using the oecd principles of corporate g
TRANSCRIPT
-
7/26/2019 Using the OECD Principles of Corporate G
1/103
1
ANGLIA RUSKIN UNIVERSITY
Using the OECD Principle of Corporate
Governance as an International Benchmark: A
Comparative Analysis of Corporate Governance
Legislation in the UK, US and South Africa
PAUL CHU NGUM
A Dissertation in partial fulfilment of therequirements of Anglia Ruskin University for thedegree of Master of Law (LL.M International and
European Business Law)
Submitted: January 2009
-
7/26/2019 Using the OECD Principles of Corporate G
2/103
2
ABSTRACT
Adopting corporate governance practises has been a great concern to the academia,
professionals and policy makers. This concern might be partially triggered by the
realization of the importance of an official corporate governance regime, which provides
a platform for market integrity and efficiency, as well as facilitating economic growth.
Formulating effective corporate governance measures is a complex task for legislators.
The purpose of this paper is to provide an in depth analysis and comparison of the
corporate governance legislative frameworks in three countriesthe UK, US and South
Africa. In 2004, the Organization for Economic Cooperation and Development (OECD),
in conjunction with national and international governmental organizations, finalized auniversal set of corporate governance principles. Although non-binding, the OECD
Principles 2004 are a serious attempt to strengthen every aspect of corporate governance
and, accordingly, have been utilized in this paper as an international benchmark.
Emphasis is placed on South Africa as an emerging economy and because of its
international links with Anglo-American corporate governance and domestic pursuit of
socio-economic development. The ultimate objective of this paper is to formulate a
number of detailed and specific recommendations to the South African Government.
This paper is organized as follows; the first chapter sets out an introductory explanation
of the concept of corporate governance in an attempt to reach a well-tuned concept
comprising the origin, importance and theoretical aspects that influence corporate
governance development. The second Chapter provides a detailed discussion of the
corporate governance principles formulated by the OECD. The process began in 1999
and was completed in 2004 after extensive revision and consultation. The third chapter
examines the background and development of corporate governance practices in the UK,
US and South Africa. Chapter four, the core part of the paper, presents a comparative
analysis of the implementation of the OECD principles in the UK, US and South Africa.
The last chapter provides a summary of analysis and sets out a list of recommendations to
the South African Government.
-
7/26/2019 Using the OECD Principles of Corporate G
3/103
3
TABLE OF CONTENTS
ABSTRACT1
TABLE OF CONTENTS..2
Introduction..5
CHAPTER 1 The Concept of corporate governance.10
1.1 What is Governance.................................................................................................101.2 What is Corporate Governance?..............................................................................10
1.3 Origin of corporate Governance .....12
1.4 Importance of corporate Governance...16
1.5 Theoretical Aspects of corporate Governance ....17
1.5.1 Agency Theory..17
1.5.2 Stakeholder Theory...20
1.5.3 Stewardship Theory...21
CHAPTER 2 The OECD Principles of corporate
Governance..24
2.1. Historical Background..24
2.2 How the principles work26
2.3 Reasoning behind the Principles.28
2.4 OECD Principles (1999)Critical Content....29
2.4.1 Core Standards..29
(a) Fairness.29
(b) Responsibility..30
(c)Transparency30
-
7/26/2019 Using the OECD Principles of Corporate G
4/103
4
(d) Accountability..31
2.5 OECD Principles (2004)..32
I. Ensuring the basis for an effective corporate governance framework...34
II. The Rights of Shareholders...35
III. Equitable Treatment of Shareholders..36
IV. The Role of Stakeholders in Corporate Governance...37
V. Disclosure and Transparency39
VI. Responsibility of the Board.40
CHAPTER 3 An Overview of Corporate Governance in
United Kingdom, United States AND South Africa..433.1 Background and development of corporate Governance in the UK43
3.1.1The Cadbury Report 1992..43
3.1.2 The Greenbury Report 1995.....45
3.1.3 The Hampel Report 1998..46
3.1.4 The Combined Code 1998 and Beyond....47
3.2 Background and development of Corporate Governance in the US.......50
3.2.1Sarbanes Oxley..52
3.2.2 The NYSE and NASDAQ54
3.3 Background and development of Corporate Governance in SA.55
3.3.1The King Report I and II56
CHAPTER 4 Implementation of the OECD Principles
2004 in the United Kingdom, United States AND South
Africa.60
-
7/26/2019 Using the OECD Principles of Corporate G
5/103
5
Comparative Analysis .60
4.1 Framework of Analysis60
4.2Content of Analysis..60
4.2.1 Ensuring the Basis for an effective Corporate Governance Framework..61
4.2.2 The Rights of Shareholders and Key Ownership Functions.65
4.2.3 Equitable Treatment of Shareholders............................75
4.2.4 The Role of Stakeholders in Corporate Governance....79
4.2.5Disclosure and Transparency.82
4.4.6Responsibility of the Board...84
CHAPTER 5 Conclusion and Recommendations87
5.1 Conclusion.87
5.2. Recommendations91
Final Remarks..92
-
7/26/2019 Using the OECD Principles of Corporate G
6/103
6
INTRODUCTION
Governance is a word that barely existed 20 years ago. Now it is in common use not just
in companies but also in charities, universities, local authorities and National Health
Trusts. It has become shorthand for the way an organization is run, with particular
emphasis on its accountability, integrity and risk management. The corporation has a vital
role to play in promoting economic development and social progress. It is the engine of
growth internationally and is increasingly responsible for providing employment, public
and private sector services, goods and infrastructure.1The efficiency and accountability
of the corporation is now a matter of both private and public interest, and corporate
governance has thereby come to the head of the international private enterprise agenda.2
The corporate collapses, which have taken, place in the US, UK and around the world in
the recent years (2001-2004), and their disastrous consequences, have been generating
far-reaching effects at governmental level and at an academic level. On the one hand, the
corporate collapses have brought corporate governance at the top of the reform agenda of
Governments all over the world. Not surprisingly, in the aftermath of these collapses, the
OECD published in 2004 a revised version of its Principles of Corporate Governance,
first published in 1999 and which represent a common basis that OECD member
countries consider essential for the development of good corporate practices.
These Principles evidence the overriding concern that should guide the development of
the corporate governance framework, the impact on overall economic performance,
irrespective of the legal environment in which companies operate (common law or civillaw) and irrespective of the companys ownership structure. They serve as a benchmark
for identification of good elements of corporate governance, though there is no single
1 Mallin C, Corporate Governance: An International Review (2004).2 Center for International Private Enterprise, Strengthening Corporate Governance (2004).
-
7/26/2019 Using the OECD Principles of Corporate G
7/103
7
model of good corporate governance. The OECD principles cover five aspects of
governance: (a) the rights of shareholders; (b) the equitable treatment of shareholders; (c)
the role of stakeholders in corporate governance; (d) disclosure and transparency; and (e)
the responsibilities of the board
It is interesting to note that there are variations in the corporate governance systems in the
US, UK and South Africa. The key distinction between US and UK corporate governance
lies in the regulatory methods and styles adopted by each country. The more prescriptive
regulatory approach of the US that is based on a formal legalism in the context of a
litigation culture3stands in contrast to the principles-based approach of the UK.
The regulation of corporate governance in the UK is provided by a number of differentrules, regulations and recommendations, namely: Common law rules (e.g. directors'
fiduciary duties), Statute (notably the Companies Act 1985)4. A company's constitutional
documents (the memorandum and articles of association), The Listing Rules, which apply
to all companies that are listed on the Official List (or AIM Rules, as appropriate), The
Combined Code on Corporate Governance (the provisions of the Code are not mandatory
but listed companies are required to include a statement in their annual reports as to
whether or not they comply with the Code and give reasons for non-compliance). The
Code is supplemented by: the Turnbull Guidance (relating to the internal control
requirements of the Code), the Smith Guidance (on audit committees and auditors) and
suggestions of good practice from the Higgs Review, Non-legal guidelines issued by
bodies that represent institutional investors (such as the Association of British Insurers
(ABI), the National Association of Pension Funds (NAPF) and the Pensions &
Investment Research Consultants (PIRC). These guidelines apply to listed companies and
although they are informal, some institutional investors may oppose any corporate actions
that contravene them. In the context of takeovers of public companies, the City Code on
Takeovers and Mergers and the rules of the Takeover Panel apply. The Financial
3 Kagan, R. A. (2001). Adversarial Legalism: The American Way of Law. Cambridge, MA: HarvardUniversity Press.4 The Companies Act 2006 has now effectively replaced existing company legislation by re-writing,updating and modernising company law. The 2006 Act received Royal Assent on 8th November 2006. Allreferences will be to the 2006 Act unless expressly stated
-
7/26/2019 Using the OECD Principles of Corporate G
8/103
8
Services Authority's Code of Market Conduct (relating to the disclosure and use of
confidential and price sensitive information and the creation of a false market).
