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Corporate Governance

Corporate Governance. Chapter 1. What is Corporate Governance?. Deals with the problems arising from the separation of ownership and control. . Separation of Ownership and Control.

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Corporate Governance

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  1. Corporate Governance Chapter 1

  2. What is Corporate Governance? • Deals with the problems arising from the separation of ownership and control.

  3. Separation of Ownership and Control • The thousands, or more, investors who own public corporations could not collectively make the daily decisions needed to operate a business. Therefore: • The shareholders are owners of the firm • The shareholders elect directors to act as their agents in supervising the firm • The directors appoint officers (or executives) to actually run the firm on a day-to-day basis

  4. Separation of Ownership and Control Shareholders Ownership Board Management Control Employees

  5. Focus of Corporate Governance • Shareholders elect directors who represent them. • Directors vote on key matters and adopt the majority decisions. • Decisions are made in a transparent manner so that shareholders and others can hold directors accountable. • Company adopts accounting standards to generate the information necessary for directors, investors and other stakeholders to make decisions. • The company's policies and practices adhere to applicable national, state and local news.

  6. Principal-agent problem • Principal-agent problem represents the conflict of interest between the principal and the agent. • Primary principal-agent problem in corporations: Principal = Shareholders Agent = Officers If shareholders cannot effectively monitor the officers’ behavior, then officers may be tempted to use firm’s assets for their own personal use.

  7. Solutions to Principal-agent problem • Incentives—aligning executive incentives with shareholder desires. • Monitoring—setting up mechanisms for monitoring the behavior of managers.

  8. Can Shareholders Influence Managers? • Shareholders do not directly hire/fire managers – so they can’t vote to replace them • Shareholders can influence managers indirectly through the board of directors • Changing board members can be difficult as management controls the process and some inactive shareholders will go along with whatever management wants. • Some “active” shareholders are large enough to try and influence management or change the board, but they are often met with defeat.

  9. Monitors • Monitors are called for because managers may not act in the shareholder’s best interest. • Figure 1.1 shows that monitors exist: • inside the corporate structure • Board of directors • outside the structure • Auditors, analysts, bankers, credit agencies, and attorneys • in government • SECP

  10. Figure 1.1

  11. Inside monitors-Board of directors • Oversee management and are supposed to represent shareholders’ interests. • Evaluates management and design compensation contracts to tie management’s salaries to the firm’s performance.

  12. Outside monitors • Interact with the firm and monitor manager activities • Auditors • Analysts • Bankers • Credit agencies • Attorneys

  13. Government monitors • The SECP regulates public firms for the protection of public investors • The SECP also makes policy and prosecutes violators in civil courts.

  14. Governance is more than just Board Processes and Procedures • It involves the full set of Relationship between • a company’s management • Its Board • Its Shareholders • Its other stakeholders • One size doesn’t fit all. The Board Objectives and Procedures may be the same to all societies but when it comes to applying them to individual countries we have to reckon the peculiar, socio-cultural characteristics, the history of its people, their value systems, their economic system, etc.

  15. Corporate Governance Guidelines • Most worldwide organizations have strongly promoted good corporate governance by the implications of following corporate governance guidelines: • 1. Rights of shareholders • 2. Equitable treatment of shareholders • 3. Role of stakeholders in corporate governance • 4. Disclosure and transparency • 5. Responsibilities of the board

  16. Corporate Governance Guidelines • 1. Rights of shareholders • All shareholders must be given their due rights i.e. They all should have • Secured ownership of their shares • Voting rights • Right to full disclosure of information • participation on decisions on sale or change in corporate assets or new share issues • Capital structure must be disclosed • All transactions should be at transparent prices and under fair conditions

  17. Corporate Governance Guidelines • 2. Equitable treatment of shareholders • All shareholders should have equal opportunity for redressal of the violation of their rights • Insider trading should be prohibited

  18. Corporate Governance Guidelines • 3. Role of stakeholders in corporate governance • Corporate governance framework apart from the rights of shareholders allow • Employees representation on BOD • Profit sharing • Creditors’ involvement in insolvency proceedings

  19. Corporate Governance Guidelines • 4. Disclosure and transparency • Financial details, operating results, policies, governance structure should be disclosed • Annual audits should be performed by independent auditors • When in D oubt isclose

  20. Corporate Governance Guidelines • 5. Responsibilities of the board • Board is responsible for • Protecting the company, its shareholders and other stakeholders • Making policies, strategies • Monitoring effectiveness

  21. McKinsey’s Two-Version Governance Chain Models • Model 1: Market Model • In Market Model governance chain, there are efficient, well-developed equity markets and dispersed ownership. • Model 2: Control Model • In Control Model governance chain is represented by underdeveloped equity markets, concentrated(family) ownership, less shareholder transparency and inadequate protection of minority and foreign shareholders.

