oecd principles of corporate governance - policy brief

POLICY BRIEF

Organisation

Aug

ust

2004

© OECD 2004

What are the Principlesand what issues

do they address?

How to strengthenthe ownership role

of shareholders?

How do the Principles dealwith conflicts of interest?

How do the Principles helpstrengthen company

oversight by boards?

How can governments usethe Principles?

How was the review ofthe Principles carried out?

What happens next?

For further information

For further reading

Where to contact us?

The OECD Principles of Corporate Governance

Introduction

The integrity of businesses and markets is central to the vitality andstability of our economies. So good corporate governance – therules and practices that govern the relationship between themanagers and shareholders of corporations, as well as stake-holders like employees and creditors – contributes to growth andfinancial stability by underpinning market confidence, financialmarket integrity and economic efficiency. Recent corporatescandals have focussed the minds of governments, regulators,companies, investors and the general public on weaknesses incorporate governance systems and the need to address this issue.

The OECD Principles of Corporate Governance provide specificguidance for policymakers, regulators and market participants inimproving the legal, institutional and regulatory framework thatunderpins corporate governance, with a focus on publicly tradedcompanies. They also provide practical suggestions for stockexchanges, investors, corporations and other parties that have arole in the process of developing good corporate governance. Theyhave been endorsed as one of the Financial Stability Forum’s12 key standards essential for financial stability.

The OECD Principles were originally issued in 1999 and have sincebecome the international benchmark for corporate governance,forming the basis for a number of reform initiatives, both by govern-ments and the private sector. The Principles were revised in 2003 totake into account developments since 1999, through a process ofextensive and open consultations, and drawing on the work of theRegional Corporate Governance Roundtables for non-OECD coun-tries. The new Principles were agreed by OECD governments inApril 2004. This Policy Brief outlines the salient features of thePrinciples and illustrates how they address key corporate gover-nance issues. ■

for Economic Co-operation and Development

Policy BriefThe OECD Principles of Corporate Governance

What are the Principles and what issues do they address?

The Principles cover six key areas of corporate gover-nance – ensuring the basis for an effective corporategovernance framework; the rights of shareholders; theequitable treatment of shareholders; the role of stake-holders in corporate governance; disclosure andtransparency; and the responsibilities of the board(see Box 1). There are explanatory annotations foreach area that also indicate the range of policy mea-sures which have proved useful in achieving them.Key to the success of the Principles is that they areprinciples-based and non-prescriptive so that theyretain their relevance in varying legal, economic andsocial contexts.

The basic requirements of the institutional and legal/regulatory framework needed to support effective

corporate governance are an integral part of thePrinciples. The text includes principles for developingsuch a framework and addresses the need for lawsand regulations which are both enforceable and arebacked by effective enforcement agencies. Experi-ence around the world shows that although thepowerful concept of a listed company has beensuccessfully introduced in many countries, theaccompanying legal and regulatory system has oftenlagged, leading in some cases to abuse of minorityshareholders and to reduced growth prospects whenfinancial markets lose credibility – or fail to achieve itin the first place.

Other areas covered by the Principles are aimed atestablishing an effective system of checks andbalances between boards and management. Profes-sional managers, for example, have a key role to playin the modern listed or widely-held company, but toavoid possible misuse of their position requires, inter

Box 1. The main areas of the OECD Principles

I. Ensuring the basis for an effective corporate governance framework

The corporate governance framework should promote transparent and efficient markets, be consistent with therule of law and clearly articulate the division of responsibilities among different supervisory, regulatory andenforcement authorities.

II. The rights of shareholders and key ownership functions

The corporate governance framework should protect and facilitate the exercise of shareholders’ rights.

III. The equitable treatment of shareholders

The corporate governance framework should ensure the equitable treatment of all shareholders, includingminority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress forviolation of their rights.

IV. The role of stakeholders in corporate governance

The corporate governance framework should recognise the rights of stakeholders established by law or throughmutual agreements and encourage active co-operation between corporations and stakeholders in creatingwealth, jobs, and the sustainability of financially sound enterprises.

V. Disclosure and transparency

The corporate governance framework should ensure that timely and accurate disclosure is made on all materialmatters regarding the corporation, including the financial situation, performance, ownership, and governance ofthe company.

VI. The responsibilities of the board

The corporate governance framework should ensure the strategic guidance of the company, the effectivemonitoring of management by the board, and the board’s accountability to the company and the shareholders.

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alia, effective monitoring by the board. The Principlesstress that such monitoring should not involve day-to-day management but rather ensure strategic guid-ance of the company and the oversight of internalcontrols.