In the U.S., corporate governance is determined predominantly by legislation in the form
of the Sarbanes-Oxley Act of 2002 ("SOX") and detailed regulations which SOX
required the Securities and Exchange Commission ("SEC"), New York Stock Exchange
("NYSE") and NASDAQ to draw up.
The UK "comply or explain" approach to corporate governance varies significantly from
the general approach taken by SOX. Although SOX-related regulations use the "comply
or explain" method in some instances5, in most other instances, U.S. regulation tends to
rely on the legislation and fines and imprisonment penalties for violating the
requirements of SOX.
Kelemen and Sibbitt6argue that the adversarial style of the US regulatory approach
undermines insider networks, which might in turn make this approach incompatible with
informal co-operative processes that facilitate and support social partnerships. This
difference between the US and UK approaches is not new, but it has been made more
pronounced with the enactment of new legislation in the wake of recent US corporate
scandals.
On the other hand, South Africas colonial legacy and resultant ties with the UK and US
has shaped the countries approach to corporate governance to lean towards the traditional
Anglo-America model.7 Corporate governance has been a reasonably well-developed
concept in South Africa since the establishment of the King Committee on Corporate
Governance in 1992, at the instigation of the Institute of Directors of Southern Africa
(IoD) and the release of the first King Report in November 1994. It was not stimulated by
any significant crisis in the corporate sector at that time; rather it concerned the
5For example, in relation to whether a company has a "code of ethics" or its audit committee has a"financial expert"),6 Kelemen, R. D., & Sibbitt, E. C. (2004). The Globalization of American Law. International Organization,58(1), 103-136.7 Reed, D. (2002). Corporate governance reforms in developing countries. Journal of Business Ethics, 37,223-247.
-
7/26/2019 Using the OECD Principles of Corporate G
9/103
9
competitiveness of the South African private sector following the re-admission of the
country to the global economy following its transition to a fully-fledged democracy after
the collapse of apartheid.
The first Kind Report on corporate Governance (King I) was released on the 29 thof
November 1994. The purpose of King I was to promote the highest Standards of
corporate governance in SA. The King Committee issued a detailed report on corporate
governance, a series of recommendations and a code of Good Corporate Practices and
Conduct. A number of the recommendations in King I were superseded by legislation in
the social and political transformation in SA. Further, a dominant feature of business
since 1994 was the emergence of information technology. In light of these factors, as well
as many others, the king committee reviewed corporate governance standards and
practices for SA against developments that took place after publication of King I. The
code of corporate Practices and Conduct in King II replaced the code of Good Corporate
Practice and Conduct in Kind I, with effect from 1 march 2002. In January 2009, King
Report III will appear in South Africa, having been written by a committee of 90
members.
This paper serves to provide an analysis and comparison of the systems of corporategovernance in the UK, US and South Africa measured against the principles of corporate
governance recently formulated by the OECD as an international benchmark. The
ultimate objective of this paper is to formulate a number of detailed and specific
recommendations to the South African Government
This paper is organized as follows; the first chapter sets out an introductory explanation
of the concept of corporate governance in an attempt to reach a well-tuned concept
comprising the origin, importance and theoretical aspects that influence corporate
governance development. The second Chapter provides a detailed discussion of the
corporate governance principles formulated by the OECD. The process began in 1999
and was completed in 2004 after extensive revision and consultation. The third chapter
examines the background and development of corporate governance practices in the UK,
-
7/26/2019 Using the OECD Principles of Corporate G
10/103
10
US and South Africa. Chapter four, the core part of the paper, presents a comparative
analysis of the implementation of the OECD principles in the UK, US and South Africa.
The last chapter provides a summary of analysis and sets out a list of recommendations to
the South African Government
-
7/26/2019 Using the OECD Principles of Corporate G
11/103
11
CHAPTER 1
The Concept of corporate governance
1.1 What Is Governance
The concept of "governance" is not new. It is as old as human civilization. The term
governance in itself derives from the Latingubernare,meaning to steer, usually
applying to the steering of a ship.8A dictionary definition of the word governance yields
the following: The act, manner, function, or power of government.
9
Governance in itswidest sense refers to how any organization, including a nation, is run. It includes all the
processes, systems, and controls that are used to safeguard and grow assets.10Governance
can be used in several contexts such as corporate governance, international governance,
national governance and local governance. When applied to organizations that operate
commercially, it is often termed "corporate governance
1.2
What Is Corporate Governance
Corporate governance has succeeded in attracting a good deal of public interest because
of its apparent importance for the economic health of corporations and society in general.
However, the concept of corporate governance is poorly defined because it potentially
covers a large number of distinct economic phenomenon11
. As a result different people
have come up with different definitions depending on the viewpoint of the policy maker,
8 Jill Solomon & Aris Solomon (2004): Corporate Governance and Accountability John Wiley & Sons,Ltd9 Websters New World Dictionary, Simon and Schuster.10 Te Puni Kkiri (Wed, 25 Oct 2006) Effective Governance [online]http://governance.tpk.govt.nz/why/index.aspx[accessed 13/08/2008]11 Encycogov.com, The Encyclopedia about corporate Governance,http://www.encycogov.com/WhatIsGorpGov.asp[accessed 14/08/08]
http://governance.tpk.govt.nz/why/index.aspxhttp://www.encycogov.com/WhatIsGorpGov.asphttp://www.encycogov.com/WhatIsGorpGov.asphttp://governance.tpk.govt.nz/why/index.aspx -
7/26/2019 Using the OECD Principles of Corporate G
12/103
12
practitioner, researcher or theorist.12There is therefore no single accepted definition of
the concept. Some take a narrow view, seeing governance as a fancy term for the way
in which directors and auditors handle their responsibilities towards shareholders. Others
expand the concept to explain a firms relationship to society, often blurring the
distinction between corporate governance and corporate social responsibility. Be that as it
may, it seems that existing definitions of corporate governance either adopt a narrow
view where corporate governance is restricted to the relationship between a company and
its shareholders (agency theory), or a broader view where corporate governance maybe
seen as a web of relationships, not only between a company and its owners (shareholders)
but also between a company and a broad range of other stakeholders: employees,
customers, suppliers, bondholders (stakeholder theory)13Cadburys definition is
illustrative of the former view
Corporate governance is the system by which companies are directed and controlled.
Boards of directors are responsible for the governance of their companies. The
shareholders role in governance is to appoint the directors and the auditors and to
satisfy themselves that an appropriate governance structure is in place. The
responsibilities of the board include setting the companys strategic aims, providing the
leadership to put them into effect, supervising the management of the business and
reporting to shareholders on their stewardship. The boards actions are subject to laws,
regulations and the shareholders in general meetings14
The OECD provides the most authoritative functional definition of corporate governance
that tally with the latter view.
"Corporate governance is the system by which business corporations are directed and
controlled. The corporate governance structure specifies the distribution of rights and
responsibilities among different participants in the corporation, such as, the board,
12 Lannoo (1995) states in this context: the notion of Corporate Governance is perceived differentlyfrom one country to anotheritsometimes refers to distinctly different matters for different persons andinstitutions, depending on the circumstances.
13 See generally Jill Solomon & Aris Solomon (2004): Corporate Governance and Accountability JohnWiley & Sons, Ltd pg 1214 Cadbury Report 1992 (The Financial Aspects of Corporate Governance) pg 14, 2.5
-
7/26/2019 Using the OECD Principles of Corporate G
13/103
13
managers, shareholders and other stakeholders, and spells out the rules and procedures
for making decisions on corporate affairs. By doing this, it also provides the structure
through which the company objectives are set and the means of attaining those objectives
and monitoring performance"15
Some writers16in defining corporate governance go as far as establishing a fiduciary
relationship between directors and shareholders:
Corporate Governance could be thoughtof as the combined statutory and non-
statutory framework within which boards of directors exercise their fiduciary
duties to the organizations that appoint them.
