Corporate Governance and Performance - Assignment Example

Corporate Governance and Performance Name Name of Institution Corporate Governance and Performance Question 1 Part 1 The practice of corporate governance changes over time, and the ASX Corporate Governance Council articulates and updates policies that guide good corporate governance. The 2010 version of the corporate governance principles and recommendation offers eight principles that act as a reference point for Australian businesses. The first principle addresses the fundamental need for businesses to have boards that can provide strategic guidance and oversight. The second principle addresses the composition of the board by stating that members should have independence, experience and a variety of skills to ensure that the board is suited to the scope of the company’s operations. The third principle focuses on ethical behaviour and responsible decision-making (ASX Corporate Governance Council 2007). The fourth principle concentrates on meeting the information needs of modern investors by providing factual data on the company’s financial position. The fifth principle goes on to state that all critical aspects of a business need to be reported in a factual and timely manner. The sixth principle addresses the need for companies to respect the rights of shareholders and create an environment where they can exercise their rights in an effective manner. Risk evaluation is part of the corporate governance framework. The seventh principle recommends that companies should strive to identify, monitor, manage, and disclose business risks. Finally, the eighth principle concentrates on fair and responsible remuneration (ASX Corporate Governance Council 2007). Part 2 According to Edwards & Clough (2005, p. 1), performance is one of the dimensions of corporate governance. Therefore, it can be assumed that a high-performing governing body can play a vital role in guaranteeing improved organizational performance. To confirm this assumption, there is a need to examine empirical research on the link between organizational performance and corporate governance. Pham, Suchard & Zein (2007) conducted a study on large firms in Australia with the aim of determining the relationship between corporate governance mechanisms and the cost of capital. The study found that smaller and more independent boards, greater insider ownership, and the presence of institutional block holders reduce the perception of risk in a firm. Therefore, investors and lenders demand a lower return on capital leading to greater value for shareholders. In a subsequent study, Pham, Suchard & Zein (2011) studied the top 150 firms in Australia to determine whether there is a relationship between corporate governance and a firm’s performance. The selected performance measures were Tobin’s Q and Stern Stewart EVA, and the finding was that there was no significant relationship between these performance measures and corporate governance (Pham, Suchard & Zein 2011, p.12). However, this finding suggested that there are weaknesses in the two performance measures that hinder the recognition of the impacts of governance mechanisms on organizational performance. While the two studies by Pham, Suchard & Zein concentrated on large firms, Lama (2012) undertook a similar study but focused on mid-sized organizations. The study compared the corporate governance ratings of 60 firms with their performance in terms of return on equity, earning yield, and return on assets. The conclusion from this empirical study was that shareholders get better returns in companies that have good governance systems as measured by their compliance with corporate governance best practice (Lama 2012, p. 75). This confirms the validity of the theoretical assumption that high-performing governing bodies guarantee better organizational performance. Part 3 An evaluation of the annual reports of Cochlear Limited (COH) and Federation Centres (FDC) shows that Cochlear Limited is the firm that has adopted all the ASX Corporate Governance Principles and Recommendations. FDC’s 2014 annual report confirms adherence to Principle 1 as the functions of the board members are described, and there are provisions for the evaluation of the Board’s performance (FDC 2014). Adherence to Principle 2 is found in the description of a nomination committee while compliance with Principle 3 is seen in the diversity and inclusion policy statement (FDC 2014). The description of the audit and risk committee shows compliance with Principle 4, and the section on continuous disclosure confirms that FDC has adopted principle 5. Principle 6 is seen in the section on investor communication, 7 in the risk management and internal control framework, and 8 in the board remuneration section (FDC 2014). The 2013 and 2012 annual reports follow a similar structure where the firm defines its own corporate governance framework and then indicates the sections that are related to the ASX Corporate Governance Principles and Recommendations. When it comes to