Issues of Corporate Governance - Essay Example

CORPORATE GOVERNANCE + Submitted Corporate Governance QUESTION Corporate governance is the structure in which corporations are managed and directed. For a business to thrive properly corporate governance is essential. Good corporate governance gives accountability and creates trust among investors. Investors rely on company performances by viewing their reports and accounts to verify the standards of the business and its viability for investment. This may not always be the effective way of analyzing a business unless you dive into its governance. Christine A. Millian made a step into looking at good governance and its relation to growth and development of companies and also the scandals that arise where good governance is eliminated and the ways in which these scandals can be eliminated in businesses through proper regulation and legal control. Corporate governance in UK dates back to the growing anxiety in 2002 where corporate scandals had started being experienced in the US. UK set up the Smith committee and the Higgs committee to investigate these failures and the reports were evident of the latent manegiarialism in companies. This raised concerns on integrity of the managerial system of companies. It was argued that high-quality corporate governance was supposed to reduce costs and improve good working conditions of the workers. CASESTUDY ROYAL BANK OF SCOTLAND It was caught up in a scandal in 2008 in which there was an asset scandal which led to loss of value of the bank’s shares. It had a win- win situation where traders who won were rewarded hand those who lost their money to the bank. This was a short term performance that led to the loss of the value. They could have used a much longer term performance. THE ROYAL DUTCH SHELL It has been up with a number of controversies e.g. that of environmental pollution particularly in African countries. In 1990 protesters were against the company’s environmental record because of the possible pollution that was caused by the proposed disposal of Brent spar. This was a platform in the North Sea. Shell reversed the decision despite the massive support it received from the United Kingdom government. It maintained that the sinking of the platform would also have done better for the environment than the revised decision. Shell had also another scandal in 2004 of overstatement of oil reserves. This resulted to the loss of confidence of investors and stakeholders for the group. The financial services authority fined them 17million Euros. This also saw the departure of Phillip Warts. In 2008 the Advertising standards authority passed a ruling that it had misled the public when it said that $10 billion oil sands project located in Alberta was an energy sustainable source In Africa, it has led to environmental issues some of which are very extreme. Many pipes are much cored and are doomed to causes danger to the environment such as massive loss of biodiversity. I.e. massive death of fish and loss of vegetation, degradation of the environment Etc. Shell has in its part accepted the responsibility of maintaining their pipes new but have refused the responsibility of the great environmental degradation that is caused by the company. This has led to increased number of protests that are rampant in the Niger delta area. Human rights group s has also planned many boycotts against the shell group. The group has also seen many of their oil tankers pollute the environment e.g. in 1999 the shell tanker collided with a freighter from German and all its contents spilled into the lake. This led to pollution of the drinkable water, marine animals and plants. The two companies portray a shortage of good corporate governance and are to be used in the entire report. The growth of corporate governance has grown rapidly in many countries due to set codes that have been set by different governments and which companies are required to abide to. These codes put more weight on accountability, control both internal and external control the composition of the board members, the directors of the company and the payment of executive according to performance. The shareholders are also required to take active ownership of the companies by being the part of the daily running of the company. These codes have therefore been very effective in ensuring good governance in the company. Companies like the royal Dutch shell listed in the FTSE 100 companies has been affected by controversies such as the overstatement of oil reserves of 2004 which resulted to loss of confidence in the group and saw the departure of chairman Phillip Warts (Marlin 2013, 49) The development of corporate governance has been affected by several theories among them are a. Agency theory- the owners delegate their duties to the directors of the company b. Transaction cost economy- when appropriate governance is put in place the interest of shareholders and investors are put in place c. stakeholder- the stakeholders have direct representation in the company d. stewardship-the directors are the stewards of the company’s assets and should protect them with the company’s interest at heart e. class hegemony- the directors are liable for appointments in the company f. managerial hegemony-management of the company may dominate day to day operations hence weaken the directors g. path dependence- they depended on the paths that are stated by the economy h. resource dependence- directors are able to provide the required resources i. institutional-the institution will be an actor in the community environment j. political- it influences the ownership and government structures k. Network governance-it allows for risk management of the superior. Corporate have grown in the recent years due to need for accountability of investors, the government, the shareholders and stockholders in general. The global financial implosion of 2008, which had started in 2006, has led to improved corporate governance. It was brought about by failure of boards to study and understand the risk and put in place incentives that would tolerate this. This had given room to corporate scandals. Corporate scandals can be prevented by setting up an effective legal framework e.g. in the UK directors of companies are directly accountable to shareholders though they should consider the stakeholders views (the companies act 2006). The directors should also be discussing the risks affecting the companies with the shareholders and stakeholders. There is also the stewardship code (2012) ‘instances when institutional investors may want to