The key issue is that directors owe to shareholders, or perhaps to the corporation, two
basic fiduciary duties: the duty of loyalty and the duty of care17
One thing is clear from both definitions however, they tend to share certain
characteristics, paramount of which is the notion of accountability: either to shareholders
specifically or to shareholders and other stakeholders.
1.3 Origin of Corporate Governance
The etymology of the words corporate governance is derived from the ancient Greek and
Latin (though there are similar words in most languages). The word corporate derives
from the Latin word corpusmeaning body, and comes from the Latin verb corporareto
form into one body, hence a corporation represents a body of people that is a group of
people authorized to act as an individual.18The word governance is from the Latinized
Greekgubernatiomeaning management or government, and comes from the ancient
15 OECD April 1999.16 Alan Calder, Corporate Governance (2008), A Practical Guide to the Legal Frameworks andInternational Codes of Practice Kogan Page Limited, pg 317 Professor Bernard S Black, Stanford Law School, Presentation at Third Asian Roundtable on CorporateGovernance, April 2001.18 Clarke, T. 2007, International Corporate Governance: A Comparative Approach, Routledge, London pg1
-
7/26/2019 Using the OECD Principles of Corporate G
14/103
14
Greek,kybernaoto steer, to drive, to guide, to act as a pilot.19This etymological origin of
the concept of corporate governance captures a creative meaning of collective endeavor
that defies the contemporary inclination to place a passive and regulatory emphasis on the
phrase. Adrian Cadbury cites Cicero in conveying the original meaning of this contested
concept
Governance is a word with a pedigree that dates back to Chaucer and in his day
the word carried with it the connotation wise and responsible, which is
appropriate. It means either the action of governing or the method of governing
and it is in the latter sense it is used with reference to companiesA quotation
which is worth keeping in mind in this context is He that governs sits quietly at
the stern and scarce is seen to stir.20
Corporate governance has been practised for as long as there have been corporate entities
developed to resolve group relations in religious and social communities. These medieval
elements were transformed by the application of corporate ideas and practices of the
business enterprises that came later21Among these devices was the idea of incorporate
person-the interpretation of companies as legal persons with rights and duties.
In many ancient and modern organisations legal transactions had to be carried out and
duties incurred by the succession of joint holders of an office on behalf of a number of
people who were interested in carrying out a common purpose or object. There therefore
arose the need from the point of view of both private and public law to replace the vague
group by something more definite- an artificial person. Such corporate bodies recognised
by common law were applied to business organisations in England and Holland when
charters were granted to incorporate trading companies.
The problem of corporate governance actually arose with the formation of the first
trading company, where the distinction between ownership and leadership gave rise to
19 Id.20 Cadbury 2002: 121 Clarke, T. 2007, International Corporate Governance: A Comparative Approach, Routledge, London pg3,citing Redmond 2005:28
-
7/26/2019 Using the OECD Principles of Corporate G
15/103
15
the so-called agency problems between the ownership/shareholder on the one hand and
the manager/business manager on the other hand. It is believed that this occurrence took
place around 1602, with the formation in the United East India Company.22Investors
were disillusioned as they found their capital locked into a company only publishing its
accounts every ten years, and which insisted on paying dividends in spices (pepper, mace
and nutmeg)23LHeliasalso sees the origin of corporate governance in the distinction
between ownership and leadership24which she refers to as a societal schism.
However the study of the subject corporate governance is less than half a century old.
Indeed, the phrase 'corporate governance' was scarcely used until the 1980s. According to
Monks & Minow25the concept is one, which has only emerged in the last 10 years:
Whereas the systematic development and application of improved management
practices has been going on now for 100 years, the term Corporate Governance
has been in use for not much more than 10.26
Adam Smithin 1776 in The Wealth of Nations27made a comment on company
management that would echo through the ages: Being managers of other peoples money
than their own, it cannot well be expected that should watch over it with the same
anxious vigilance with which the partners in a private co-partnership frequently watch
over their ownNegligence and profusion, therefore, must always prevail more of less in
the management of the affairs of a joint stock company.
With the industrial revolution, there was advancement in technology and hence a wider
diffusion of ownership of many large companies owing to the fact that no individual,
22 Weimer, J., Pape, J.C. (1999), "A taxonomy of systems of corporate governance", Corporate
Governance: An International Review, Vol. 723 Clarke, T. 2007, International Corporate Governance: A Comparative Approach, Routledge, London pg3,citing Frentrop 2003: 75-7624 The pioneering work of Berle & Means (1932) looks closely at the consequences of this division for thegovernance and management of the enterprise.25 Robert A.G Monks and Nell Minow, Corporate Governance 1996, Blackwell Publishing26 For a general discussion on this, See Prof. dr. Lutgart Van Den Berghe & Liesbeth De Ridder:International Standardisation of Good Corporate Governance; BestPractice for the Board of Diractors,Kluwer Academic Publishers 199927 Smith 1976: 264-265
-
7/26/2019 Using the OECD Principles of Corporate G
16/103
16
family or group of managers could provide sufficient capital to sustain growth.
Columbian University professorsAdolf Berleand Gardiner Means coined the phrase the
separation of ownership and control in their landmark 1932 book The Modern
Corporation and Private Property, and it remains the most widely used expression in the
voluminous literature on corporate governance. It refers to their observation that during
the 1920s the structure of ownership in large corporations changed from the traditional
arrangements of owners managing their own companies to one in which shareholders had
become so numerous and dispersed that they were no longer willing or able to manage
the corporations they owned. They therefore basically made management decisions of the
corporation and claimed profits thereof. (These claims are sometimes called residual
claims to reflect that they accrue after all costs and fixed claims have been satisfied). In a
large publicly held corporation, the shareholders own residual claims but lack direct
control over management decision-making. Correspondingly, managers have control but
possess relatively small (if any) residual claims.
The influence ofBerle and Meanswork cannot be underestimated: it has coloured
thinking about the way companies are owned, managed, and controlled for over seventy
years, and represents the reality in many US and UK companies. Monks (2001)28states
The tendency during this period [the twentieth century] has been the dilution of the
controlling blocks of shares to the present situation of institutional and widely dispersed
ownershipownership without power.
The call ofBerle and Meansfor an increase in the recognition and scope of fiduciary
duties of those who controlled corporations influenced legal thinking for much of the
century. If this view fell from favour in the rampant opportunism of the 1980s and 1990s,
the importance of the principle of fiduciary duty has re-emerged with a vengeance in the
reaction to the revelations of managerial irresponsibility that were exposed in the US and
UK after the major corporate bankruptcies.Berle and Meansleft an enduring legacy in
their work written during the depths of the 1930s Great Depression, concerning the need
to enforce accountability and the responsible management of corporations, arguments
28 Robert A.G Monks and Nell Minow, Corporate Governance 1996, Blackwell Publishing
-
7/26/2019 Using the OECD Principles of Corporate G
17/103
17
that shaped the US Securities Acts of the 1930s that remain the basis for federal securities
law today29
1.4 Importance of Corporate Governance
We have come across companies which apparently were very efficiently managed but
which came to grief because the governance was not all right. Corporate governance is a
matter of high importance in the Company and is undertaken with due regard to all of the
Company's stakeholders and its role in the community. Good corporate governance is a
fundamental part of the culture and the business practices of any nation and its controlled
entities.Monks & Minow (1996)30affirms the fact that good governance is of national
importance by stating The government must explicitly adopt the policy that commercial
competiveness is a national priority and that an effective governance system is a
necessary precondition.Bain and Band (1996)31are of the same opinion and point out
that directors are thinking along the same lines: Companies and other enterprises with a
professional and positive attitude to governance are stronger and have a greater record of
achievement.
During the last decade, policy makers, regulators, and market participants around the
world have increasingly come to emphasize the need to develop good corporate
governance policies and practices. An increasing amount of empirical evidence shows
that good corporate governance contributes to competitiveness facilitates corporate
access to capital markets, and thus helps develop financial markets and spur economic
growth.
Today, both domestic and foreign investors place an ever-greater emphasis on the way
that corporations are operated and how they respond to their needs and demands.
