3/1/2013

Divorce of ownership and control

Corporate Governance & Social Responsibility

Agency theory Stakeholder theory Stewardship theory Agency problems

STEWARDSHIP THEORY
This theory considers that directors will want to do a good job in looking after the organisation and its assets and that the interests of the directors are aligned with those of the organisation. This goal congruence results in directors who are motivated to improve organizational performance for the good of the shareholders and themselves.

STAKEHOLDER THEORY
This theory considers the interests of not just the owners (shareholders) but also the interest of all the stakeholder groups of the organisation

Agency Problem
If you pay somebody else to do something for you, how would you know that they are going to do it for you? There is always a risk that they would do it differently from the way you have approved of, or they may just do it for themselves (their own interest) not for you.

Agency theory
This theory believes that there is a danger that the directors, as agents of the shareholders (the principal),may make decisions which are in their own interests, rather than running the company with the best interest of the shareholders in mind.

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Corporate governance
System (laws and guidance) which companies are directed and controlled for the interest of the shareholders and other stakeholders Its an attempt to deal with agency problem The objective is to contribute to improved corporate performance and accountability in creating long term shareholder value

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 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 (OECD)

Other definitions
The way in which organizations are directed and controlled (Cadbury) The system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all stakeholders and act in a socially responsible way in all areas of their business activity. (Solomon) The ethical corporate behaviour by directors or others charged with governance in the creation of wealth for all stakeholders.

Elements of corporate governance

Risk management Promote ethical behavior Internal control Good governance is not just about externally established codes, it also requires a willingness to apply the spirit as well as the letter of the law. Accountability Accounting standards Code of professional conduct

Corporate governance concepts

Fairness Openness/transparency Independence/objectivity Probity/honesty Responsibility Accountably Reputation Judgment Integrity

Fairness
A sense of equality in dealing with internal stakeholders. A sense of evenhandedness in dealing with external stakeholders. All the people affected by a decision should be treated with equal consideration

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Openness/transparency
Lack of withholding relevant information unless necessary, leading to a default position of information provision (rather than concealment). All information should be made available to stakeholders and in a clear manner Add voluntary disclosure if it adds to transparency

Objectivity
A state of mind where only the matter in hand is considered, with no outside factors influencing the decision Be objective and be seen to be objective

Independence
Independence from personal influence of senior management for nonexecutive directors (NEDs). Independence of the board from operational involvement Independence of directorships from evident personal motivation since the organisation should be run for the benefit of its owners. Monitoring functions should be independent of what it is monitoring

Probity/honesty
Honesty in financial/positional reporting Perception of honesty of the finance from internal and external stakeholders. This is not just telling the truth it also means finding out the truth. Not ignoring it. (not turning a blind eye)

Responsibility
Directors should understand and accept their responsibility to shareholders and other stakeholders, and act in their best interest and be willing to accept the consequences if they fail in responsibility Clarity in the definition of roles and responsibilities for action. Conscientious business and personal behaviour.

Accountability
Accounting for business position as a result of acceptance of responsibility. Accountability is about the presenting the information to those whom we are responsible Providing clarity in communication channels with internal and external stakeholders.

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Reputation
Developing and sustaining personal reputation through other moral virtues. Developing and sustaining the moral stance of the organisation Reputation breeds trust Developing and sustaining the moral stance of the accounting profession.

Judgment
The ability to reach and communicate meaningful conclusions. The ability to weigh numerous issues and give each due consideration.

Integrity
Steadfast adherence to a strict moral or ethical code, high moral virtue. The highest standards of professionalism and probity. Honesty, fair dealings, presenting information without any attempts to bias opinion and in more general sense, doing the right thing

Poor governance
Domination by a single individual Lack of involvement of board Lack of adequate control function Lack of supervision Lack of independent scrutiny Lack of contact with shareholders Emphasis on short-term profitability Misleading accounts and information

Key issues
The board Directors Remuneration Financial reporting External audit Shareholders Principles v Rules

The Board
'To define the purpose of the company and the values by which the company will perform its daily existence and to identify the stakeholders relevant to the business of the company. The board must then develop a strategy combining all three factors and ensure management implements that strategy. - The King report