intervene include, but are not limited to, when they have concerns about the company’s strategy, performance, governance, remuneration or approach to risks, including those that may arise from social and environmental matters’ (Guidance to Principle 4). QUESTION 2 CASE STUDY: BARINGS BANK Barings Bank was in February 1995 bankrupted by a single man to finance the Napoleonic wars. The bank is one of the oldest merchant banks in Britain that was frequently used by the Queen Elizabeth personally, and it was founded in 1762 by the Louisiana Purchase and the Erie Canal. It came to be one of the leading banks in the industry. Though one of his rascal trader who was based in Singapore, Barings came crumbling to its knees after the rascal trader ensued with $1.4 billion hole in Barings balance sheet due to his unauthorized derivatives that led to the demise of the 233-year old bank (Kershaw 2012, 48). The collapse of the Barings bank came with many question as well as lessons with it. But the most important thing that issue that came up was how to came up with a legal framework that or regulation mechanism that would prevent such scandals from happening. In order to avoid such derivatives from happening in the future, then a financial regulation has to be designed to ensure the soundness of an individual, institution, principally commercial banks to prevent the risk of loss of assets. If an individual bank, in its attempt tries to remain solvent in a crisis then its failure may threaten the well-being of other financial institution. The focus on an individual financial institution can also result to the regulators overlooking the important changes in the overall financial systems. After coming to power in 1997, the United Kingdom through the new Labor government announced that there will be independence of operation of monetary policy to the Bank of England. This move was later formalized under the Bank of England Act of 1998. This Act was accompanied by significant redesigned to architecture of the financial regulation in the United Kingdom. One of the regulations that were designed was the institutional design of financial regulation. Under the institutional design of financial regulation the financial services authority was set up to succeed the organization to the existing Securities and Investment Board. This meant that they took over the role of eight other supervisory bodies. This body was to regulate deposit taking, safekeeping and the administration of assists that were dealt with in by the management investment and providing investment advices (Sheehan 2012, 49). The next important part that this body was to highlight was how to establish a single authorization regime for all regulated activities. This body had the task of introducing new sanctions that would be used in restraining the market abusers, lastly this body was responsible to the establishment of the Financial Service Compensation Scheme by unifying the previously separated schemes for banks, building societies, insurance companies as well as the securities and the investment firms. The United Kingdom government created tripartite system for regulation of banks. This system included the FSA, the Bank of England and HM Treasury. The FSA was in charge of the micro-prudential regulation of banks, though it was not clear whether its objectives were to maintain the confidence of the financial system that amounted to functions of the micro-prudent. The Bank of England Act of 1998 was left the responsibility of protecting and enhancing the financial stability in the United Kingdom. The Treasury of the United Kingdom was responsible for the overall institutional structure of the financial regulation and the legislation which governs it. CASE STUDY: ENRON Enron an American energy company was base in Houston, Texas became bankrupt in 2001. It was one of the worlds leading when it came to the production of electricity, natural gas, pulp and paper, and communication companies. Its annual revenues of the year 2000 amounted to over $101 billion. Enron later became popular of willful corporate, fraud and corruption. After this scandals were revealed to the public, it share dropped in value from above $90 to $50. Then there was drop in profits and revenue hence many depts. And losses were reported in its financial statement that led to the company filing for bankruptcy protection. And after long standing scandals and lawsuits it was forced to dissolution. In such a case, the government of the United Kingdom came up with a legal framework that would regulate the occurrence of a similar situation. The prudential regulation of banks would tackle such cases. The prudential regulation of banks was created with the aim of imposing capital requirements on individual banks. The first regulation to be imposed was the Basel Accord that had 8% as its minimum capital requirement of bank’s risk-weighted assets. This however went through many amendments as a result of much criticism from time to time. The United Kingdom later saw the need of introducing a unique part of the FSA to continue with the Bank of England’s practice of setting a bank-specific ratio that would be used to regulate the minimum capital ratios. The aim of the Bank of England to use the target ratio as that it would help them specify any breach from any bank. This system encourages financial institutions to hold capital at a buffer above the minimum trigger. The use of trigger ratio is very vital as it provide interesting research that is a test bed used in time-varying capital ratios that are sometimes proposed as a method of macprodential regulation. QUESTION 3 Introduction Studying remuneration committees is largely motivated by the questioning effectiveness of the already existing regulations. This is as a result of public dissatisfaction with the so stated excessive executive remuneration especially when the company in question records a low performance. This report will relate to the Aviva Plc, UK case study to discuss why this issue of executive director’s remuneration interests the investors and argue out reasons why it should be performance linked. Executive Director’s Remuneration Executive remuneration refers to the compensation of executive and non-executive directors according policies set by the company’s article of association and as approved by the shareholders. It varies from salary, fees, or use of company property. It connection to the company profits depends on the company policy, it could be tied to or not. The disapproval power of executive director’s remuneration remains with the