29 Clarke, T. 2007, International Corporate Governance: A Comparative Approach, Routledge, London pg3,citing Holderness 200330 Robert A.G Monks and Nell Minow, Corporate Governance 1996, Blackwell Publishing31 Corporate Governance, Class materials in Corporate Governance and Shareholder Remedies,CGSR.4/900(SG), Faculty of Law, University of Hong Kong, 26 December 2000
-
7/26/2019 Using the OECD Principles of Corporate G
18/103
18
Investors are increasingly willing to pay a premium for well-governed companies that
adhere to good board practices, provide for information disclosure and financial
transparency, and respect shareholder rights. Well-governed companies are also better
positioned to fulfil their economic, environmental, and social responsibilities, and
contribute to sustainable growth.
Corporate governance is a key element in enhancing investor confidence, promoting
competitiveness, and ultimately improving economic growth. It is at the top of the
international development agenda as emphasized by James Wolfensohn, President of the
World Bank:
The governance of companies is more important for world economic growth than the
government of countries.
Improvement in corporate governance practices can improve the decision-making process
within and between a companys governing bodies, and should thus enhance the
efficiency of the financial and business operations. Better corporate governance also
leads to an improvement in the accountability system, minimizing the risk of fraud or
self-dealing by company officers. An effective system of governance should help ensure
compliance with applicable laws and regulations, and further, allow companies to avoidcostly litigation. Also, Russian companies should stand to benefit from a better reputation
and standing, both at home and in the international community.
Sound corporate governance is therefore very essential to the wellbeing of an individual
company and its stakeholders, particularly its shareholders and creditors. It ensures that
constituencies (stakeholders) with a relevant interest in the companys business are fully
taken into account. In addition, good governance can make a significant contribution to
the prevention of malpractice and fraud, although it cannot prevent them absolutely.
1.5 Theoretical Aspects of corporate governance
-
7/26/2019 Using the OECD Principles of Corporate G
19/103
19
There are several diverse and well-established theories associated with corporate
governance. They approach corporate governance in different ways using different
terminology. They each attempt to analyse the same problems but from different
perspectives. Tricker (1996:31) states:
Stewardship theory, stakeholder theory and agency theory are all essentially
ethnocentric. Although the underlying ideological paradigms are seldom
articulated, the essential ideas are derived from Western thought, with its
perceptions and expectations of the respective roles of individual, enterprise and
the state and of the relationships between them.
1.5.1 Agency Theory
Agency theory argues that in the modern corporation, in which share ownership is widely
held, managerial actions depart from those required to maximise shareholder returns.32
The agency relationship is a contract under which one party (the principal) engages
another party (the agent) to perform some services on their behalf. As part of this, the
principal will delegate some decision-making authority to the agent. Jensen and Meckling
argue that, the agency theory rests upon this contractual view of the firm.
The agency problems basically arise because of the impossibility of perfectly contracting
for every possible action of an agent whose decisions affect both his own welfare and the
welfare of the principal. Arising from this problem is how to induce the agent to act in the
best interests of the principal.
The essence of the agency problem is the separation of management and finance.
Managers raise funds from investors to put them to productive use or to cash out their
holdings in the firm. Financiers need the managers specialised human capital to generatereturns on their funds.33A contract is signed in principle wherein both parties specify
32 Berle, A. and Means, G (1932) The Modern Corporation and Private Property, New York. AND Jensen,M. C. and Meckling, W. H. (1976) Theory of the Firm: Managerial behaviour, agency, costs and
ownership structure, Journal of Financial Economics, 3, October 305-360.33 Thomas Clarke: Theories of Corporate Governance The Philosophical Foundations of corporateGovernance, Taylor & Francis ltd, pg 5
-
7/26/2019 Using the OECD Principles of Corporate G
20/103
20
what the mangers do with the funds, and how the returns are divided between them and
the financiers. The problem that arises as a result of this system of corporate ownership is
that the agents do not necessarily make decisions in the interests of the principal.34
Agency theory offers shareholders a pre-eminent position in the firm legitimized not by
the idea that they are the firms owners, but instead its residual risk takers. Fama35
emphasises the irrelevance of ownership:
Ownership of capital should not be confused with ownership of the firm. Each
factor in a firm is owned by somebody. The firm is just the set of contracts
covering the way inputs are joined to create outputs and the way receipts from
outputs are shared among inputs. In this nexus of contracts perspective,
ownership of the firm is an irrelevant concept.
In the context of corporations and issues of corporate control, agency theory views
corporate governance mechanisms, especially the board of directors, as being an essential
monitoring device to try to ensure that any problems that may be brought about by the
principal-agent relationship are maximized. Blair (1996) states:
Managers are supposed to be the agent of a corporations owners, but
managers must be monitored and institutional arrangements must provide some
checks and balances to make sure they do not abuse their power. The costs
resulting from managers misusing their position, as well as the costs of
monitoring and disciplining them to try to prevent abuse, have been called
agency cost
The total agency cost arising from the agency problem has been summarised as
comprising of: the sum of the principals monitoring expenditures; the agents bonding
34 See generally Jill Solomon & Aris Solomon (2004): Corporate Governance and Accountability JohnWiley & Sons, Ltd pg 1735 Fama, E. F. (1980) Agency problems and the theory of the firm, Journal of Political Economy, 88,288-307
-
7/26/2019 Using the OECD Principles of Corporate G
21/103
21
expenditures; and any remaining residual loss36. It is contended that risk sharing is one
of the main reasons that the desired actions of principal and agent diverge.37This is
because of their different attitudes toward risk38
A basic conclusion of agency theory is that the value of a firm cannot be maximised
because managers possess discretions, which allow them to expropriate value to
themselves. In an ideal world, managers would sign a complete contract that specifies
exactly what they could do under all states of the world and how profits would be
allocated. The problem is that most future contingencies are too hard to describe and
foresee, and as a result, complete contracts are technologically unfeasible.
1.5.2 Stakeholder Theory
The definition of stakeholderis not set in stone. Indeed, there are almost as many
varying definitions of what a stakeholder is and who can be characterised as a
stakeholder as there are individuals who have written about stakeholders in corporate
governance.
One very broad definition of a stakeholder is any group or individual which can affect or
is affected by an organization." Such a broad conception would include suppliers,
customers, stockholders, employees, the media, political action groups, communities, and
governments. A more narrow view of stakeholder would include employees, suppliers,
customers, financial institutions, and local communities where the corporation does its
business. But in either case, the claims on corporate conscience are considerably greater
than the imperatives of maximizing financial return to stockholders.
The stakeholder theory was first presented by Freeman39, who proposed a general theory
of the firm, incorporating corporate accountability to a broad range of stakeholders. It is
a theory of organisational management and business ethics that addresses morals and
36 Hill, C. W. and Jones , T. M. (1992) Stakeholder-agency theory, Journal of Management Studies,29,134-13537 ibid 5 at pg 1738 Shankman, N. A.(1999) Reframing the debate between agency and stakeholder theories of the firm,Journal of Business Ethics, 19, 319-33439 Freeman, E. (1984) Strategic Management: A stakeholder Approach, Pitman Press, Boston
-
7/26/2019 Using the OECD Principles of Corporate G
22/103
22
values in managing an organisation.40The stakeholder theory takes account of a wider
group of constituents rather than focusing on shareholders. .
In the UK the Corporate Report (ASSC, 1975) was a radical proposal for its time, which
suggested that companies should be made accountable for their impact on a wide group
of stakeholders. The way that the Corporate Report hoped to achieve this was by
encouraging companies to disclose voluntarily a range of statements aimed for
stakeholder use, in addition to the traditional profit and loss account and balance sheet.
This was the first time that such an all encompassing approach to financial reporting was
considered seriously by a professional UK accounting body.41
An interesting development in relation to the stakeholder theory is that put forward by
Jensen, who state s that traditional stakeholder theory argues that the managers of a firm
should take account of the interests of all stakeholders in affirm but, because the theorists
refuse to say how the trade-offs against the interests of each of these stakeholder groups
might be made, there are no defined measurable objectives and this leaves managers
unaccountable for their actions. Jensen therefore advocates enlightened value
maximisation, which he says is identical to enlightened stakeholder theory: Enlightened
value maximisation utilises much of the structure of stakeholder theory but accepts
maximisation of the long-run value of the firm as the criterion for making the requisite
trade-offs among its stakeholdersand therefore solves the problems that arise from
multiple objectives that accompany traditional stakeholder theory.