But who monitors the monitors? The board in turn isaccountable to shareholders who, the Principlesmaintain, should be able to exercise their fundamentalownership rights, including appointing and removingboard members, and should be treated equitably bythe company. Effective use of ownership rights tomonitor and influence the board requires basic stan-dards of disclosure and transparency, another areawhich is considered. Reality is, however, often morecomplex with companies and their managementcontrolled by a dominant shareholder – a somewhatdifferent case for monitoring, but one that is alsocovered by the Principles. Finally, if the enterprise isto be successful, the board will also have to considerstakeholders such as employees and creditors whosupply the firm with resources and who also needaccess to timely and relevant information. Attention tostakeholders is a unique feature of the Principles.

The OECD Principles are highly relevant to a numberof recent high-profile cases of corporate failure. Forexample, in a number of cases, boards appear tohave been dormant or even to have become a part ofmanagement, rather than an active monitor of itsperformance. In other cases, boards appear to actsimply as rubber stamps, responding to the wishes ofa dominant shareholder. Shareholders appear to havebeen either passive or ineffective at sanctioning theboard and in a number of cases controlling share-holders have pursued their interests at the expense ofminority shareholders. Complex financial institutionsand complex corporate structures around the worldhave also thrown into stark relief the question ofconflicts of interest, which have been most apparentin some brokerage research and in fund management.The Principles have always addressed these issues,but the revised version gives them more emphasis. ■

How to strengthen the ownership role of shareholders?

The significant increase in the shareholdings of institu-tional investors in many countries in recent years isoften thought to have led to the formation of a largeand powerful constituency in favour of monitoringcompanies. In fact, institutional investors, especially

those acting in a fiduciary role such as collectiveinvestment schemes and pension funds, continue toplay a limited role in corporate governance as ownersof companies. The central policy issue is not neces-sarily whether they should have additional rights asshareholders, but rather that they do not makeinformed use of rights they already have. This is ofcourse to the detriment of the investor who hasentrusted funds to these institutions. The generalapproach taken by the Principles is that the decision toexercise voting rights in an informed manner is relatedto both the costs and benefits of voting, so in manyinstances it is the incentive to vote which needs tobe improved, in part through policy initiatives. ThePrinciples do not oblige institutional investors acting ina fiduciary capacity to vote their shares, but they docall on them to disclose their voting policies. Whenthese policies include active use of ownership rights,the Principles also recommend that institutionalinvestors disclose how they implement these policies,including the resources they set aside for this purpose.The Principles also call for impediments to cross-border voting to be eliminated and for companies toavoid making it unduly difficult or expensive to vote.

With respect to exercising ownership rights, thePrinciples advocate that shareholders should have theright to remove board members and to participate innominating them. Shareholders should be able to askquestions of the board at the general meeting and toplace items on the agenda. The Principles call for theboard to formulate and disclose a remuneration policyfor board members and key executives, highlightingthe link between remuneration and performance.Shareholders should be able to make their viewsknown about this policy and any equity component,such as share options, should be subject to theirapproval.

Even for institutional investors, the informed use ofownership rights is costly. In many instances, institu-tional investors feel that their stakes in individualcompanies are not large enough to justify these costs.To overcome this situation, the Principles recommendthat the authorities allow or even encourage institu-tions (and other shareholders) to co-operate andco-ordinate their actions. However, there is an impor-tant caveat that such co-operation is not aimed atmanipulating the market or obtaining control of thecompany without going through accepted takeoverprocedures. Better co-ordination in nominating andelecting board members, placing proposals on theagenda and holding discussions directly with acompany are all welcome as valid methods of improv-

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ing corporate governance. Overall, the Principles takethe view that the costs of effective ownership can andshould be reduced.

As part of its approach to participation by institutionalinvestors, the Principles call on countries to lift unnec-essary regulatory barriers to a continuing dialoguebetween investors and companies. At the same time,recognising that such close relations can degenerateinto abuses, particularly in situations where there areinherent conflicts of interest, the Principles recom-mend that general disclosure of information to themarket should remain the practice. Any additionalinformation released by a company to institutionalinvestors should be aimed at helping them understandthe background to such published information. ■

How do the Principles deal with conflicts of interest?

One of the most striking lessons of recent years isthat conflicts of interest are widespread and can oftenlead to behaviour detrimental to shareholders, inves-tors and stakeholders. Since conflicts of interest takemany different forms they are dealt with in severaldifferent sections of the Principles. As a generalapproach, the Principles advocate both full disclo-sure and an explanation by the parties involved as tohow the conflict of interest is being managed.

