WHAT IS CORPORATE GOVERNANCE?

- mechanisms, processes and relations by which corporations are controlled and directed

-about the distribution of different corporate parties for making decisions in corporate affairs.

“If management is about running the business, corporate governance is about seeing that it is run properly and accordingly. All companies need managing and governing.”

WHY CORPORATE GOVERNANCE?

- Improved company performance - Higher firm valuation and share performance - Reduced risk of corporate crisis and scandal

CORPORATE GOVERNANCE PARTIES

*Shareholders*Directors*Manager *Creditors

CORPORATE GOVERNANCE PILLARS

Accountability

- ensure that management is accountable to the board and board is accountable to shareholders

Fairness

- treat all shareholders equally- provide equal and effective consequences for violations

Transparency

- ensure timely, accurate disclosure on all material matters

Independence

- free from influence of others

CORPORATE GOVERNANCE ELEMENTS

Good board practices

*Clearly defined roles and authorities

*Duties & responsibilities are understood by Directors

*Board is well-structured

*Appropriate composition and mix of skills

*Board self-evaluation and training conducted

Control Environment

*Internal control procedures

*Risk management framework present

*Independent audit committee

*Management information systems established

*Independent external auditor conducts audit

Transparent disclosure

*Financial information disclosed

*Non-financial information disclosed

*In compliance with IFRS

*Companies registry filings are up to date

*High-quality annual report published

Well-defined shareholder rights

*Minority shareholder rights formalised

*Organised shareholder meetings conducted

*The board discuss corporate governance issues and created a governance committee

*The corporate governance improvement plan has been created and implemented

*Policies and procedures have been formalised and distributed to relevant staff

Price- earning ratio

*ratio used for valuing a company that measures its current share price relative to its per-share-earnings

Corporate Governance and Agency Theory

• AGENCY THEORY -is the branch of financial economics that looks at conflicts of interest between people with different interests in the same assets.

AGENCY THEORY DIAGRAM

Origins Of Agency Theory

During the 1960s & 1970s, economists explored risk sharing among individuals or groups. This literature described the risk sharing problem as one that arises when co-operating parties have different attitudes toward risks.

Agency Theory broadened this risk sharing literature to include the so called agency problem that occurs when co-operating parties have different goals and division of labour. Specifically, this theory is directed at the ubiquitous agency relationship in which one party delegates work to another agent who performs that work.

CONFLICTS BETWEEN MANAGERS AND SHAREHOLDERS

SELF-INTERESTED BEHAVIOR-Agents have the ability to operate in their own self-interest rather than in the best interests of the firm because of asymmetric information and uncertainty.

COSTS OF SHAREHOLDER-MANAGEMENT CONFLICT

Agency costs are defined as those costs borne by shareholders to encourage managers to maximize shareholder wealth rather than behave in their own self-interests.

-There are three major types of agency costs:

1. expenditures to monitor managerial activities, such as audit costs;

2. expenditures to structure the organization in a way that will limit undesirable managerial behavior, such as appointing outside members to the board of directors or restructuring the company's business units and management hierarchy; and

3. opportunity costs which are incurred when shareholder-imposed restrictions, such as requirements for shareholder votes on specific issues, limit the ability of managers to take actions that advance shareholder wealth.

STOCKHOLDERS VERSUS CREDITORS: A SECOND AGENCY CONFLICT

Shareholder-creditor agency conflicts can result in situations in which a firm's total value declines but its stock price rises. This occurs if the value of the firm's outstanding debt falls by more than the increase in the value of the firm's common stock.

AGENCY VERSUS CONTRACT

Although the notions of agency and contract are closely intertwined, some academics bristle at the suggestion they are essentially the same. A conventional view holds that agency is a special application of contract theory. However, some argue that the reverse is true: a contract is a formalized, structured, and limited version of agency, but agency itself is not based on contracts

AGENCY AND ETHICS

Since agency relationships are usually more complex and ambiguous than contractual relationships, agency carries with it special ethical issues and problems, concerning both agents and principals.