1.5.3 Stewardship Theory
The stewardship theory was propounded by Donaldson and Davis42who cautioned
against accepting agency theory and argued a view of managerial motivation alternative
to the agency theory and which was termed stewardship theory. In the stewardship
40 Phillips, R. Robert Edward Freeman (2003). Stakeholder Theory and Organisational Ethics. Berrett-Koehler Publisher41 ibid 5 at pg 2442 DONALDSON, L.; DAVIS, J.H. (1991). Stewardship Theory or Agency Theory: CEO governance andshareholder returns. Australian Journal of Management. Vol.16, 1, pp.49-64.
-
7/26/2019 Using the OECD Principles of Corporate G
23/103
23
model, 'managers are good stewards of the corporations and diligently work to attain high
levels of corporate profit and shareholders returns'.43
They state that the owners-managers relationship depends on the behaviour adopted
respectively by them. Managers choose to act as agent or as steward according to certain
personal characteristics and their own perceptions of particular situational factors.
Principals choose to create a relationship of one type or the other depending on their
perceptions of the same situational factors and of their managers psychological
mechanisms.
The executive manager, under this theory, far from being an opportunistic shirker,
essentially wants to do a good job, to be a good steward of the corporate assets. The
executive managers pro-organisational actions are best facilitated when the corporate
governance structures give them high authority and discretion.
Thus, stewardship theory holds that there is no inherent, general problem of executive
motivation. Given the absence of an inner motivational problem among executives, there
is the question of how far executives can achieve the good corporate performance to
which they aspire. Thus, stewardship theory holds that performance variations arise from
whether the structural situation in which the executive is located facilitates effective
action by the executive. The issue becomes whether or not the organisation structure
helps the executive to formulate and implement plans for high corporate performance.
Structures will be facilitative of this goal to the extent that they provide clear, consistent
role expectations and authorise and empower senior management.
Stewardship theory stresses the beneficial consequences on shareholder returns of
facilitative authority structures which unify command by having roles of executive
director and chair held by the same person. The safeguarding of returns to shareholders
may be along the track, not placing management under greater control by owners, but by
empowering managers to take autonomous executive action.
43 Id
-
7/26/2019 Using the OECD Principles of Corporate G
24/103
24
It is therefore been seen that the above theories have influenced the development of
corporate governance The preceding chapters will cover the OECD principles of
corporate governance which will in tend be used as a benchmark to see how they are
being used and complied with in the UK, US and South
-
7/26/2019 Using the OECD Principles of Corporate G
25/103
25
CHAPTER 2
The OECD Principles of corporate Governance
2.1 Historical Background
The OECD grew out of the Organisation for European Economic Co-operation (OEEC),
which was set up in 1948 with support from the United States and Canada to co-ordinate
the Marshall Plan for the reconstruction of Europe after World War II
The OECD is a unique forum where the governments of 30 market democracies work
together to address the economic, social and governance challenges of globalisation as
well as to exploit its opportunities.
The Organisation provides a setting where governments can compare policy experiences,
seek answers to common problems, identify good practice and co-ordinate domestic and
international policies. It is a forum where peer pressure can act as a powerful incentive to
improve policy and which produces internationally-agreed instruments, decisions and
recommendations in areas where multilateral agreement is necessary for individual
countries to make progress in a globalised economy.
The OECD principles of corporate governance were developed as a result of f inancial
crises and a series of corporate scandals and failures that began in East Asia and rapidly
spread to Russia44Investors in the affected countries watched helplessly as their
investments crashed due to systematic failures of investor protection mechanisms,
combined with weak capital market regulation.45These financial crisis and the corporate
scandals raised serious concerns about the stability of the international financial market
and further focused the minds of governments, regulators, companies, investors and the
44 Gregary H, The Globalisation of Corporate Governance (2002), 245 Jesover F and Kirkpatrick G, The revised OECD Principles of Corporate Governance and theirrelevance to Non-OECD Countries (2004), 2
-
7/26/2019 Using the OECD Principles of Corporate G
26/103
26
public on weaknesses in corporate governance systems.46This situation created some
awareness on the need for good corporate governance and the importance of an official
corporate governance regime, which could underpin market confidence, integrity and
efficiency as well as assist in the strengthening of economic growth47.
In response to the growing awareness of the importance of good corporate governance
and a model of corporate governance applicable to all countries, the OECD was asked by
Ministers in 1998 to develop a set of standards and guidelines for presentation to
Ministers by May 199948, which became known as the OECD principles of corporate
governance
At a council meeting in May 1999 the Ministers agreed and adopted principles, which
have been referred to as the first initiative by an inter-governmental organisation to
develop the core elements of a good corporate governance regime.
Since the principles were agreed in 1999, they have formed the basis for corporate
governance initiatives in both OECD and non-OECD countries alike. The OECD
Principles 1999 provided the landscape for the establishment of regional corporategovernance roundtables in cooperation with the World Bank and the International
Monetary Fund.49In fact the international monetary fund adopted the OECD Principles
as a benchmark instrument for their member countries and surveillance procedures.50
Moreover, they have been adopted as one of the Twelve Key Standards for Sound
46 Ibid47 Chee L, Corporate Governance: An Asia-Pacific Critique (2002), 55. See also Kirkpatrick G, ImprovingCorporate Governance Standards: The Work of the OECD and the Principles (2005).48 To fulfil the Ministerial mandate, the OECD established an AD-Hoc Task Force, comprised of allMember governments: the European Commission; four international organisations (the World Bank,International Monetary Fund, Basle Committee on Banking Supervision, and the international Organisationof Securities Commission); the OECDs Business and Industry Advisory Committee (BIAC) and TradeUnion Advisory Committee (TUAC); and representatives from selected other private sector organisations.49 Ibid 42 at 1850 Ibid
-
7/26/2019 Using the OECD Principles of Corporate G
27/103
27
Financial Systems by the Financial Stability Forum. Accordingly, they form the basis of
the World Bank/IMF Reports on the Observance of Standards and Codes (ROSC).51
The principles were however revised in 2004 following high-profile cases of Corporate
Governance failure. There was therefore the need to take into account new developments
and concerns
2.2 How the Principles Work
Generally, the OECDs way of working consists of a highly effective process that begins
with data collection and analysis and moves on to collective discussion of policy, then
decision-making and implementation. Mutual examination by governments, multilateral
surveillance and peer pressure to conform or reform are at the heart of OECD
effectiveness in areas such as corporate governance.
The principles offer broad guidance for governments to follow when reviewing whether
their corporate governance framework is compatible with establishing the corporate
governance they want. Policy makers are encouraged to develop the governance
framework with a view to its impact on overall economic performance, market integrity
and incentives it creates for market participants and the promotion of transparent and
efficient markets. This should help reduce the risk of costly over-regulation and minimise
the unintended consequences of policy measures. To underpin market integrity, the legal
and regulatory requirements that affect corporate governance practices should be
consistent with the rule of law, transparent and enforceable
The OECD principles of corporate governance are Non-binding. They are principle-based
and non prescriptive and are intended to assist OECD and non-OECD governments, and
to provide guidance for stock exchanges, investors, corporations and others related to
Corporate Governance. It is up to governments and market participants to decide how to
apply these Principles in developing their own frameworks for corporate governance,
taking into account the costs and benefits of regulation.The non prescriptive nature of the
51 Using the OECD Principles Of Corporate Governance: A Boardroom Guide. OECD 2008
-
7/26/2019 Using the OECD Principles of Corporate G
28/103
28
principles is its principle success as the principles retain their relevance in varying legal,
economic and its social contexts
The Principles focus on publicly traded companies, both financial and non-financial.
However, to the extent they are deemed applicable, they might also be a useful tool to
improve corporate governance in non-traded companies, for example, privately held and
state owned enterprises. The Principles represent a common basis that OECD member
countries consider essential for the development of good governance practices.
Since 1999, the OECD Corporate Governance Principles have become the globally
recognised benchmark in the area of corporate governance. They have been used as a
basis for development of regulatory frameworks in many countries. They have also been
endorsed by the Financial Stability Forum as one of twelve key standards considered
essential for financial stability. In addition, the IMF and World Bank have been using the
Principles as a benchmark in their country Reports on the Observance of Standards and
Codes.