Cochlear Limited, the Corporate Governance reports from 2010-2014 show complete compliance with ASX Principles and Recommendations. This is done by the actual listing the eight ASX Corporate Governance Principles and Recommendations and stating how the firm has adhered to each one of them. The complete compliance on the part of Cochlear Limited and the more selective compliance on the part of Federation Centres implies that COH should have better organizational performance that FDC. This assumption comes from the outcomes of empirical studies that have shown that proper governance leads to better organizational performance. The financial results of FDC suggest that it has performed to a satisfactory level over the period under review. However, the more selective nature of its compliance with ASX principles means that the firm could have performed better. On the other hand, total adoption of the ASX principles at Cochlear limited indicates that the firm is performing at its maximum level. Question 2 Part 1 The annual reports of FDC indicate that executive remuneration is market driven and linked to performance. In 2014, the CEO at FDC received a base salary that accounted for 28% of total earnings. The short term and long term rewards each made up 36% of the CEO’s earnings. The rest of the executives had base compensation of 40-50% and short-term and long-term earnings of between 25 and 30% of all earnings (FDC 2014, p. 54). The fixed remunerations of the senior executives in 2013 ranged from between 31% and 50% of their total remunerations. The executives received short-term incentives that ranged from 22% and 31% of total remuneration while long-term remuneration ranged from 25-38% of total remuneration (FDC 2013, p. 53). In 2012, Federation Centres maintained the same composition of fixed, short-term, and long-term remuneration. However, there was one executive who received 57% of earnings in base remuneration and 43% in short-term remuneration as a result of his commencement date (FDC 2012, p. 57). The short term and long term salary and performance benchmarks at Cochlear Limited were similar to those at Federation Centres. In 2014, the CEO received fixed remuneration (TFR) that was worth 33.4% of total earnings. Both the short-term (STI) and long-term (LTI) incentives made up 33.3% of earnings and they relied on performance. Other senior executives received at least 45% in base earnings, 32.1% in short-term incentives, and 22.6% in long-term incentives (COH 2014, 39). In 2013, the CEO received 40% of total remuneration in TFR, 30% in STI%, and 30% in LTI. Other executives earned at least 52%, 24%, and 24% in TFR, STI, and LTI respectively (COH 2013, p. 39). The 2012, 2011, and 2010 annual reports indicate similar benchmarks where a significant proportion of total remuneration is at risk and goes towards long term and short term incentives. Part 2 The disclosure of executive remuneration was clear and appropriate in the two companies. Cochlear Limited began its remuneration report by defining fixed, short-term, and long-term incentives. In addition to stating the composition of remuneration, the firm also provided the actual payments to senior executives. The firm also indicated that forces in the market drove all remuneration. This allows the firm to attract and retain some of the most talented senior executives. In the same way, Federation Centres had remuneration reports that presented clear and appropriate information on executive compensation. Part 3 The annual reports also indicate that remuneration and performance are appropriately linked. In both cases, senior executives get between 40 and 50% of their earnings from short-term and long-term incentives. These incentives are dependent on the non-financial and financial performance of the organization, meaning that senior executives get the motivation to meet the needs of shareholders. The composition of the short and long term incentives also shows the link to performance. These incentives come in the form of deferred cash locked shares that facilitate good performance. The existence of performance hurdles and a clear vesting schedule in the annual reports of both firms also confirms the link between remuneration and performance. Additionally, a look at FDC’s annual reports shows a consistent increase in net profits between 2012 and 2014. Total remuneration followed a similar trend with the CEO earning a base salary of 315,147 in 2012, 880,019 in 2013, and 1,142,392 in 2014. The short-term and long-term incentives also increased over the same period thereby confirming the link between performance and remuneration. Question 3 Part 1 There are a number of similarities and differences in the principles of good governance for NFPs and ASX listed companies. The recommendations in principle 1 and 2 for ASX firms can be seen in a number of recommendations for NFPs. Specifically, they are related to principles 1, 2, and 5 which address roles and responsibilities of the board, board composition, and organizational performance