees

Chair

CEO

NON - EXECUTIVES

Chairman &

Chief Executive

E X E C U T I V E S Investors relations

Board Appointments

Auditing of Accounts

Executive Remuneration

Management Controlling the Levels of Power

Source: Taylor (2004

The Board Controlling the Levers of Power

EXECUTIVES

Investors relations

Board Appointments

Auditing of Accounts

Executive Remuneration

Chairman

Chief Executive

N O N - E X E C U T I V E S

Senior Independent

directors

Nomination Committee

Audit Committee

Remuneration

Committee

Source: Taylor (2004)

CEO Pay

Source: UK High Pay Commission Interim Report 2011 Figure 6 p 28

93

98

92

86

68

63

60

61

46

42

40

44

40

32

37

38

38

42

34

38

99

62

66

58

62

62

63

68

60

56

60

58

54

40

43 37

32

24

Source: Data up to 2001, compiled from Hall B. (2003). ‘Six Challenges in Designing Equity-Based Pay’. Journal of Applied Corporate Finance, 15(3): 21-23. From 2002, compiled from Salmans, C (2007). ‘Mercer

Issues Annual Study of CEO Compensation at Large US Firms’. Mercer LLC 2009; Towers Perrin ‘2009 Proxy Statements Highlight the New Realities in Executive Compensation’; Institute for Policy Studies

‘Executive Excess Report 2008 and 2007’.

38

62

Agency achieves the opposite of its intended effect:

Composition of Median CEO Pay in the US

(1980- end 2008)

Jensen and Murphy (1990)

Performance Pay and Top

Management Incentives,

Journal of Political

Economy, University of

Chicago Press

Murphy 1999 “It is difficult to document that the

increase in stock-based incentives has led CEOs

to work harder, smarter, and more in the interest

of shareholders “

Murphy 2005 “We wanted to give them a bottle of

wine to thank them for their efforts. We never

imagined they would take the whole vineyard...”

OUTSIDER MODEL

(e.g. UK)

INSIDER MODEL

(e.g. Europe)

Market Culture Consensus culture

Market Orientated Network orientated

Relatively more Reliance on

Equity

Relatively more Reliance on

Debt

Stock Exchange Relatively

Large Stock Exchange Relatively Small

Relatively less influence of

controlling sharerholders

Relatively more influence of

controlling shareholders

Source: Welt, Gotshat and Manges (2002). Eurosif Research 2007

Corporate Governance Alternative Systems Keenan, J and Aggestam M. (2001); Clarke and Bostock (1994)

Corporate Governance:

Alternative Institutional Systems

Feature Anglo-Saxon Germanic Latin Japanese

Orientation Market oriented (an

active external market

for corporate control)

Market-oriented (relatively

oligarchic, influenced by

networks of shareholders,

families and banks)

Network-oriented Network-oriented

Representative

countries

USA, UK, Canada,

Australia, NZ

Germany, Netherlands,

Switzerland, Sweden, Austria,

Denmark, Norway, Finland

France, Italy,

Spain, Belgium,

Brazil, Argentina

Japan

Prevailing

concept of the

firm

Instrumental (as a

means for creative

shareholder value)

Institutional (autonomous

economic units coming out of a

coalition of shareholders,

corporate managers, suppliers

of goods and debts, and

customers)

Institutional Institutional

The Board

System

One-tier (governance

with one level of

directors, making no

distinction but

executives and non-

executives

Two-tier (executive and

supervisory board, the latter

monitoring, appointing or

dismissing managers; large

shareholders on the Board and

high pressure from banks)

Optional (France)

in general one-

tier

Board of directors,

offices of representative

directors, of auditors, de

facto one-tier

Main

stakeholders to

exert influence

on managerial

decision-making

Shareholders Industrial banks (mainly in

Germany; in general, oligarchic

group inclusive of employees’

representatives)

Financial

holdings, the

government,

families, in

general

oligarchic

groups

City banks, other

financial institutions,

employees in general

oligarchic groups

Importance of

stock and bond

markets

High (requiring

continued action and

performance)

Moderate or high (legal and

regulatory bias against non-

bank finance)

Moderate or poor High (legal and

regulatory bias against

non-bank finance)

Corporate Governance:

Alternative Productive Systems Feature Anglo-Saxon Germanic Latin Japanese

Is there a market

for corporate

control?

Yes No No No

Ownership

concentration

Low Moderate or high (very high

in Germany)

High Low or moderate

Compensation

based on

performance

High Low Moderate Low

Time horizon of

economic

relationships

Short-termism

(management and

governance myopia)

Long termism Long termism Long termism

Strengths Dynamic market

orientation, fluid

capital,

internationalization

extensive

Long-term industrial

strategy, very stable capital,

robust governance

procedures

Creative, aesthetic,

flexible, continuity

in skill

development

Very long-term

industrial strategy,

stable capital, major

overseas investment

Weaknesses Volatile, short-termism,

inadequate

Internationalization more

difficult, lack of flexibility,

inadequate investment for

new industries

Weak governance,

majority control,

little transparency

Financial speculation,

secretive governance

procedures, weak

accountability.

Financial services, software, high tech, media Products

Sources: Keenan, J and Aggestam M. (2001); Clarke and Bostock (1994)

Cars, consumer electronic goods

Fashion goods, Clothes, shoes

Precision engineering, Quality automobiles, high Quality manufacturing

US Combination of Roles of CEO and Chairman

Independence and Role of Non-Executive Directors

Primacy of Shareholder Value

Actual Role of Shareholders

Impact of Financial Markets

Instability of Investment

Short term investment and strategy horizons

Displacement of goals towards CEO remuneration

Progressive deregulation of financial markets.

Globalization of financial markets.

Financial product innovation.

Increasing prominence of institutional investors in the market.

Securitisation and leverage

Global financial crisis

Majority ownership of voting shares Owning significant minority holdings and

employing a combination of devices to increase their control through:

Arranging pyramid corporate structures Shareholder agreements Discriminatory voting rights Procedures intended to reduce the

participation or influence of other minority investors.

In an analysis of corporate governance from a cross-country perspective, the question arises whether a common, global framework is optimal for all.

With the emergence of China, India, and Brazil, among

others, as global economic powers, the traditional model for corporate governance—monitoring and supervision through active investors, free and informed financial media, and so on—is not necessarily the framework that works best in the increasingly significant emerging market economies.

Concepts such as accountability and safeguarding shareholders’ interests have cultural moorings in addition to legal and economic foundations.

Western concepts and approaches may not be translatable, easily understood, or relevant to non-Western cultures.

Stijn Claessens and Burcin Yurtoglu (2012:16)

Adapted from Mudambi (2007