Equally very importantly is the fact that the principles are used as the reference point by
the private sector. It is believed that today there is hardly any initiatives that do not use
the OECD Principles as the reference point or benchmark. This is the attraction of the
Principles. They provide a common language and a shared aspiration that everyone can
understand and relate to.52
52 Veronique Ingram, Speech to ICGN Annual Conference. Rio De Janiero8 JULY 2004. Online athttp://www.midcgroup.com/j_libry/2_ICGN%E5%B9%B4%E6%AC%A1%E5%A4%A7%E4%BC%9A%E3%82%B9%E3%83%94%E3%83%BC%E3%83%81%EF%BC%88%E5%8E%9F%E6%96%87OECD%20VI%20jun04%EF%BC%89.pdf accessed 09/09/2008
-
7/26/2019 Using the OECD Principles of Corporate G
29/103
29
2.3 Reasoning behind the Principles
As has been seen earlier, as a consequence of corporate scandals53, the minds of
governments, regulators, companies, investors and the general public were focused on
weaknesses in corporate governance systems and the need to address this issue.
The OECD principles of corporate governance were therefore developed not as a panacea
to this but as guidance to policymakers, regulators and the market participants in
improving the legal, institutional and regulatory framework that underpins corporate
governance, with a focus on publicly traded companies. The principles are meant to
provide practical suggestions for stock exchanges, investors, corporations and other
parties that have a role in the process of developing good corporate governance.
The Principles are intended to assist OECD and non-OECD governments in their efforts
to evaluate and improve the legal, institutional and regulatory framework for corporate
governance in their countries and to provide guidance and suggestions for stock
exchanges, investors, corporations, and other parties that have a role in the process of
developing good corporate governance. They are intended to be concise, understandable
and accessible to the international community. They are not intended to substitute for
government, semi-government or private sector initiatives to develop more detailed bestpractice in corporate governance.
54
The original text of the OECD Principles basically evolved to be a statement of existing
good corporate governance practices in OECD countries. It served to provide a non-
binding statement of the key elements essential for good corporate governance just the
basic necessities. The Principles were designed to assist policy advisers in evaluating and
improving the legal, regulatory and institutional framework underpinning corporate
governance. As such, the Principles have served as a guide to governments, regulators,
stock exchanges, directors, investors and other market participants regarding good
practice.
53 For example, the collapse of Enron, Tyco and WorldCom in the United Sates, Maxwell and BCCI in theUnited Kingdom;54 Preamble OECD principles of Corporate Governance 2004
-
7/26/2019 Using the OECD Principles of Corporate G
30/103
30
2.4 OECD Principles (1999) Critical Content
The Principles address governance problems that result from the separation of ownership
and control in the modern corporation. They identify the critical elements required for
good governance. They describe the basic elements of an effective corporate governance
framework for corporations that seek to attract capital from equity investors.
Specifically, they focus upon:
Rights of Shareholders
Equitable Treatment of Shareholders
Role of Stakeholders in Corporate Governance
Disclosure and Transparency
The Responsibilities of the Board
2.4.1 Core Standards
According to the Millstein Report (1998)55, corporate governance takes place within the
corporation and as such it depends very much on investors, boards and managements for
its successful implementation. The report noted that for corporate governance to be
effective in attracting capital, it must focus on four important areas. The OECD
Principles 1999 were built on these core standards: fairness, transparency, accountability,
and responsibility.
(a) Fairness
In relation to this core concept, two separate principles were developed. The first
principle states that the corporate governance framework should protect the rights of
shareholders. This includes both their proprietary as well as their participatory rights.
Effective corporate governance depends on laws, procedures and practices that protect
their property right and ensure the security of ownership as well as the unfettered
55 Millstein, I.M. (1998). The Evolution of Corporate Governance in the United States, Remarks to theWorld Economic Forum, Davos, Switzerland (February 2, 1998).
-
7/26/2019 Using the OECD Principles of Corporate G
31/103
31
transferability of shares. This principle also recognizes their participatory rights on key
corporate decisions such as the election of directors and the approval of major mergers or
acquisitions.
The second principle states that the corporate governance framework should ensure the
equitable treatment of all shareholders including the minority and foreign shareholders
and that all shareholders should have the opportunity to obtain effective redress for
violation of their rights. This means that the legal framework should include laws that
protect the rights of the minority shareholders against misappropriation of assets or self-
dealing by the controlling shareholders, managers or directors.
(b) Responsibility
The third principle states that the corporate governance framework should recognize the
rights of stakeholders as established by law and encourage active cooperation between
corporations and stakeholders in creating wealth, jobs and the sustainability of financially
sound enterprises. This means that corporations must abide by the laws and regulations
of the countries in which they operate. However, laws and regulations impose only
minimal expectations as to conduct and corporations should be encouraged to act
responsibly and ethically with special consideration for the interests of stakeholders
particularly the employees. It is now acknowledged that socially responsible corporate
conduct is consistent with the principle of shareholder wealth maximization. In numerous
countries around the globe, the practice of corporate social responsibility accounting is
now well established with corporations going beyond the legal requirements to provide
health care and retirement benefits, financially supporting education and formulating and
adopting environmentally friendly technologies. Similarly other companies strive to
avoid practices, which are socially undesirable even if not prohibited under the law.
(c) Transparency
The fourth principle states that the corporate governance framework should ensure that
timely and accurate disclosure is made on all material matters regarding the corporation
including the financial situation, performance, ownership and governance of the
company. This is in recognition of the fact that both investors and shareholders need
-
7/26/2019 Using the OECD Principles of Corporate G
32/103
32
information regarding the financial and operating performance of the company as well as
information about their corporate objectives and material risk exposures. This
information should be prepared in accordance with internationally acceptable accounting
and auditing standards and should be subject to an independent audit, which is conducted
annually. The use of internationally accepted accounting standards would enhance
comparability and assist both investors and analysts in comparing corporate performance
and decision-making based on their relative merits. Likewise information about the
companys governance such as share ownership, voting rights, identity of board
members, key executives and executive compensation is also a critical component of
transparency.
(d) Accountability
The fifth principle states that the corporate governance framework should ensure the
strategic guidance of the company, the effective monitoring of management by the board
as well as the boards accountability to the company and the shareholders. This principle
implies a legal duty on the part of the directors to the company and its shareholders. The
directors are said to have a fiduciary relationship to both the shareholders and the
company, which requires that they avoid self-interest in their decision-making and act
diligently and on a fully informed basis. This principle also recognizes the duty of the
board to oversee the professional managers who have been entrusted to run the company
and who are accountable to the board for the use of firm assets. Thus the board acts as a
mechanism for minimizing the agency problem inherent in the separation of ownership
and control. If the board is to be an effective monitor of managerial conduct it must be
suitably distinct from the management in order to be objective in its assessment of
management. This requires that some of the directors are neither members of the
management team nor closely related to them through family or business ties. A critical
aspect of effective corporate governance is the quality of the directors. Objective
oversight therefore necessitates the participation of professionally competent non-
executive and independent directors on the board. The latter must have the capability,
fiduciary commitment and objectivity to provide strategic guidance and monitor
performance on behalf of the shareholders. In order for the board to be able to play their
-
7/26/2019 Using the OECD Principles of Corporate G
33/103
33
roles effectively, they should meet often, at least once every three months and if possible
more often. Additionally, for the non-executive directors to be effective and to ensure
that independent oversight has meaning, they must have access to important information
in advance of board meetings. In the developed countries, board committees have played
an important role in performing detailed board work. In these countries, it is common to
rely on an audit committee, remuneration committee and a nomination committee staffed
either wholly or primarily with non-executive or independent directors.