Managing conflicts of interest is particularly impor-tant with respect to external auditors, whose indepen-dence is crucial for financial market integrity. ThePrinciples support the Principles of Auditor Oversightissued by the International Organisation of SecuritiesCommissions (IOSCO) in 2002. These recommendcreating a body, acting in the public interest, toprovide oversight of the quality and implementation ofaudits. The OECD Principles recognise the impor-tance of recent provisions introduced by manycountries to deal with the skewed incentive structurethat arises when the external auditor provides non-audit services or when he might be involved in audit-ing his own work. Managing the relationship with theexternal auditor so as to ensure a high-qualityindependent audit is also identified by the Principlesas a key duty of the board.

An effective corporate governance framework needsto be backed by effective ways to ensure the integrityof those such as financial analysts, brokers and ratingagencies that provide information or advice whichcould influence investors’ decisions. This is necessary

since close relationships between service providersand their client companies introduce the potential forconflict of interests.

It is important for the market to know whether thecompany is run with due regard to the interests of allits investors. To this end, the Principles state that it isessential for the company to fully disclose any mate-rial related-party transactions. Such transactions aretypically between the company and entities in which itor its management have an interest, or with significantshareholders, including their close relatives andassociates. The Principles call for the beneficiary ofsuch a transaction to be obliged to inform the board,which in turn should make a disclosure to the market.This should not, however, absolve the firm from main-taining its own monitoring.

The Principles emphasise the need to protect minorityshareholders, most notably where there are control-ling shareholders whose interests might diverge fromthose of the others. This is particularly a source ofconcern in jurisdictions where the legal and regulatoryframework for minority protection is weak. ThePrinciples reaffirm that it is reasonable for investors toexpect that the abuse of insider power, including bycontrolling shareholders, will be prohibited. In caseswhere such abuses are not specifically forbidden bylegislation or where enforcement is not effective, thePrinciples call on policymakers to consider measuresto fill such gaps. ■

How do the Principles help strengthen company oversight by boards?

The company board serves as the fulcrum thatbalances the ownership rights enjoyed by share-holders with the discretion granted to managers.Good corporate governance requires that the board,whatever its structure, focus on long-term issues,such as assessing corporate strategy, and activitiesthat might involve a change in the nature and direc-tion of the company, rather than taking on day-to-dayoperational responsibilities. However, boards as awhole and their individual members must haveclearly-defined incentives and duties to ensure thatthe board effectively exercises its functions.

The Principles specify clearly-defined responsibilitiesfor the board that include establishing a code ofcorporate ethics, ensuring compliance with laws andstandards, and oversight of internal control systemsfor financial reporting. The board should also be

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responsible for formulating and disclosing a remuner-ation policy that highlights the link between remu-neration and performance for key executives andboard members. Many countries now regard as bestpractice the creation of a remuneration committeewith independent directors.

Since the board and its members have a fiduciaryduty to the company and all its shareholders, thePrinciples embrace a general notion of boardindependence and objectivity, rather than referringsimply to independence from management. When acompany is part of a group, the board’s duty is to thecompany, not the group. Boards should review relatedparty transactions using independent board mem-bers and provide confidential access for whistle-blowers who may be in a position to identify unethicalconduct and abusive transactions. Although boardcommittees for tasks such as audit, remuneration andnomination have spread in the past few years, theunderlying concepts are not always well understoodand committees often serve quite different roles indifferent companies. To avoid confusion and to informinvestors, the Principles advocate that the composi-tion, mandate and remit of committees be clearlydefined and fully disclosed. ■

How can governments use the Principles?

Although a number of features advocated by thePrinciples require action by boards, investors andothers, there is also an important role for govern-ments to play. For example, boards will usually beable to adopt a structure consistent with effectivesupervision of management and effective account-ability to shareholders. However, desirable featuressuch as cooperation between investors and protec-tion of minority shareholders may depend to a greatextent on government action to remove regulatorybarriers and to enforce rights. In addition, privateactions alone might not lead to desirable corporategovernance practices. Where management isentrenched and capital markets are weak, forexample, boards may continue to avoid their respon-sibilities unless the authorities take remedial action.

The Principles offer broad guidance for governmentsto follow when reviewing whether their corporategovernance framework is compatible with establish-ing the corporate governance they want. Policy-makers are encouraged to develop the governanceframework with a view to its impact on overalleconomic performance, market integrity and the

incentives it creates for market participants and thepromotion of transparent and efficient markets. Thisshould help reduce the risk of costly over-regulationand minimise the unintended consequences of policymeasures. To underpin market integrity, the legal andregulatory requirements that affect corporate gover-nance practices should be consistent with the rule oflaw, transparent and enforceable.