shareholders. Several companies have had their fair share of executive remuneration and has even seen the effects of this very much debated subject. One such company is Aviva Plc, a top insurance firm in the United Kingdom providing life and general insurance. Its customer base is quite large, estimated to about 43 million served by over 36,000 dedicated employees worldwide. Its governance structure consists of twelve directors eight of whom are independent non-executive directors. I has four committees namely; audit; remuneration; nomination; corporate responsibility and risk. Its remuneration committee comprises three non-executive directors, one of whom chairs it. The remuneration committee at Aviva is tasked to consult experts when setting the packages for its executive directors. In 2011, the committee approved the appointment of Fit Remuneration Consultants. In a bid to restructure, the company announced that it would lay off 10% of its workforce and later announcements concerning the simplification of the Management structure. The former announcement led to mass walk out of its most respected executives. All these were due to poor remuneration plans. The plan was reviewed and the company offered the top executives handsome pays to stay but it was late. This shows the critical role remuneration plays in an organization. Companies are linking performance more closely to the business strategy than basing bonus payouts purely on short-term financial achievements. Almost three-quarters of companies base the payout on more than three factors, there has been a significant increase in the use of non-financial measures, and those related to very specific business objectives. We have witnessed companies make major changes to remuneration structures generally and particularly to long term incentive plans. However, the new disclosure requirements, which will require companies to put remuneration policies to a binding vote in 2014, are likely to encourage remuneration committees to take a fresh look at current arrangements and to consider whether these remain appropriate. (Deloite report, 2010) FTSE 100 Company directors for example get a median salary increase of about 2.5% in 2012. This make the remuneration committee decline any further increment in the 2014 remuneration report conducted by Deloite given they had received a 20% increment in 2013. The director says,” We believe that the starting point for any committee is to consider whether salaries should increase at all and where increases are awarded they should be limited to those given to other employees, although there are clearly situations where higher increases may be appropriate” He further adds that the idea behind this is to maintain good personnel relations and saves the company a lot without getting into disputes with the customers. The FTSE 100 companies have continued to improve the structure of executive compensation although there is no room for complacency. The debate whether these remunerations should be issued based on performance or not has raised various sentiments across the globe It is seen that the Aviva Plc had bad remuneration rates therefore leading to major failure in the company. The company sorts to desperate measures like offering huge compensations to the executive directors. This led to the withdrawal of investors and drop in share values in the company. Aviva Plc should learn from the FTSE 100 companies and come up with substantial Remuneration plans that do not fringe the resources of the company and works with the board of executives. When the company is low on finance then the remunerations should be provided on basis of merit to bring that motivation and keep the organization running. Companies are currently required to include a statement of how the pay and conditions of employees across the group have been taken into account, as part of the remuneration report. In reality, few reports provide meaningful information about this; but as executive pay has raised must faster than that of other employees, some stakeholders have argued for better disclosure in this area. Finally, the consultation proposes that companies should be required to disclose fees paid to remuneration consultants, on the same basis as the fees paid for audit services; and include details of the services provided to the remuneration committee and to management. The consultation also asks whether there is additional information, which should be disclosed in relation to the procedure for setting remuneration in order to prevent conflict of interest. Shareholders should play a central role in tackling the issues around executive remuneration and challenging companies to use pay to appropriately incentives and reward. Nevertheless, we need to look at whether they have the right tools to be able to do this job effectively. It is almost ten years on from the introduction of ‘Say On Pay’ in the UK. Pay has continued to rise with no clear link to performance. It is right to review whether the vote is effective in holding companies to account; and whether other ways in which shareholders could be empowered or engaged on the issue of executive remuneration are available. Several stakeholders have suggested that the most effective way of moving away from the status quo on remuneration and to encourage greater challenge would be to employee representatives to sit on remuneration committees. They claim that this would bring a different perspective to the discussion on executive pay and ensure that pay and conditions elsewhere in the company, which remuneration committees. There is already evidence that around half of FTSE100 companies are no longer focusing solely on TSR and EPS but combining them with alternative performance metrics such as cash flow and return on invested capital. In one study of the remuneration structure in high performing firms in the UK, the most successful companies were found to be more likely to use relevant measures, directly linked to company strategy, in addition to traditional measures such as TSR and EPS. Executive remuneration plays an important role in the development of a company. It should be handled with caution though. Reference List MALLIN, C. A. (2013). Corporate governance. Oxford, Oxford University Press KERSHAW, D. (2012). Company law in context: text and materials. Oxford, U.K., Oxford University Press. SHEEHAN, K. M. (2012). Regulation of executive compensation greed, accountability and say on pay. Cheltenham, UK, Edward Elgar Pub. http://search.ebscohost.com/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&AN=483145 Read More