2.5 OECD Principles (2004)
In 2004, at a Council Meeting at Ministerial Level, the OECD agreed to survey
developments in OECD countries and to assess the Principles in light of developments in
corporate governance. This task was entrusted to the OECD Steering Group on Corporate
Governance, which comprises representatives from OECD countries.56Review
committees were established and, in some countries, significant policy initiatives were set
in motion. Further, the OECD implementation process continued in developing and
transition countries. However, systemic corporate failures and scandals57
continued to
occur and undermine confidence in the integrity of corporations, financial institutions and
the market generally. Accordingly, the OECD Ministerial Council formally launched areview process in 2002 which resulted in the call for a reassessment of the OECD
Principles 1999 by 2004.58
The OECD Steering Group on Corporate Governance was entrusted with the task of
undertaking a survey and consultations with member countries highlighting the key
features of corporate governance arrangements and requesting comments on some
significant issues that had not been addressed in the OECD Principles 1999.59
Consultations were also made with experts from a large number of countries which took
56 OECD Principles of Corporate Governance 2004, 957 For example, the collapse of Enron, Tyco and WorldCom in the United Sates, Maxwell and BCCI in theUnited Kingdom58 Trade Union Advisory Committee (TUAC) to the OECD, The OECD Principles of CorporateGovernance: An Evaluation of the 2004 Review by the TUAC Secretariat, (2004) 659 Ibid
-
7/26/2019 Using the OECD Principles of Corporate G
34/103
34
part in the Regional Corporate Governance Roundtables that the OECD organized in
Russia, Asia, South East Europe, Latin America and Eurasia with the support of the
Global Corporate Governance Forum and others, and in co-operation with the World
Bank and other non-OECD countries as well.60There was also some participation of
leading business and labor representatives, including the OECDs Business Industry
Advisory Committee61and Trade Union Advisory Committee.62
A draft of the revised Principles was later in January 2004 made public by putting them
up on the OECD website for comment. This attracted a number of responses. Based on
these responses and comments from the general public it was concluded that the 1999
Principles should be revised to take into account new developments and concerns.63It
was agreed that the revision should be pursued with a view to maintaining a non-binding
principles-based approach, which recognises the need to adapt implementation to varying
legal economic and cultural circumstances. It is worthy of note that the revised principles
thus build upon a wide range of experience not only in the OECD area but also in non-
OECD countries.64
The new OECD principles of corporate governance focused primarily on public
companies and on developing corporate governance in emerging countries.65The OECD
recognises that one size does not fit all, that is, there is no single model of corporate
governance that is applicable to all countries. However the principles represent a certain
common characteristics that are fundamental to good corporate governance.66The
Principles build on these common elements and are formulated to
60 OECD Principles of Corporate Governance 2004, 961 The Business Industry Advisory Committee to the OECD is an independent organisation officiallyrecognised by the OECD as being representative of the OECD business community. Its members are themajor industrial and employers organisations in the 30 OECD member countries. The principal objective
of the Committee is to ensure that business andindustry needs are adequately addressed in OECD policyinstruments.62 The Trade Union Advisory Committee to the OECD is an interface for labour unions with the OECD. Itis an international trade union organisation which has consultative status with the OECD and its variouscommittees.63 OECD Principles of Corporate Governance 2004, 1064 OECD Principles of Corporate Governance 2004, 1065 Alan Calder: 2008 Corporate Governance A practical Guide to the Legal Frameworks andInternational Codes of Practice, Kogan Page66 Christine A. Mallin: Corporate Governance2007 Oxford University Press, second Edition
-
7/26/2019 Using the OECD Principles of Corporate G
35/103
35
embrace the different models that exist. They provide solutions to governance problems
that stem from the separation of ownership and control, and suggest methods of dealing
with complex issues relating to shareholders, employees, boards, management, and
decision-making.There are six high level principles each supported by a number of
recommendations.67
I. Ensuring the basis for an effective corporate governance framework
This is an innovation from the previous 1999 OECD principles of corporate governance.
It deals with the basis for ensuring an effective enforcement of the principles. To ensure
an effective corporate governance framework, it is important to improve the enforcement
of existing laws and regulations. It is necessary to put in place an appropriate and
effective legal, regulatory and institutional foundation is established upon which all
market participants can rely in establishing their private contractual relations. The
drafters of the OECD principles therefore established the fact that it was very necessary
for an effective mechanism to be put in place in overseeing the enforcement of the
principles.
The corporate governance framework should promote transparent and efficient markets,
be consistent with the rule of law and clearly articulate the division of responsibilities
among different supervisory, regulatory and enforcement authorities.68
A. The corporate governance framework should be developed with a view to its impact
on overall economic performance, market integrity and the incentives it creates for
market participants and the promotion of transparent and efficient markets.
B. The legal and regulatory requirements that affect corporate governance practices in a
jurisdiction should be consistent with the rule of law, transparent and enforceable.
C. The division of responsibilities among different authorities in a jurisdiction should be
clearly articulated and ensure that the public interest is served.
67 Ibid68 OECD principles of corporate governance 2004 at pg 17
-
7/26/2019 Using the OECD Principles of Corporate G
36/103
36
D. Supervisory, regulatory and enforcement authorities should have the authority,
integrity and resources to fulfill their duties in a professional and objective manner.
Moreover, their rulings should be timely, transparent and fully explained.
II. The Rights of Shareholders
It is a generally accepted principle of good corporate governance that organizations
should respect the rights of shareholders and help shareholders to exercise those rights.
They can help shareholders exercise their rights by effectively communicating
information that is understandable and accessible and encouraging shareholders to
participate in general meetings
Chapter 2 of the 2004 principles is an amendment to chapter one of the 1999 principles.
The chapter concerns the protection of shareholders rights and the ability of shareholders
to influence the behavior of corporations. Shareholders have a right for their shares to be
registered and secured.
The Principles list some basic rights including those to: secure methods of ownership
registration, convey or transfer shares, obtain relevant and material information on the
corporation on a timely and regular basis, participate and vote in general shareholder
meetings, elect and remove members of the board and share in the profits of the
corporation.69In addition Shareholders per the 2004 principles have been empowered to
participate in, and to be sufficiently informed on, decisions concerning fundamental
corporate changes such as amendments to the statute, authorisation of additional shares,
extraordinary transactions, including the transfer of all or substantially all assets that in
effect result in the sale of the company.70
The 2004 principles further made amendments to ownership rights for all shareholders,
including institutional investors. Under the original OECD Principles 1999, there was no
mention of the need to facilitate the exercise of ownership rights by institutional
investors. The revised Chapter 2 encourages authorities to allow institutional investors to
69 OECD Principles 2004, Chapter 2, Principle A.70OECD Principles 2004, Chapter 2,.Principle B
-
7/26/2019 Using the OECD Principles of Corporate G
37/103
37
cooperate and consult with each other on issues of corporate governance.71 It is a
significant improvement to include a provision calling for an active ownership policy by
institutional investors. The chapter also recommends that institutional investors maintain
a good practice of disclosing information to the market.72This has been said to be
particularly important for trade unions in pre-funded retirement systems, collective
investment schemes and some activities of insurance companies.73
It is worthy of note that some of the innovations in the 2004 OECD principles have been
criticised. Union Network international74commented that it would have been more clear
and concise if the title of the chapter referred to the rights and responsibilities of
shareholders.75It is further argued that, although the chapter calls for shareholders
effective participation in the nomination of directors, it does not explain or introduce the
means by which shareholders can effectively access the nomination process, specifically,
the company material.76
On his part, George Loladze,77is to the opinion that chapter 2
should have been amended with a more specific and detailed requirement that
shareholders have the opportunity to effectively buy or sell shares.78
III. Equitable Treatment of Shareholders
Chapter 3 of the 2004 principles is an equivalent of chapter 2 of the 1999 principles
which generally calls for an equitable treatment of all shareholders, including minority
and foreign shareholders. The 2004 principles place more emphasis on minority
shareholders. It calls for their protection from abusive actions by, or in the interest of,
71 OECD Principles 2004, Chapter 2, Principle G.72 OECD Principles 2004, Chapter 2, Principle F.73 Trade Union Advisory Committee (TUAC) to the OECD, The OECD Principles of CorporateGovernance: An Evaluation of the 2004 Review by the TUAC Secretariat, (2004), 1374 For more information about the union network see www.union-network.org.75 OECD, Comments Received from Web consultations, Union Network International (UNI) (2004).76 Ibid77 He is the Chairman of the Supervisory Board of the Georgian Stock Exchange.78 OECD, Comments Received from Web consultations, George Loladze, Chair, Supervisory Board,Georgian Stock Exchange (2003).