The Principles also cover the types of mechanismsthat should be established for parties to protect theirrights. Supervisory, regulatory and enforcementauthorities should have the authority, integrity andresources to fulfil their duties in a professional andobjective manner. However, where institutionalresources are constrained, the legal and regulatoryrequirements could be adjusted. For example, wherecourts are weak more reliance might have to beplaced on other mechanisms to protect shareholderrights such as low shareholding thresholds for callingmeetings and proposing board members or highvoting thresholds for major decisions. Rulings shouldbe timely, transparent and fully explained. Box 2discusses in detail how the OECD helps govern-ments to improve corporate governance. ■

How was the review of the Principles carried out?

OECD Ministers in 2002 called for an assessmentof the OECD Principles by 2004, a year earlier thanpreviously intended, in the wake of a series of corpo-rate scandals that had undermined confidence in theintegrity of corporations, financial institutions andmarkets. To support this work, the Ministersrequested a survey of corporate governance develop-ments in OECD countries with a view to identifyinglessons to be learned and possible implications forthe Principles.

The assessment was carried out under the responsi-bility of the OECD Steering Group on CorporateGovernance with the active participation of observersfrom key international institutions, notably the Bank forInternational Settlement, International Monetary Fund,World Bank, Financial Stability Forum, InternationalOrganisation of Securities Commissions and the BaselCommittee. Leading business and labour representa-tives, notably the Business and Industry AdvisoryCommittee to the OECD and the Trade Union AdvisoryCommittee to the OECD also participated in theSteering Group’s meetings on an ad hoc basis.

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The Steering Group sent a questionnaire to membercountries requesting information about corporategovernance issues, the forces at work and proposedpolicy measures. The responses, together with areview of practices in OECD member countriesformed the basis of a report entitled Corporate Gover-nance: A Survey of Developments in OECD Countriesand informed the discussions of the Steering Group.

In undertaking its review, the Steering Group organ-ised comprehensive and transparent consultations.The assessment process included extensive consulta-tions with the private sector, labour and civil society atlarge. Three major consultative meetings with broadparticipation were held in conjunction with theSteering Group meetings. In addition, the OECDSecretary General convened two informal roundtablemeetings with senior representatives from key inter-national organisations, business and labour.

Consultations with non-member partners were firstundertaken through meetings of the five RegionalCorporate Governance Roundtables. Additional inputwas obtained from a special meeting attended by43 non-member countries organised in co-operationwith the Global Corporate Governance Forum.

In January 2004 a draft of the revised Principles wasposted on the Internet for comments from the generalpublic. Some 75 submissions were received from privateindividuals, professional associations, business andtrade unions and, where permission was given, theywere posted on the OECD website for public access. ■

What happens next?

The Principles should be considered a living docu-ment. It is an OECD priority to make sure that they arewidely disseminated and actively used. This willinclude a continuing policy-dialogue where policy-makers, regulators and standard-setters will be ableto exchange practical experience of implementing thePrinciples. The OECD will also continue to monitordevelopments and identify new trends and challengesthat deserve attention. As an important part of futurework, the OECD will host an international multi-stakeholder dialogue on corporate governance. Thisdialogue among corporations, investors, serviceproviders, labour and others will be as inclusive aspossible and provide an important opportunity toensure that the Principles remain relevant and areactively used in the private sector. Beyond the

Box 2. OECD activities to improve corporate governance

Through its Steering Group on Corporate Governance and the Regional Corporate Governance Roundtables, the OECDserves as the international nexus for policy discussions in corporate governance. The Principles are the centrepiece ofthe numerous activities undertaken by the OECD to improve corporate governance. In co-operation with the WorldBank, the OECD Regional Roundtables have used the Principles as a framework for policy dialogue to promote regionalcorporate governance reforms in Asia, Latin America, Eurasia, Southeast Europe and Russia. This activity has resultedin regional White Papers, which develop common policy objectives and highlight recommendations for policy action.The knowledge gained from the Roundtables has been made available to the public and is summarised in a recentOECD report, Experiences from the Regional Corporate Governance Roundtables, which compares the corporategovernance problems faced by widely different emerging market and developing economies and elaborates on thepriorities which these regions have established. This experience was in turn influential in the review of the Principles.

