Corporate Governance - Assignment Example

College: Corporate Governance Introduction Corporate governance refers to a Set of processes, laws, customs, policies and institutions affecting the way a company is directed, controlled and administered is called Corporate Governance. It can also be defined as a system by which a company is controlled and directed. Share holders, board of directors and the management are the main stake holders in corporate governance mechanism. Employees and the executive are the other stake holders in corporate mechanism. In corporate governance the board of directors play significant role. They endorse organization plan, come up with directional policy, appoint supervise and pay senior executives they sure transparency of the firm to its authorities and owners. (McCahery, Moreland, Reinboag, Raaijmakers. 2002, 2) Corporate governance’s high standards, compliance, effective operations and administration are maintained by a trained company secretary who is supposed to be a high ranking professional. It has a set of relationships between the board, company’s management and its shareholder. Corporate governance provides a structure by which the goals of the company are set, how they will be implemented and achieved and a monitoring performance system is put in place. The very essential elements of corporate governance are accountability framework and strategic decision making systems. Corporate Governance in UK is based on combination of voluntary codes which have gone through a sequence of amendments over the past they include (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) Cadbury committee: In 1980s the scandal of Polly Peck, Maxwell’s Communication Group and BCCI led to reforms in UK Corporate Governance, to clarify responsibilities and duties of the board. Greenbury committee: This committee was established 1995, after a protest against the increased salaries given to directors in the new private companies. Hampel committee: This committee was formed in 1996 so as to review the Cadbury code, if it was implemented, the roles given to executive directors and also review the Greenbury Committee recommendations in their report. Lastly it was to address the role of auditors and shareholders in Corporate Governance. The Combined Code: This was as a result of the Hampel Committee put together the work of the other committees and also its own in 1998 to come up with this code. This code was as a result of 10 years of gradual improvement. Comply or Explain: Comply or Explain was a follow up of the combined code since it did not have legislative force. It was a list of rules that companies were meant to follow and disclose in their annual report if they were following them, and if not they were meant to give a reason why. Post Enron Initiative: The UK government was not ready to be complacent after the accounting scandal in the USA. Though their systems were different they were afraid that the same could happen the UK responded through Post Enron Initiative. Company Law review: Company Law is concerned with legal rules in detail that intend to support the competitive financial system, unlike the Combined Code that deals with best practice. Operating and financial review: is a form of a revised company law that seeks to address irregularities in the reporting rules by redefining director’s roles, wider stakeholder interest whereas maintaining their legal responsibility to shareholders only. A Holistic Approach to Regulation: Addresses the pillars of corporate governance this are the executives, NEDs, internal and external auditors, and senior managing board committees. The decision rights in corporations are delegated by the shareholders to the managers for them to act in best principle interest. Shareholders lose control to the managers by separation of control from ownership. The result of separation on both parties a system of corporate governance controls is put in place. It helps align the ideas of the shareholders and those of the managers. (Colgate,2006, 203, 220) Principles of Corporate Governance Trust, honesty, openness integrity, responsibility, accountability, performance orientation and commitment to the firm are some of the principles in good corporate governance. But what is crucial is development of models of governance that has values of the corporate participant and evaluation of the model time to time to check on its effectiveness by the management and directors. Senior executives in particular ought to be sincere and ethical, and especially about unambiguous or evident revelation in financial report conflicts of interest. Normally accepted principles in corporate governance are: (McCahery, MoerLand, Reinboag, Raaijmakers. p. 2002, 176) Corporate are supposed to respect shareholders rights and help them in exercise of their rights by sharing with the information that they can comprehend, accessible and by encouraging their participation. The firm should recognize their legal and other roles to all official stakeholders The role and the responsibility of the board should be clearly stated and carried out effectively Reliability and ethical behavior firms should have a code of conduct for their directors and executives in promotion of ethical decision making. Organizations should be accountable. (Parkinson, Gamble, Kelly, 2001, 233) Mechanisms and Controls in Corporate Governance This controls and mechanisms are formulated to reduce irregularities that come from adverse selection and moral hazard in corporate governance. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) Internal corporate governance controls They monitor activities and take a counteractive action to achieve organizational goals some of them include; (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) Monitoring by the board of directors The board of director has legal authority to hire fire and recompense the top management, they protect invested capital. Problems are identified, discussed and avoided in the various board meetings. NEDs are more independent; they do not always results to effective governance and also on their part may not improve performance. Different board structures are more favorable for various companies. The board is able to monitor the firm executives are through access of information. Executive directors have information on resolution making procedure; they assess the apex management on the ground of their value of decisions that leads to financial performance result. (Parkinson, Gamble, Kelly, 2001, 17) Remuneration A proportion of the salary is designed and relates to a person performance. It is usually in cash or in non cash form such as superannuation, shares and share options or even other benefits. This scheme has no device of governing it so it can lead to mistakes or opportunistic and myopic activities (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) . External corporate governance controls External corporate governance controls include the controls external stakeholders use over the association for instance: require for and evaluation of performance information mainly financial statement, government rules, media stress, invasions, telephone tapping competition and managerial labor market (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) Problems in Corporate Governance Systems An imperfect financial report causes imperfections in the effectiveness of the corporate governance. This error can be rectified by external auditors. The cost of processing information and especially for the small scale shareholders is significantly high they can solve this by use of traditional answer which is efficient market hypothesis (EMH). This hypothesis indicates; share holder’s free ride on judgments of bigger professional investors. Shareholders should combine with other voting groups that are significant and can pose a threat of carrying resolutions or at directors appointment at general meeting, this to influence the director. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) In the late 20th century East Asian economies collapsed and the World Bank president warned those nations of lasting growth and corporate governance had to be good. Corporate governance is an instrument for social economic growth. A nation economic well being depends on good corporate governance system. This mechanism is not the same in countries for it is shaped by is shaped by political, economic legal framework and social history in different countries. Good governance should be encouraged despite of the differences. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) Internationally the process of merger in corporate governance is gaining force because of the global incorporation of financial and product market growth. Economies that adapt transparent and world accepted accounting and governance principles foreign creditors and investors prefer dealing with such economies Discussions have taken place opposing the hostile take-over in the world many anti take- over (Defense) mechanisms have been established, in Europe a commission that put down measures to protect the investors (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) . Board of Directors The difference has to be made between the one-tier board and two-tier board structure. The one-tier board: the executive and non executive directors merge to form one board also referred to us monistic or unitary board. In a set up like this, the executive perform double functions as the director and executive they carry out responsibilities under each position. While in the two-tier board structure or supervisory board, the ‘highest’ board has NEDs or outside directors only. Their role lies in supervision and control and strategic advice. In this set up the board of executive director or management board is responsible of execution. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) This term can be confusing since for in Dutch the second tier is referred to as the board of directors. A term commonly used for the merge between the executive and non executive in unitary board. There is a correlation in the difference between roles attached to the corporation and board structuring from the international view. Small companies mostly prefer one-tire board even where the two-tier is more dominant and rule for large firms. In countries that use unitary board structure in many large firms they entrust an amount of their executive committee or executive to other directors and managers. On this analysis shows the complex trend of the growing merger in the world forms and the differences both nationally and internationally on the type of form. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) Institutional Investors In the past rich businessmen or families were the buyers and sellers of corporation stock worldwide, on the corporations where they own share they put a lot of emotional and personal interest. Institutionalization of the market has grown with time so buying and selling is the responsibility of institutions example being insurance companies and investor groups. The stock market regulation has improved due to increase of institutional investors and professional diligence. Institutionalization process was spontaneous with direct growth of individuals indirectly invested in the market a good example an individual could have a double amount in an insurance company than the amount in the bank. The growth of institutions was a result of people giving their money to professional to mange it, majority of this kind of investment is referred to as “institutional investment” although most of the fund benefits the person investing. (Macmillan, 2003, p.10) There has been a continuous lapse in the oversight of large corporations which is unfortunate. Almost all corporations are currently own by large corporations. In the recent past the board of directors was elected by the principle share holders who had both monitory and emotion effect in the company. The board of director could hire or fire the Chief Executive Officer or the president for their role was to diligently safe guard the company and top executive. The board currently is selected by the president and the CEO, The likely hood being that it is composed of associates and friends. The owner s of the institution if they are not fond of the CEO/President actions they sell their interest for firing the top person would cost them a lot i.e. golden handshake. The investors rarely are in support of share holders resolutions such as anti takeovers or executive pay. The reason being the CEO/president takes the position of the chair of the board making it hard for the shareholders to fire him. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) Lastly the emergence of internet transactions in the 1990s internationally the direct and indirect ownership of stock by individuals and professional stock investors has come up as a new kind of force. The sale of derivatives such as exchange traded funds has largely increased while buying of individual share by individual investor has reduced in corporations. Investor interest currently is not tied to fortunes of individual corporations (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) Board independence/ Non- Executive Directors An independent director is considered to be the one who is free from any family, business or other any other close association with the organization, controlling management or shareholder if this is present it may cause conflict of interest in areas he is required to make sound judgment. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) In the 7th international world council conference for corporate governance, the following guidelines were given on selection of a non executive director “The Non executive director is not supposed to be a managing director, executive or employee of the company or was in such position in the past five years; should not receive any fee from the firm or any associated firm apart from the fee given to non executive directors; they should not represent controlling share holders; they should not have had or have business relation ship with the firm or an associate firm the past year; should not have been a partner or employee of the firm’s external auditor or in an associated company in the last three years; Should not be and executive or managing director in another company in which an executive or managing director of the company is non executive director, and not to have other significant links with executive directors of the company through involvement in other companies or bodies; not to have served on the board for than 12years (at most), not to be a close family member of an executive or managing director, or of persons in the in the situations referred above”. (Parkinson, Gamble, Kelly, 2001, 233) Cadbury code introduction has made many companies to have NEDs in the UK and European countries are following up. Reports on corporate governance stress on contracting enough number of non executive directors and honest independent directors that are not in the daily carrying out of the firm and separate from share holders. Independence is seen as a remedy for many malfunctioning in corporate governance for example conflicts of interest and misuse of powerful positions. Definition of independence should be according to power and control structure for they are different across nations and in firms. The board structure is endogenous to the company choice. (Colgate,2006, 203, 220) Non Executive Directors Roles The evolution of the independence of NEDs led to crystallization and emergence of two associated notions, “negative probabilistic concept” and “negative bilateral concept.” The negative bilateral idea assigns self-governing status to a executive according to his/her lack of relations with a specific firm whereas the negative probabilistic concept assigns sovereign status to a executive according to the lack of connections with specific categories and/or groups in the general population. (Parkinson, Gamble, Kelly, 2001, 233) The Non Executive Director is appointed on the board of a company on part-time. Their work involves going for some board meetings and the organization functions. They provide qualified, smart advice to the corporation chairman, board or management. They offer their advice on the basis of an outsider look of the organization and according to their skills, experience and industry contract. (Parkinson, Gamble, Kelly. 2001, 15, 187) They are also referred to as NEDS (non executive directors). In some companies, their job is to sit on the Audit Committee, Pension Trustee Body, Directors Remuneration Committee and any other Committees that have need of an autonomous body view; these committees are separate and not accountable to the Chief Executive, Managing Director or Chairman. Non executive directors should meet yearly as a group, without the chairman or the executive directors being present. The annual report should include if such a meeting took place. Before new NEDs are appointed a due diligence exercise should be conducted on the board and the company to satisfy themselves that they have knowledge, experience, skills and it is a time to make optimistic input. (Parkinson, Gamble, Kelly. 2001, 69) They constructively challenge the corporation and give contribution to development of strategy. They should also provide appointments, resources and standards of conduct. Non executive directors should also examine the performance of organization in meeting developed goals and objectives and monitoring, and where necessary coming up with senior organization and in sequence planning. Non- executive directors they are like custodians of the corporate governance process. NEDs were few years ago seen useful but relatively costly and an addition to boards of big companies. Companies of all sizes are increasingly recognizing the importance of NEDs. The emerging entrepreneur can benefit from the support of energetic, the NEDs professional like the other established firms. