CBEB3101 Business Ethics Lecture 7 Semester 1, 2011/2012 Prepared by Zulkufly Ramly. 1. Contents of Topic 6. Ownership and control Agency theory Agency costs Definition of Corporate Governance (CG) Objectives of CG Issues of CG. Topic 6 Learning Objectives. 3.
Ownership belongs to shareholders
Control surrendered to board of directors
Shareholders have voting power only
Board of directors makes strategic decisions
Limited power relative to board and management team
Management team makes daily operational decisions
Conflict of interest when management team does not act in the best interest of shareholders
Both are powerful relative to shareholders
Corporate governance problems
Conflict of interest
Managers and shareholders have conflicting objectives
Shareholders want maximization of profit and wealth
Managers have personal interest
Governance refers to
Hence, CG is principally concerned with the way PLCs is governed.
Corporate refers mainly to large listed companies
Malaysian Code on CG (2000)
“... as the process and structure used to direct and manage business and affairs of the company towards enhancing business prosperity and corporate accountability with the ultimate objective of realising long term shareholder value, whilst taking into account the interests of other stakeholders.”
The board and its directors are to be properly structured with sufficiently experienced, skilled and knowledgeable members;
The composition of the board should be balanced by executive, non-executive and independent directors;
Committees of the board should be established to carry out review and recommend important matters concerning auditing, remuneration and nomination, among others;
The should be reasonable systems to evaluate and access risks and internal control, so as to form risk management;
Sufficient care should be devoted in financial reporting and disclosure;
Constructive communication and dialogue with shareholders and individual directors should be encouraged.
Directors’ remuneration made at their own discretion;
Financial Reporting irregularities and auditing;
Lopsided decision making powers;
In Malaysia there is no legal requirement for board to seek shareholders’ approval for remunerating directors (exception - share option scheme)
Directors decide their own remuneration
The basis for remunerating sometimes are not based on their individual, company and peer companies performance
Shareholders do not object high remuneration UNLESS it is not supported by good performance
Shareholders object ‘fat cat directors’
There should be procedures to determine remuneration packages
Yes to high pay
Rewarded for outstanding performance
Provide an incentive for innovation and risk-taking
Scarce talents to run large and complex organizations
Directors are accountable to report the financial health and status of the company to shareholders
They control financial information, hence may manipulate or ‘window dressed’ - misleading
Financial reports should show balanced assessment of company’s position and adhere to financial reporting standards
Enron scandal 2001
In August 2002, Michael Kopper, an assistant to Andy Fastow (the former finance director) pleaded guilt to charges of wire fraud and money laundering.
Andy Fastow was found guilty of money laundering, fraud, conspired to inflate profits and enriched himself.
Enron top executives sold over $1b of Enron shares to other investors fully knowing that the co. was in trouble financially – shareholders were told the opposite.
In short, this is a clear e.g. of agency problems
Case Example 1
Twice a year, Chairman and CEO boards one of his company’s four jets to visit his own small vineyard in Italy that produces RM300 wine per bottle. Cost = USD$60k –USD$170k per trip.
Former vice-chairman flies to his vacation homes in Florida and Boston using company’s jet.
Who pays? SHAREHOLDERS
Issue – pursue own benefit at the expense of shareholders wealth.
Case Example 2
Lone Star Industries (a US Company)
CEO James Stewart allegedly billed the company USD1m for ‘purely personal expenses’ including taking his personal music teacher on Lone Star trips to three continents.
The BOD did not scrutinise the CEO’s expenses and admitted that they ‘did not know what he was doing.’
In 1990, Lone Star filed for bankruptcy.
An illustration of opportunistic behaviour and managerial agenda at the expense of shareholders.
Case Example 3
RJR Nabisco (a US Company)
CEO Wilson spent USD68m developing smokeless cigarettes without informing the BOD.
Issue: He exceeded spending limits without BOD’s approval.
Wilson’s successor arranged for his directors to rub shoulders with celebrities, use corporate planes and apartments.
He handpicked the directors hoping they will support him
Case Example 4
The HIH Insurance Group (Australian co.)
Was one of the largest underwriter in Australia; collapsed in 2001.
Investigation by the government revealed that money was wasted by extravagance, paying too much for business acquired (empire building?), largesse and questionable transactions.
Also revealed, an unwise acquisition of FAI Insurance, which performed poorly in the UK and USA.
It was concluded that HIH’s collapsed was due to the lack of accountability for performance, and a lack of integrity in the company’s internal processes and systems.
Combined, all these features led to a series of biz decisions that were poorly conceived and poorly executed.
Case Example 5