Good corporate governance is also necessary for state-owned companies. The ownership function of the state incompanies where it is a shareholder has yet to be fully resolved, even after taking into account the beneficial effects ofpartial privatisation, which in many countries has opened the way to unprecedented restructuring initiatives and increasedexposure to competition from private entities. The OECD Working Group on Privatisation and Corporate Governance ofState-Owned Enterprises is developing a set of Guidelines that, once completed in 2005, should allow countries to betterbenchmark the ownership functions of the state. This work is subject to an open consultation process.

Regulatory reform is often associated with changes in the corporate governance framework. The OECD’s response to thegrowing demand for up-to-date, comprehensive and comparable information about recent regulatory developments hasbeen to develop the Company Law and Corporate Governance Database, a unique interactive tool for the dissemination ofcorporate governance legal and regulatory information. Presently available to only OECD governments, it will be madeaccessible to the general public via the Internet before the end of 2004.

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Principles, once the Guidelines for CorporateGovernance of State-Owned Enterprises are agreedthey will also become an aspect of the dialogue.

As for non-OECD countries, the next stage of theRegional Roundtable process is already underway. Inthe case of the Russian Roundtable, the participantshave agreed to create two ad hoc Task Forces toexamine policy options in two priority areas: thetransition towards internationally recognised financialreporting standards, and problems arising fromrelated-party transactions, transparency of beneficialownership and control. The Asian, Latin American andSoutheast Europe Roundtables will also focus onimplementation and enforcement of White Paperrecommendations. The Eurasian Roundtable willshortly issue a Comparative Overview of corporategovernance in the region, containing priorities forfurther action to be pursued in the follow-up phase. ■

For further information

More information about the OECD Principles ofCorporate Governance can be obtained from:Mats Isaksson, Tel.: (33-1) 49 10 43 40(email: [email protected]),Grant Kirkpatrick, Tel.: (33-1) 49 10 43 42(email: [email protected]), orAlessandro Goglio, Tel.: (33-1) 49 10 43 46(email: [email protected]). ■

Or visit the Corporate Governance Principles websiteat: www.oecd.org/corporate/principles/.

Contact the OECD Secretariat by email:[email protected].

By post: OECD DAF/CA (Principles) – 2, rue AndréPascal – 75775 Paris CEDEX 16 – France.

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FRANCE

OECD Headquarters2, rue André-Pascal75775 PARIS Cedex 16

Tel.: (33) 01 45 24 81 67Fax: (33) 01 45 24 19 50

E-mail: [email protected]: www.oecd.org

GERMANY

OECD BERLIN CentreAlbrechtstrasse 9/10D-10117 BERLIN

Tel.: (49-30) 288 8353Fax: (49-30) 288 83545

E-mail:[email protected]:www.oecd.org/deutschland

JAPAN

OECD TOKYO CentreNippon Press Center Bldg2-2-1 Uchisaiwaicho,Chiyoda-kuTOKYO 100-0011

Tel.: (81-3) 5532 0021Fax: (81-3) 5532 0035

E-mail: [email protected]: www.oecdtokyo.org

MEXICO

OECD MEXICO CentreAv. Presidente Mazaryk 526Colonia: PolancoC.P. 11560MEXICO, D.F

Tel.: (00.52.55) 9138 6233Fax: (00.52.55) 5280 0480

E-mail: [email protected]:

www.ocdemexico.org.mx

UNITED STATES

OECD WASHINGTON Center2001 L Street N.W., Suite 650WASHINGTON D.C. 20036-4922

Tel.: (1-202) 785 6323Fax: (1-202) 785 0350

E-mail: [email protected]: www.oecdwash.org

For further reading

■ The full text of the Principles can be obtained in pdf format from our website:www.oecd.org/daf/corporate/principles/

■ Corporate Governance: A Survey of OECD Countries, OECD 2004.ISBN: 92-64-10605-7, € 21.00, 72 p.

■ Experiences from the Regional Corporate Governance Roundtables, www.oecd.org/daf/corporate-affairs/.

■ OECD Guidelines for Multinational Enterprises, www.oecd.org/daf/investment/guidelines.

■ IOSCO Principles of Auditor Oversight, www.iosco.org/pubdocs/pdf/IOSCOPD134.pdf.

Where to contact us?

The OECD Policy Briefs are prepared by the Public Affairs Division,

Public Affairs and Communications Directorate.

They are published under the responsibility of the Secretary-General.

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www.oecd.org/bookshop

The OECD Policy Briefs are available on the OECD’s Internet site

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oecd principles of corporate governance - policy brief

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