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) Non Executive Directors help small or medium companies in: creation of sound business strategy and policy, review the budget and plans, to be a confidential sounding board for the chief executive and chairman, assess the company overall performance, review the management structure, contact with third party e.g. financial sources, outside of the workings of the other companies and industries. The law in UK does not the separate category of non executive director. In the business practice the executive and the non executives are not treated the same. This separation has no evidence that it has led to improvement of governance. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) . Corporate Governance models around the world There is variation in corporate governance models in the world though the US model is most tarnished. They are arrangements such as the complex share holding structures chaebols in South Korea, keiretsus in Japan and many others (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, 176) Anglo-American Model The main determinant factor that that differentiate the models around the world is the variety of capitalism in the model. In Anglo American countries liberal model is common since this countries prioritize shareholders interests. In continental Europe and Japan they have coordinated model it also recognizes the interest of workers, suppliers customers, managers and the community. They both have completive advantage but in different ways. The liberal encourages radical innovation and cost competition while coordinated facilitates incremental innovation and quality competition. (Macmillan, 2003, 88) Boards of directors are the ones that govern US corporations it has the power to choose chief executive officer. The CEO has power of running the corporation on daily basis but needs boards’ approval on some major decisions such as hiring immediate subordinates and raisin money. The share holders elect the board of directors and they are accountable to them. In the bylaws the largest shareholders are not allowed to influence the setup of the board in many companies. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) UK put together a code called “comply or explain” This code of governance is a flexible model of regulation in corporate governance. This code is principle based; it lists many recommended practices for example: separation of the chairman and CEO of the board, CEO contract time limit, Designation of senior executive director, non-executive directors and independent director’s minimum number, audit, formation and composition of remuneration. (Macmillan, 2003, p.10) Non Anglo- American Model There is domination over companies owned by families in East Asia countries. In a system of family cross holdings in countries such as Pakistan, Philippines and Indonesia a 50% of publicly owned corporations 15 top families own them leading to domination of capital markets. This system also dominates Latin model corporate governance, like companies in Italy, Mexico France to some extent, also Brazil Argentina and other countries in South America. Transformation and growth of economies of the third world countries is rapidly growing and there s need to put in place corporate governance mechanism to have sustainable development. They have evolved from closed, market-unfriendly, undemocratic systems to open, market friendly, democratic systems. Firm realize their maximum effectiveness and fruitfulness in good corporate governance systems. Managerial transparency is seen when there is minimal abuse of power and corruption. The above goals are important for both government and private corporation’s bodies. McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p.176) According to Nicolas Meisel, there are four priorities which developing countries should concentrate on while experimenting with new forms of corporation and public governance. The first is to focus on improving the quality of information and increasing the speed at which it is created and distributed to the public. Good communication is important to the functioning of any organization. The second is to allow individual actors more autonomy while at the same time maintaining or increasing accountability. Thirdly, if a hierarchical organization used to orient private activities toward the general interest, new countervailing powers should be encouraged to fill this role. Finally, the part the state plays and how government officials are selected must be considered if a developing economy is to achieve sustainable growth. This may involve making it easier for newcomers with new ideas incumbents who may hold to older, possibly outdated, models. (McCahery, MoerLand, Reinboag, Raaijmakers. 2002, p. 176) Conclusion In Post Enron era attention has been given to non-executive directors NEDs and their role in corporate governance. It was formulated after there was a succession of corporate wrongs, malfunctions and crisis. Regulatory reports such as the Cadbury Report of 1992, the Greenbury Report of 1995, the Hampel Report of 1998, and the Combined Code 2003 for transparency and efficiency in corporate governance they emphasize on importance of the appointment of independent non executive directors. (Maarty, 2005, 8) In conclusion the non executive directors, regulate concentration of power with the chief executive officer and/or senior executive directors of the firm. Since they are separate from the corporate they are effective in countering weight to the executive membership of a board. (Macmillan, 2003, 8) Reference List Colgate Peter, 2006, Accounting Standards, Cambridge University Press, ISBN: 0521607221 Gourevitch, A.P., Shinn J, 2005, Corporate Governance, Princeton University Press, Macmillan Fiona, 2003, Corporation Law, Hart Publishers ISBN: 184113158X Mantysaari Petri, 2005, Corporate Governance Law and Legislation Europe, Springer Publisher, ISBN 3540253807 McCahery, Moerland, Rennboog, Raaijmakers, 2000, Corporate Governance Law and Legislation Europe Oxford University ISBN: 0199247870 Parkinson J., Gamble A., Kelly G., 2001, Microeconomics, Hart Publishing ISBN: 1841131202 Read More