-
7/26/2019 Using the OECD Principles of Corporate G
38/103
38
controlling shareholders acting either directly or indirectly, and should have effective
means of redress.79
Another innovation to this chapter was the modification of the provision relating to
disclosure to read Members of the board and key executives should be required to
disclose to the board whether they, directly, indirectly or on behalf of third parties, have a
material interest in any transaction or matter directly affecting the corporation.80Lastly a
new clause was introduced in this chapter to the effect that impediments to cross border
voting should be eliminated.81
Some commentators82are of the view that the principles do not recognise the concept of
one share one vote as best practice, as this is increasingly the case in governance
regimes around the world. This therefore means the principle will benefit one set of
shareholders at the expense of the others and will act as a deterrent to takeovers by
entrenching management. They further hold that any benefits from the dual share
structures are outweighed by the potential for abuse as identified in the Principles in
section A.2.
IV. The role of the stakeholders in corporate governance
Chapter 4 of the 2004 principles is an equivalent of chapter 3 of the 1999 principles. The
chapter recognises the rights of stakeholders as established by law and encourage active
co-operation between corporations and stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises. The chapter also provides that the rights of
stakeholders that are established by law or through mutual agreements are to be
respected.83 Principle C84has been modified to read as performance-enhancing
79 OECD Principles 2004, Chapter 3, Principle A2.80 OECD Principles 2004, Chapter 3, Principle C.81 OECD Principles 2004, Chapter 3, Principle A4.82 OECD, Comments Received from Web consultations, Australian Pensions & Investment ResearchConsultant Ltd (PIRC) (2003).
83 OECD Principles 2004, Chapter 4, Principle A.
-
7/26/2019 Using the OECD Principles of Corporate G
39/103
39
mechanisms for employee participation should be permitted to develop. This
modification is important as it seeks to allow such performance mechanisms to develop,
especially in countries where they have no effective mechanisms to ensure and encourage
employees to participate in the corporate governance of the company.
Chapter 4 of the 2004 principles also call for individual employees and their
representative bodies, to be able to freely communicate their concerns about illegal or
unethical practices to the board and their rights should not be compromised for doing
this.85This new principle advocates protection for whistleblowers, including institutions
through which their complaints or allegations can be addressed and provides for
confidential access to a board member. Effective enforcement of this is covered by
principle F86of the same chapter.
The new principle was not totally satisfactory to some commentators. The FIDH87
for
instance was particularly concerned with the lack of a definition for a stakeholder.
According to the FIDH88the chapter should have included a definition of stakeholders as
given by the Norms on the responsibilities of transnational corporations and other
business enterprises with regard to human rights adopted by the Sub-Commission on
human rights in august 200389The FIDH also pointed the vagueness of the wording of
chapter 4 regarding the participation of stakeholders, pointing out that it falls short of an
objectively effective mechanism to ensure stakeholder participation. This criticism was
particularly targeted at Principles B1, C, and D. It was contended that these provisions
allow a wide margin of discretion to managers with respect to the information they agree
84 OECD Principles 2004, Chapter 4, Principle C.
85 OECD Principles 2004, Chapter 4, Principle E.86 The corporate governance framework should be complemented by an effective, efficient insolvencyframework and by effective enforcement of creditor rights.87 International Federation for Human Rights88 OECD, Comments Received from Web consultations, The International Federation for Human Rights(IFHR) (2003).89 See Norms on the responsibilities of transnational corporations and other business enterprises withregard to human r ights, (E/CN.4/Sub.2/2003/12/Rev.2) for its definition of a stakeholder
-
7/26/2019 Using the OECD Principles of Corporate G
40/103
40
to make public and they do not go far enough to ensuring access to judicial recourses for
affected stakeholders.90
V. Disclosure and Transparency
Chapter 6 of the 2004 principles again is the equivalent of chapter 5 of the 1999
principles. Key elements of the disclosure and transparency provision include
Major share ownership and voting rights
Material foreseeable risk factors
Full financial disclosure
Governance structure and policies, and what code if any followed
Information should be prepared audited and disclosed in accordance with high
standards of accounting, audit and non financial disclosure
Regular continuous disclosure
Full disclosure of related party transactions, usually with controlling shareholders
Some exciting additions were made to these provisions which significantly improved
standards for disclosure and auditing procedures. 91New Disclosure issues for intellectual
asset driven economy were also added to the 2004 principles.92
Another new principle
was introduced providing that the corporate governance framework should include an
effective approach to ensure the integrity of those professions that serve as conduits of
analysis and advice to the market, such as brokers, analysts, and rating agencies.93
Unlike the foregoing chapters, Chapter 5 did not go unnoticed in relation to flaws
from some commentators and prominent business societies. FIDH94was not
90 OECD, Comments Received from Web consultations, International Federation for Human Rights(FIDH) (2003).91 See for instance OECD Principles 2004, Chapter 5, Principle A and C relating to Disclosurerequirements for board members and key executives; and the requirement for an annual external auditrespectively92 OECD Principles 2004, Chapter 5, Principle D.93 OECD Principles 2004, Chapter 5, Principle F.94 OECD, Comments Received from Web consultations, International Federation for Human Rights(FIDH) (2003).
-
7/26/2019 Using the OECD Principles of Corporate G
41/103
41
happy with the chapters limited scope on material to be disclosed by a company
and called for disclosure obligations of a company to include the companys
policies regarding human rights, social and environmental responsibilities, as well
as the actual impact on such activities.95
VI. Responsibility of the Board
Chapter 6 of the 2004 principles is an equivalent to chapter 5 of the 1999 principles.
Many of the provisions of the chapter were modified and some new ones added. The
duties and responsibilities of the board have been clarified as fiduciary in nature,
particularly important where company groups are concerned. The principle covering
board independence and objectivity has been extended to avoid conflicts of interest and
to cover situations characterised by block and controlling shareholders, as well as the
board's responsibility for oversight of internal control systems covering financial
reporting.
Board members are required to act on a fully informed basis, in good faith, with due
diligence and care, and in the best interest of the company and the shareholders.96The
chapter also calls for fairness on the part of the board and to apply high ethical
standards.97This is a new modification from the 1999 principles when looking at the
interest of shareholders.
Other changes were made to the key functions to be performed by the board paramount
of which was monitoring the effectiveness of the companys governance practices and
making changes as needed. This was to involve continuous review of the internal
structure of the company to ensure that there are clear lines of accountability for
management throughout the organisation.98Moreover the provision on board
remuneration was modified which called for boards to develop and disclose a
95 OECD, Comments Received from Web consultations, International Federation for Human Rights(FIDH) (2003).96 OECD Principles 2004, Chapter 6, Principle A.97 OECD Principles 2004, Chapter 6, Principle C.98 OECD Principles 2004, Chapter 6, Principle D.2
-
7/26/2019 Using the OECD Principles of Corporate G
42/103
42
remuneration policy statement covering board members and key executives and for such
policy statements to specify the relationship between remuneration and performance, and
include measurable standards that emphasise the longer run interests of the company over
short-term considerations.99
Further modifications were made in relation to exercise of judgements by the board.100
Objective judgement is very necessary for the exercise of the boards duties of
monitoring managerial performance, preventing conflicts of interest and balancing
competing demands on the corporation101. In order to prevent conflicts of interest an
independent board is most desirable. Independent board members can contribute
significantly to the decision-making of the board and for them to do this; it is desirable
that boards declare who they consider to be independent and the criterion for this
judgement. One of such criteria is when committees of the board are established; their
mandate, composition and working procedures should be well defined and disclosed by
the board.102Another criterion is for board members to be able to commit themselves
effectively to their responsibilities103.
In order to fulfil their responsibilities, board members should have access to accurate,
relevant and timely information.104
Chapter 6 also came under scrutiny from various divisions. The FIDH105for instance
finds it particularly regrettable principle C does not call for the duties of directors to
respect explicitly Human Rights Declaration and other human rights instruments, which
form the only possible foundation of such ethical standards (interest of stakeholders was
not taken into account). It further holds that the principle is not an internationally
accepted norm.
99 OECD Principles 2004, Chapter 6, Principle D.4100 OECD Principles 2004, Chapter 6, Principle D101 Ibid102 OECD Principles 2004, Chapter 6, Principle E.2103 OECD Principles 2004, Chapter 6, Principle E.2104 OECD Principles 2004, Chapter 6