Corporate Governance

Lec 1
By:
Saif Ullah
PhD Finance Scholar
+92 321 6633271, Saifullah271@Yahoo.com

Lecture Outline
Defining Corporate Governance
Difference Between Governance and
Management
Corporate Body
Stakeholders
Scope of corporate Governance
Different Board Types
Responsibilities of The Board
Responsibilities of CEO and Senior
Management
Tools Available to Board
Functions of Corporate Governance
Objective of Corporate Governance
Tools Available to the Board for Better
Corporate Governance Practices
Corporate Governance as a filed of Study
Approaches to CG
Corporate Wrongs

Definition
According to OECD:
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, 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
these objectives and monitoring performance.

Another Definition
According to LaPorta et al., (2000),
Corporate governance is a set of mechanisms through which
outside investors protect themselves against expropriation by the insiders.
They define the insiders as both managers and controlling shareholders.
Yet Another Definition
Corporate governance refers to the manner
in which the affairs of a corporate body should be conducted
in order to serve and protect
the individual and collective interests
of all stakeholders.
(Safdar A Butt)

Governance And Management
How do these terms differ?
Does Governance include Management?
Or
Does Management include Governance?
Governance
Strategic
Setting Objectives
Devising plans to achieve these objectives
Setting rules or parameters
Not directly concerned with routine affairs
Protection of Interests of all stakeholders

Management
Current Affairs
Implementing the Plans
Developing Suggestions and Alternatives
Operational Matters

What is 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.
Greatest emphasis is on those that are controlled by closed groups.
In USA and Europe, companies are frequently run by minority shareholders.
Hence, they require even greater degree of CG.

Stakeholders in a Company
Management and Employees
Lenders
Suppliers and Clients
Shareholders
Society at large (this includes government)

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Classification of Stakeholders
Classified on
basis of Role
in the Company
Classified on basis of opportunity to protect individual interests
Those with
Full Opportunity
Those with a
Partial Opportunity
Those with
Virtually No opportunity
Owners
Controlling
Shareholders
Institutional Investors
with Board representation
Minority and individual
shareholders with no board
Representation
Lenders
Financial institutions
with elaborate lending
Contracts
Buyers of listed bonds
with trustee arrangements
Other lenders
Employees Executive Directors Senior Managers
Other employees
on regular or
contract terms
Business Associates
Suppliers who sell
only on cash terms
Major Suppliers and
clients with contracts
Smaller suppliers
and smaller clients
Society Government Public at large
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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Controlling Groups
If in Majority:
Can protect their interest easily
Needs monitoring
If in Minority:
Can protect their interest easily
Needs highest degree of monitoring
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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. Shareholders
2. Management
Board of Directors
CEO
Senior Managers
3. 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 Sustainable growth in net worth
General Management
Legal frame work
Professional Codes
Industrial practices
Lenders Security / timely interest payments
Employees Continued employment at good terms
Business Associates Continued business at good terms
Society Good citizenship by the company
Collective Interest of all
stakeholders
Continued profitable existence
Strategic Management
Risk Management
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Different Board Types:
The Good, Bad, and Ugly
Yes-men Board
Rubber Stamp
Board
Country Club Board
Good Old Boys
Board
The Real Thing
Paper
Board
?
Trophy Board
Responsibilities of the Board
Oversight (Watchful and Responsible)
Directional
Advisory

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The Oversight Function
Approving and monitoring Companys Strategic Plans.
Approving annual budgets and plans.
Engaging outside auditors.
Ensuring integrity of financial statements
Review of major operational activities.

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The Directional Functions
Setting Mission Statement, Vision Statement and Value Statement.
Appointment of CEO / Senior Managers
Planning for succession of these managers as well as outside directors
Appointing various committees
Prescribing code of conduct for the management.
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The Advisory Function
General guidance to management.
What is happening in the rest of the world.
Specialized input in certain areas
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Responsibilities of CEO & Senior Management
Operating the company in an effective and ethical manner.
Drawing the strategic plans
Drawing annual plans and budgets
Selection of managerial and other staff
Identifying business risks
Financial reporting
Internal Controls
Code of Conduct for all staff