STEWARDSHIP THEORY

Is a theory that managers, left on their own, will indeed act as responsible stewards of the assets they control.

Is an alternative view of agency theory in which managers are assumed to act in their own self-interests at the expense of shareholders.

Managers are viewed as loyal to the company and interested in achieving high performance.

Ownership doesn’t really own a company, it’s merely holding it in trust.

EXAMPLE

Environmental concerns- operating with the littlest possible impact on Earth

EFFECT ON BUSINESS

A company committed to a higher purpose will draw clients who share that same purpose.

EFFECT ON EMPLOYEES

Employees who hold on to the same vision tend to stick around and work hard to achieve the company’s goals even if the compensation is not as much as they can get elsewhere.

EFFECT ON CLIENTS

Customers also like to feel like they are part of something, and may stay with a stewardship-driven business even if its price for goods or services is higher.

STAKEHOLDER THEORY

In the traditional view of the firm, the shareholder view, the

shareholders or stockholders are the owners of the company, and the firm

has a binding financial obligation to put their needs first, to increase value

for them. However, stakeholder theory argues that there are other parties

involved, including governmental bodies, political groups, trade

associations, trade unions, communities, financiers, suppliers, employees,

and customers. Sometimes even competitors are counted as stakeholders—

their status being derived from their capacity to affect the firm and its other

stakeholders. There have been many definitions of stakeholders.

What is a stakeholder?

It is defined as any person/ group which can affect or be affected by

the actions of the business

Any group or individual who can affect or is affected by the

achievement of the organization's objectives

Those groups "on which the organization is dependent for its

continued survival". Stanford Research Institute (1963)

What kind of entity can be a stakeholder?

Persons, groups, neighborhoods, organizations, institutions,

societies, and even the natural environment are generally thought

to qualify as actual or potential stakeholders.

The basis of the stake can be unidirectional or bidirectional- "can

affect or is affected by" - and there is no implication or necessity of

reciprocal impact, as definitions involving relationships,

transactions, or contracts require.

Excluded from having a stake are only those who cannot affect the

firm (have no power) and are not affected by it (have no claim or

relationship).

It includes employees, customers, suppliers, creditors and even the

wider community and competitors.

What is Stakeholder Theory?

It looks at the relationships between an organization and others in

its internal and external environment. It also looks at how these

connections influence how the business conducts its activities.

It is a theory that states that a company owes a responsibility to a

wider group of stakeholders, other than just shareholders.

The stakeholder concept was originally defined as including “those

groups without whose support the organization would cease to

exist.”

Organizations that manage their stakeholder relationships

effectively will survive longer and perform better than organizations

that don’t.

It attempts to articulate a fundamental question in a systematic

way: “which groups are stakeholders deserving or requiring

management attention, and which are not?”

R. Edward Freeman

The original proposer of the stakeholder theory, “Strategic

Management: A Stakeholder Approach (1984)”

Recognized it as an important element of Corporate Social

Responsibility (CSR), a concept which recognizes the responsibilities

of corporations in the world today.

The core idea of the stakeholder theory is that organizations that

manage their stakeholder relationships effectively will survive

longer and perform better than organizations that don’t.

Freeman suggests that organizations should develop certain stakeholder

competencies. These include:

Making a commitment to monitor stakeholder interests

Developing strategies to effectively deal with stakeholders and their

concerns

Dividing and categorizing interests into manageable segments

Ensuring that organizational functions address the needs of

stakeholders

What is CSR or Corporate Social Responsibility?

Defined by Jones as "the notion that corporations have an

obligation to constituent groups in society other than stockholders

and beyond that prescribed by law or union contract, indicating that

a stake may go beyond mere ownership"

The term generally applies to efforts that go beyond what may be

required by regulators or environmental protection groups.

Additional Fact:

Recent controversies surrounding the tax affairs of well-known companies

such as Starbucks, Google and Facebook in the UK have brought stakeholder

theory into the spotlight. Whilst the measures adopted by the companies

are legal, they are widely seen as unethical as they are utilizing loopholes in

the British tax system to pay less corporation tax in the UK. The public

reaction to Starbucks tax dealings has led them to pledge £10m in taxes in

each of the next two years in an attempt to win back customers.