respectively. In the same way, the recommendations in principle 3 for ASX companies are similar to the ones in principles 7 and 9 for NFPs that address integrity and accountability, and culture and ethics respectively. The fourth principle for ASX firms concentrates on safeguarding integrity in financial reports. An examination of the NFP codes shows that the same attention is not given to financial integrity as it is briefly mentioned in principle 7 which takes a broader look at integrity and accountability. Principle 5 in the recommendations for ASX firms concentrates on timely and balanced disclosures. The corporate governance recommendations for NFPs also mentions communication, but the emphasis is on a larger group of stakeholders, unlike the ASX principles that emphasize communication with shareholders. The sixth principle for ASX listed firms also concentrates on shareholders and recommends that their rights have to be respected. In the case of NFP recommendations, the organizations serve more stakeholders, and there is no single group that is given preference so that their rights have to be respected. However, Principle 5 on organizational performance and Principle 10 on engagement suggest that non-profits also intend to respect the rights of their stakeholders. Principle 7 for ASX firms addresses the recognition and management of risk. NFP firms follow similar recommendations, and they are listed under principle 4. Finally, the eighth ASX Principle addresses fair and responsible remuneration. An examination of the NFP principles and recommendation indicates that there is little emphasis on remuneration. In the same way, the third principle for NFPs states that the board plays a pivotal role in determining the vision, purpose, and strategies of the organization. A similar principle is absent in the principles and recommendations for ASX firms Part 2 The differences in the nature of work done by not-for-profit and listed organizations are responsible for the differences in the two sets of principles. Firms listed on the stock exchange put a greater emphasis on profitability while non-profits emphasize meeting the needs of various stakeholders that include beneficiaries, donors, creditors, directors, volunteers, the government, and employees. This difference explains why ASX firms put much emphasis on the integrity of financial statements and respecting the rights of shareholders as shareholders often judge results on a quarterly basis. In the same way, the difference explains why NFP recommendations emphasize the creation of visions and goals as the missions and goals of NFPs can focus on longer periods. The demand for the maximization of profits is another reason ASX principles have a section that is dedicated to fair and responsible remuneration. NFPs often benefit from having volunteers who undertake work based on their ideals. They also get funding from governments and donors, and they have greater freedom in terms of accounting for the use of these resources. On the other hand, ASX firms have to attract and retain highly qualified individuals who might demand excessive compensation. This is complicated by the fact that investors want costs to be kept at the lowest possible levels (Corkery & Medarevic 2013, p. 1). For this reason, it is recommended that ASX firms adhere to principle 8 which demands the establishment of a remuneration committee, disclosures of executive compensation, and linking pay to performance. References ASX Corporate Governance Council (2010). Corporate Governance Principles and Recommendations with 2010 Amendments. Australian Securities Exchange, Sydney. Australian Institute of Company Directors. (2013). Good Governance Principles and Guidance for Not-For-Profit Organisations. Viewed at [8 April 2015] Centro Retail Australia 2012. Annual Report 2012. Federation Centres, Melbourne Cochlear 2015. Annual Reports. Cochlear Limited. Viewed [9 April 2015] Corkery, J., & Medarevic, S. (2013). Executive remuneration under scrutiny: The cutting edge of the 'shareholder spring'. Corporate Governance eJournal, Vol. 1. pp. 1-16 Edwards, M., & Clough, R. (2005). Corporate governance and performance: an exploration of the connection in a public sector context. Canberra: University of Canberra. Federation Centres 2013. Annual Report 2013. Federation Centres Limited, Melbourne Federation Centres 2014. Annual Report 2014. Federation Centres Limited, Melbourne Lama, T. B. (2013). Empirical Evidence on the Link between Compliance with Governance of Best Practice and Firms' Operating Results. Australasian Accounting, Business and Finance Journal, 6(5), 63-80. Pham, P. K., Suchard, J. A., & Zein, J. (2011). Corporate governance and alternative performance measures: evidence from Australian firms. Australian Journal of Management, 36(3), 371-386. Pham, P. K., Suchard, J., & Zein, J. (2007). Corporate governance, cost of capital and performance: Evidence form Australian firms. Working paper. School of Banking and Finance. University of New South Wales. Read More