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The role of the board of directors

to define the purpose of the company to define the values by which the company will perform its daily duties to identify the stakeholders relevant to the company to develop a strategy combining these factors to ensure implementation of this strategy.
-King Report-

The role of the board

Monitoring the chief executive officer Overseeing strategy Monitoring risks and control systems Monitoring the human capital aspects of the company in regard to succession, morale, training, remuneration etc Ensuring that there is effective communication of its strategic plans, both internally and externally

Directors
The board of directors is made up of executive directors and non-executive directors. Must have relevant expertise in the industry, company and governance Demographical balance Must have good training program Continuing professional development (CPD) Must be accessible to both financial and non financial information to make decisions regarding broader stakeholder interest

The Higgs report recommends that performance of the board should be assessed once a year Separate appraisal of the chairman and chief executive should also be carried out, with links to the remuneration process. Due to increased accountability and responsibility, directors face the risk of legal actions and dismissal

Executive directors
Full-time employees of the company and, therefore, have two relationships and sets of duties They work for the company in a senior capacity, usually concerned with policy matters Functional business areas of major strategic importance Large companies tend to have executive directors responsible for finance, IT/IS, marketing and so on

Executive directors are usually recruited by the board of directors Their remuneration packages made up partly of basic pay and fringe benefits and partly performance-related pay Fixed term contracts, often rolling over every 12 months CEO and finance directors are mostly executive directors

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Non-executive directors (NEDs)

They are not employees of the company and are not involved in its day-to-day running Sometimes be prominent individuals from public life The majority of non-executive directors should be independent Public companies should have more nonexecutive directors than executive directors

Non-Executive Directors (NEDs)

To monitor the performance of Executives Recommend hiring and firing Decide on remuneration of Executives + Chair Monitor the systems of financial reporting Risk management and Internal control systems Contribute to the strategy

Advantages of NEDs
External experience and knowledge which executive directors do not possess Wider perspective Comfort factor for third parties such as investors or suppliers. Strong, independent element

Problems with NEDs

Lack of independence Cross directorship Difficulty imposing their views upon the board Limited time they can devote to the role Holding shares in the company does not necessarily compromise independence

Independence of NEDs
Should not have worked for the company Should not have recently had any business transactions with the company No family members in the senior position They should not take part in share option schemes After 9 years as a NED, unlikely to be considered as independent

Unitary Vs. Two-tier Board

Unitary
One board with executives and NEDs, all meeting together All the directors have equal responsibility to run the company Ensures directors work together

Two-tier
Supervisory board (NEDs who monitors the management board) and a management board (the executives who runs the company)

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Chair Vs. CEO

Division of responsibilities at the head of an organisation is most simply achieved by separating the roles of Chair and chief executive. Chair to run the board, ensure that the board sets and implements companys strategies effectively CEO to run the company, Report to Chair

Remuneration Committee
Decides on the remuneration of executive directors, and sometimes other senior executives Must be formed with NEDs Remuneration should be dependent upon organisation and individual performance. Non-disclosure Remuneration of Executives + Chair Set policies regarding directors pay Design and negotiate individual pay packages Agree expenses of senior executives + Chair

Remuneration of Directors
Enough to attract, retain and motivate Significant proportion should be long term performance-related, which can be achieved by building in rewards such as shares, share options, pensions linked to performance Should consider industry pay levels NED remuneration should not be performance related, their remuneration will be made up of fees only Across-the-board pay and incentives awards are entirely inappropriate, as they fail to acknowledge differentials in the performance of individual directors

Nomination Committee
Majority should be NEDs Succession planning Consider overall skills and experience of board Identify need to change or improve it

Audit Committee
NEDs should liaise with external audit, supervise internal audit, and review the annual accounts and internal controls. Review of financial statements and systems Liaison with external auditors Review of internal audit Review of internal control Investigations Review of risk management Reporting to shareholders

Audit Committee
All members should be independent NEDs At least one member should be of financial and accounting background The chairman of the company can be chairman of the audit committee as long as he is an independent NED

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Risk Committee
The risk committee should ensure that the systems in place identify, assess, manage and monitor financial risks.