  22. Market Model Governance ChainMore common in US, UK, Canada & Australia Shareholder environment Independence & Performance Dispersed ownership Non-executive Majority Boards Aligned incentives Sophisticated institutional ownership Institutional Context Corporate Context High disclosure Active equity market Shareholder equality Active takeover market Capital Market Liquidity Transparency & Accountability

  23. Control Model Governance Chain More common in Asia, Latin America, parts of Europe Shareholder environment Independence & Performance Concentrated ownership Insider boards Incentives aligned with core shareholders Reliance on family, bank, public finance Institutional Context Corporate Context Limited disclosure Under developed new issue market Inadequate minority protection Limited takeover market Capital Market Liquidity Transparency & Accountability

  24. Issues in Corporate Governance • Corporate Governance conveys different meanings to different people. But to all, corporate governance is a mean to an end, the end being long-term shareholder value and more importantly stakeholder value. All authorities have identified some governance issues being crucial and critical to achieve these objectives. These are: • Distinguishing the role of Board & Management • Composition of Board & related issues • Separation of the roles of CEO & chairperson • Should the board have committees? • Appointments to the board & directors’ re-election • Directors’ and executives’ remuneration • Disclosure & audit • Protection of shareholders’ rights & their expectations • Dialogue with institutional shareholders • Should investors have a say in making a company

  25. Issues in Corporate Governance1. Distinguishing the role of Board & Management • Board of the company has following functions: • Select, decide the remuneration & evaluate on regular basis and when necessary change the CEO. • Oversee indirectly the conduct of company’s business • Review and approve the company’s financial objective if necessary • Recommending candidates to the shareholders for electing them to BOD • Review the adequacy of systems to comply with all laws n regulations • All other functions required by law to be performed

  26. Issues in Corporate Governance2. Composition of Board & related issues • BOD is a committee elected by shareholders. Sometimes, full-time functional directors are appointed, each being responsible for some particular branch of the firm’s work.

  27. Issues in Corporate Governance 3. Separation of the roles of CEO & chairperson • Combining the role of chairperson with that of the CEO leads to conflict in decision making and too much concentration of power in one person resulting in unhealthy consequences. • The role of CEO is to lead the senior management team in managing the enterprise, while • The role of chairperson is to lead the board to evaluate the performance of senior executives including the CEO.

  28. Issues in Corporate Governance 4. Should the board have committees? • Following committees if made would lessen the burden of the board and enhance its effectiveness: • Nomination • Remuneration • Auditing

  29. Issues in Corporate Governance 5. Appointments to the board & directors’ re-election • The board or its specially constituted committees selects and appoints the prospective director and gets the person formally elected by the shareholders at AGM.

  30. Issues in Corporate Governance 6. Directors’ and executives’ remuneration • Shareholders are entitled to a full and clear statement of Director’s [resent and future benefits and how they have been determined. • Remuneration committee must be appointed for this task.

  31. Issues in Corporate Governance • 7. Disclosure & audit • 8. Protection of shareholders’ rights & their expectations • 9. Dialogue with institutional shareholders • 10. Should investors have a say in making a company

  32. Need & Importance for Corporate Governance • Corporate governance is needed to create a corporate culture of consciousness, transparency and openness. • It refers to the combination of laws, rules, regulations, procedures and voluntary practices to enable companies to maximize shareholders’ long-term value. • It should lead to increasing customer satisfaction, shareholder value and wealth

  33. Governance & Corporate Performance • There is a positive relationship between corporate governance and corporate performance. Improved corporate governance is linked with improved corporate performance either in terms of rise in share price or profitability.

  34. Investors’ Preference for Good Governance • Majority of investors consider governance practices to be atleast as important as financial performance, when they evaluate companies for potential investment. • They are prepared to pay a premium for shares in a well-governed company as compared to a poorly governed one exhibiting similar financial performance.

  35. Benefits of Good Corporate to a Corporation 1. Creation & enhancement of a corporation’s competitive advantage 2. Enabling a corporation perform efficiently by preventing fraud & malpractices 3. Providing protection to shareholders’ interest 4. Enhancing the valuation of an enterprise 5. Ensuring compliance of laws and regulations

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