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Issues in Corporate Governance
1. Distinguish the role of board and management
2. Composition of the board and related issues
3. Separation of the roles of CEO and Chairperson
4. Should the board have committees
5. Appointment to the Board and Directors re-election
6. Directors and executives remuneration
7. Discloser of audit
8. Protection of shareholders right
9. Dialogue with institutional shareholders
10. Should investors have a say in making a company Socially responsible corporate
citizen.
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Tools Available
Composition of the Board
Independence
Committees
Incentives
External Help
Government Intervention

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Distinguish the roles of Board and
Management
Board
Select, decide the remuneration and
evaluate and when necessary
changes CEO
Oversee the conduct of the company
Review and where necessary approve
companies plans and objectives
Render advice
Identify and recommend candidates
to shareholders for selecting as BOD
All other functions required by law

Day to day affairs
Management of the company
Prepare
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Composition of the Board
The Board should not represent interests alone.
Experienced and qualified practitioners
Pool of talent covering all areas

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Independence
Independent from those who appointed them (?)
Management
Stakeholders
No special interests (linked directorships)
Meeting in absence of CEO or Chairman

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The Concept of Independent Directors
Relatively a new concept in Pakistan
Only public sector companies have tried it
Private sector companies rarely appoint independent directors
No pool of professional directors available
Regulators trying to popularize the concept
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The Role of Independent Directors
Providing Independent Professional View point
Protecting the interest of all stakeholders
Serving on Independent Committees

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Committees
Audit Committee
CG Committee
Other Committees
Ad hoc Committees (e.g. investigation)
Permanent Committees (e.g. HR)
Remuneration Committee


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Functions of C G Committee
Compliance with CG Regulations
Nominating Independent directors
Monitor and Safeguard the independence of directors
Review of all information to the Board from Management
Drawing up CG Policy and processes

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Incentives to the Board
Financial (Carrots)
Others (Carrots)
Legal Obligations (Sticks)

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CG as a Field of Study
CG has existed for as long as companies have existed.
But as a field of study it is less than 70 years old.
Last 40 years:
A lot of activity in this field.
Codes, reports and laws have come out.
Number of research papers and theories have evolved.

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Approaches to Corporate Governance
There are three essentially approaches to governing
a company:
Shareholders Approach
Stakeholders Approach
Enlighten Shareholders Approach
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Shareholders Approach to CG
Board of Directors of a company should govern the company in
the best interest of its shareholders the owners of the company
According to this approach, Board should formulate policies that
aim at maximizing the shareholders value often at the expense of
other stakeholders.
A company can improve its profits by paying poor wages to its
workers. The interest of shareholders will be served at the expense
of employees.
A company can have more profits for its shareholders by not paying
taxes. The interest of owners will be served at the expense of
other stakeholders.

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Stakeholders approach to CG
According to this school of thoughts
Board of directors should formulate policies that provide
for equal care of interest of all stakeholders
Not practical because,
Board of directors are elected by and accountable to
shareholders.

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Enlightened Shareholders Approach
This approach is between the above discussed two
approaches
It requires that Board of Directors to work for the best
interest of shareholders, but without misappropriating
the interests of other stakeholders.
This approach keeps balance between owners and
stakeholders

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Which one is the Best Approach
Shareholders Approach
Stakeholders Approach
Enlightened Shareholders Approach
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Corporate Wrongs
Loss of ethics
Earnings became every thing.
Ineffective boards, smart executives.
Huge remunerations for executive directors.
Greed leading to disparity among senior managers and other employees.
Short term goals and considerations.
Collusion between directors and auditors.
Pressure from institutional investors
Loss of interest by small investors in big companies.
In Pakistan, family control of companies.

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Some Scandals in USA
WorldCom
Overstatement of profits by $3.8
billion
Adelphia Communications
Illegal loan to founder
Enron
Gross misuse of power by
directors
Waste Management Inc.
Overstatement of earnings by $17
billion over 6 yrs.


Tyco
Evasion of sales tax on personal
purchases.
Peregrine Systems
Overstatement of earnings by
$100 million.
Imclone Systems
Insider trading by CEO
Rite Aid
Accounting and securities fraud.

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Some Scandals in UK
BCCI Bank of Credit and Commerce International
Improper accounting and policies
Barings Bank
Ineffective internal controls, $1.4 billion loss
Mirror Group
Gross misappropriation of funds including pensions
Polly Peck
Diversion of funds to personal use.

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Some Scandals in Pakistan
Crescent Bank
Islamic Investment Bank
Bankers Equity
Bank of Punjab
Pakistan Steel Mills
Indus Bank

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