Public oversight
UK listed companies have to make certain disclosures in their Annual Report (accounts) in accordance with the Combined Code such as directors remuneration, details of the directors in committees, number of meetings such boards conducted, work of the committees etc. This ensures that information on the companys corporate governance arrangements are available for public review as all members of the public are able to access the companys accounts through Companies House.

Public oversight
Many countries also have a Public Oversight Board which is responsible for monitoring and enforcing legal and compliance standards amongst companies. As an example of a public oversight role, the Financial Reporting Council (FRC) is the UK's independent regulator responsible for promoting confidence in corporate reporting and governance.

Principles vs. rules

The extent to which the governance principles should be in the form of principles or laws and regulations UK vs. USA

Rules based
The SarbanesOxley Act of 2002 Public Company Accounting oversight Board (PCAOB) To protect investors and other stakeholders by ensuring that the auditor of a company's financial statements has adhered to strict guidelines Compliance is likely to be 100% Any non compliance punishable under the law (fines, delisting and prison) If law is good, shareholders are assured Laws are too slow to change Lack of flexibility

Principle based
Comply or explain Can allow companies of different size, nature, stages of development to use flexibility Means that companies follow spirit of the code, not just ticking boxes purely to confirm Might be ignored by some companies since there is no law to back it up and will be harder to enforce

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Advantages of Corporate governance

Good governance includes good risk management, which will improve the performance of the company It creates better impression for investors A more balanced board should reduce the risk of a single director defrauding the company Improved company's reputation among its customers, suppliers, employees

Corporate Social Responsibility

Why doing good is good for business?

Milton Friedman
Only human beings have moral responsibility for their actions. It is the managers' duty to act solely in the interest of shareholders:
this is a point of law. Any other action is shareholder betrayal.

Social Responsibility Definition and Perspectives

Corporate Social Responsibility (CSR)
The idea that business has:
Social obligations above and beyond making a profit Social obligations to constituent groups in society other than shareholders and beyond that prescribed by law

Social issue are the province of the state and not corporations.

Organizations include financial, environmental, and social responsibility in their core business strategies.

Corporate social responsibility

The continuing commitment by a business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as of the local community and society at large. Refers to all of the impacts a company may have on society and the need to deal with those impacts on all stakeholders in a responsible way

Corporate social responsibility

Encompasses the economic, legal, ethical and philanthropic expectations placed on organizations by society (Carroll) Ethical practices Ecology, environmental impact and protection Current and future needs of society Product design and customer relations Employees, communities, human rights

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Sustainability
Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their needs. It is not a fixed state of harmony, but rather a process of change in which exploitation of resources, the direction of investments, the orientation of technological development and institutional change are made consistent with future as well as present needs.

Sustainability reporting
The nature and extent of social, transformation, ethical, safety, health and environmental management policies and practices

Global Reporting Initiative

Economic Environmental Labour practices Human rights Society Product responsibility

Carroll strategies
Reactive Defence Accommodation Proactive

Reactive
The corporation denies any responsibility for social issues Corporations should do nothing and deny all responsibilities for corporate social responsibilities

Defence
The corporation admits responsibility but fights it, doing the very least that seems to be required Should admit the responsibilities where relevant, then do absolute minimum to fulfill that responsibility

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Accommodation
Using outside influence to change the demands of stakeholders This approach involves taking responsibility for actions, probably when one of the following happens.
Encouragement from special interest groups Perception that a failure to act will result in government intervention

Proactive
Companies should not wait to be told they have responsibility A strategy which a business follows where it is prepared to take full responsibility for its actions. A company which discovers a fault in a product and recalls the product without being forced to, before any injury or damage is caused, acts in a proactive way.

A Continuum of Social Responsibility Strategies

Against corporate social responsibility

Businesses do not have responsibilities, only people have responsibilities. Managers in charge of corporations are responsible to the owners of the business, by whom they are employed. If the statement that a manager has social responsibilities is to have any meaning, 'it must mean that he is to act in some way that is not in the interest of his employers. If managers do this they are, generally speaking, spending the owners' money for purposes other than those they have authorized.

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