Corporate Governance

Week 1

Have you heard about!

NICL Scam (Pakistan) Mehran Bank (Pakistan) Enron Satyam Computers

Corporate Governance An Introduction

Corporate related with corporations Governance- derived from Latin gubernare- meaning to steer The way in which companies are directed and controlled (Cadbury Report 1992) Recent examples of massive collapses resulting from weak systems of CG have highlighted the need to improve and reform CG at international level.
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Corporate Governance An Introduction

Some recent reforms:

USA issued Sarbane-Oxley Act (2002) Higgs and Smith Reports (2003) UK SECP guidelines in Pakistan OECD guidelines in European continent.

Corporate Governance An Introduction

There are different perspectives of CG and the same is evident from the definitions as well. One approach of CG adopts a narrow view, where CG is restricted to the relationship b/w a company and its shareholders. In an other approach, CG has broader spectrum beyond shareholders extending that to stakeholders such as employees, customers, suppliers, governments etc.
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Corporate Governance An Introduction

Some Definitions of CG are: the process of supervision and control intended to ensure that the companys management acts in accordance with the interests of shareholders (Parkinson 1994)

the governance of an enterprise is the sum of those activities that makeup the internal regulation of the business in compliance with the obligations placed on the firm by legislation, ownership and control. It incorporates the trusteeship of assets, their management and their deployment (Cannon 1994)
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Corporate Governance An Introduction

Some Definitions of CG are (Contd): According to Solomon & Solomon (2004: 14) CG is the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity.

This definition perceives that companies can maximize value creation over the long term by discharging their accountability to all of their stakeholders and by optimizing their system of CG
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Corporate Governance An Introduction The same outcome was identified by different independent researches such as the reports of UK Investment Institute of the Higgs report found that:
Companies that demonstrate a commitment to a broad range of stakeholders are likely to show better management skills and increase in accountability can maximise the sustainable wealth creation.

Body shop, Tesco, Patagonia

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Governance and Management

How do these terms differ? Does Governance include Management? Or Does Management include Governance?

Governance & Management

Governance
Approval of Plans

Function
Planning

Management
Preparation of plans

Providing overall leadership

Arranging resources Controlling managers

Leading
Organizing Controlling

Leading those who implement plans

Tasks division & resource usage Controlling employees
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What is a Corporate Body?

Any Company is a corporate body. However, in a broader sense only public limited companies are taken to be the subject matter of CG. So far the thrust of CG is only on listed companies. What about family businesses, private companies? In USA and Europe, companies are frequently run by minority shareholders. Hence, they require even greater degree of CG. Please refer to Butt, S (2011), Pages: 16-18
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Corporate Governance Theoretical Frameworks

A number of different theoretical frameworks have evolved to explain and analyze CG such as: The Agency Theory (Finance and Economics) Transaction Cost Theory (Economics and Organizational Theory) Stakeholder Theory (Social-oriented perspective)
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Corporate Governance Theoretical Frameworks

The Agency Theory: Owners (shareholders) delegate the running of the company to management
Owners: Principals Management: Agents

Their relationship is the agency theory. The problem is that sometime the agents take decisions which are not in the best interests of the principals. Due to managers ego-ism or personal objectives leading to short term profits but ignoring the long term sustainable profit maximisation or in other words ignoring the long term consequences.
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Corporate Governance Theoretical Frameworks The Agency Theory (Contd): Same is in case of risk sharing Again the monitoring of agents by principals is a difficult and expensive task.
Usually contract (agreements) are performed to solve this problem.

As well as the voting power of the shareholders and their power for Take-over vote is useful for the balancing of powers.
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Corporate Governance Theoretical Frameworks

Transaction Cost Theory (Caose, R) Talks about cost of transactions for a company and its relationship with the managements opportunism

Bounded rationality of managers Cost of transactions Managers try to organize the transactions in their best interests. Transaction cost theory suggests that shareholders should have control (influence) in the decision making and managers should pursue the best interests of the shareholders rather than their own personal interests and there should be some institutions to mange this sort of transactions
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Corporate Governance Theoretical Frameworks

Stakeholders Theory Freeman (1984) proposed that corporate accountability to a broader range of stakeholders.

Today you can see availability of Co information, annual reports on different medium such as newspapers, websites

The role of companies in societies has received increasing attention over time, with their impacts on employees, the environment, local communities as well their own shareholders. A basic thing is that Cos are now so large and they have impact on the society. Imagine even in KPK the role of PTC, Lakson on Tobacco growers!!! Some BS!!

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Corporate Governance Theoretical Frameworks

Stakeholders Theory (Contd) linked to stakeholders theory is the concept of corporate Social Responsibility (CSR) as well.

While researches have found a positive relationship b/w revenues and CSR. However, it is very difficult to balance the interests of different stakeholders. However, it is expected of todays enterprises that they will have to cater to the needs and wants of the different stakeholders rather than a single stakeholder in term of shareholders. Look at Apples initiative or Dell and HP initiatives, Tesco etc
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Corporate Governance Theoretical Frameworks To Conclude we can say that: Ignoring the stakeholders can result in corporate failure while concern for stakeholders attracts investors in the current times.

And to survive companies has to look beyond share holders to a broader range of stakeholders as well as companies should have more accountability (not mere financial but all encompassing) and more control on its internal processes.
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The CG Framework
Regulators Legislation

Management

Auditors

Board

Internal mechanisms

Shareholders

CG

Stakeholders

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Essential Principles of CG

Discipline Transparency Independence Accountability Responsibility Fairness Social responsibility

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Is there some global uniformity

Converging Diverging

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Stakeholders in a Company

Management and Employees Lenders Suppliers and Clients Shareholders Society at large (this includes government)

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Opportunity to protect individual interests

Managers and Employees have the greatest opportunity to protect their interest(s) Suppliers and Clients essentially go by each transaction or contract. Lenders and Shareholders are most vulnerable. Society depends entirely on law
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Shareholders

Controlling Groups (Internal Equity) Outsider Shareholders (External Equity)

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Outsider Shareholders
Institutional Investors Have some means of protecting their interest but still require protection Individual or General Public They require the greatest degree of protection, as they have virtually no means of protecting their interest.
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Lenders
Institutional Investors Have some means of protecting their interest through legal documentation, are relatively at lower risk but still require protection Individual or General Public They require the greatest degree of protection, as they have virtually no means of protecting their interest.
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Society at Large

Government (Taxes, Law and Order) Clients (Value for money) Community (Social Rights) How do we ensure that these stakeholders get their dues?

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Corporate Hierarchy
1.

2.
3.

Shareholders Board of Directors Management

CEO Executive Directors Senior Managers

4.

Employees

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Key Players

Shareholders (Voting power) Board of Directors (Represents interests) CEO (Delegated executive powers) Senior Managers (Delegated executive
powers)

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Scope of Corporate Governance

Stakeholders Objectives / interests Tools / Techniques

Shareholders
Lenders Employees

Sustainable growth in net worth

Security / timely interest payments Continued employment at good terms General Management Legal frame work Professional Codes Industrial practices

Individual

Interests

Business Associates
Society

Continued business at good terms

Good citizenship by the company Continued profitable existence

Collective Interest of all stakeholders

Strategic Management Risk Management

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References

Solomon, J. and Solomon, A. (2004). Corporate Governance and Accountability. Chichester: John Wiley & Sons Pages 1-30 Butt, S. (2011). Corporate Governance (Second Edition). Azeem Academy, Lahore Pages 15-29
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