Business Application

Stakeholder theory suggests that the purpose of a business is to create as

much value as possible for stakeholders. In order to succeed and be

sustainable over time, executives must keep the interests of customers,

suppliers, employees, communities and shareholders aligned and going in

the same direction.

A stakeholder approach can assist managers by promoting analysis of how

the company fits into its larger environment, how its standard operating

procedures affect stakeholders within the company (employees, managers,

stockholders) and immediately beyond the company (customers,

suppliers,financiers).

Generic Stakeholder Map with specific stakeholders

Freeman suggests, for example, that each firm should fill in a "generic

stakeholder map" with specific stakeholders. General categories such as

owners, financial community, activist groups, suppliers, government,

political groups, customers, unions, employees, trade associations, and

competitors would be filled in with more specific stakeholders. In turn, the

rational manager would not make major decisions for the organization

without considering the impact on each of these specific stakeholders. As

the organization changes over time, and as the issues for decision change,

the specific stakeholder map will vary.

If the corporate manager looks only to maximize stockholder wealth, other

corporate constituencies (stakeholders) can easily be overlooked. In a

normative sense, stakeholder theory strongly suggests that overlooking

these other stakeholders is (a) unwise or imprudent and/or (b) ethically

unjustified. To this extent, stakeholder theory participates in a broader

debate about business and ethics: will an ethical company be more

profitable in the long run than a company that looks only to the "bottom

line" in any given quarter or year? Those who claim that corporate

managers are imprudent or unwise in ignoring various non-stockholder

constituencies would answer "yes." Others would claim that overlooking

these other constituencies is not ethically justified, regardless of either the

short-term or long-term results for the corporation.

Inevitably, fundamental questions are raised, such as "What is a

corporation, and what is the purpose of a corporation?" Many stakeholder

theorists visualize the corporation not as a truly separate entity, but as part

of a much larger social enterprise. The corporation is not so much a

"natural" individual, in this view, but is rather constructed legally and

politically as an entity that creates social goods. Robert Reich has noted that

for many years, the tacit assumption of both corporate chiefs and U.S.

political leaders was that "the corporation existed for its shareholders, and

as they prospered, so would the nation." Yet that "root principle" may no

longer be valid, according to many critics of corporate aims and activities in

a global economy.

POTENTIAL PROBLEMS OF CORPORATE GOVERNANCE

Corporate Governance Definition

- Refers to the mechanisms, processes and relations by which corporations are controlled and directed.

- Broadly refers to the mechanisms, processes and relations by which corporations are controlled and directed. Governance structures

and principles identify the distribution of rights and responsibilities among different participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and includes the rules and procedures for making decisions in corporate affairs.

- Refers to the method by which a firm is being governed, directed, administered, or controlled, and to the goals for which it is being governed.

- Is concerned with the relative roles, rights, and accountability of such stakeholder groups as owners, boards of directors, managers, employees, and other stakeholders.

Potential Problems

I. Separation of Chief Executive Officer and Chairman of the Board roles

This Diagram shows that even on big or small firms, CEO and chairman’s roles can be separated.

The Need for Board Independence Outside directors – are independent from the firm Inside directors – have some tie to the firm

Board independence from management is crucial to good governance.

Example case:

In the wake of the financial crisis, calls to separate the Chairman of the Board and CEO roles in corporations have become common. Most recently, Jamie Dimon of JPMorgan Chase successfully fended off a challenge of his dual role from public employee unions and the New York City Comptroller. The shareholders of JPMorgan Chase voted overwhelmingly to retain the unified structure, with analysts pointing to declining profits at companies such as the Walt Disney Company in the years following separation of the roles as a motivating factor.Concerned shareholders often urge that a unified role leads to a lack of oversight and diminishes the independence of a board. Executives and other corporate associations advise that a unified role ensures strong, central leadership and increases efficiency, pointing to the relative success of companies like JPMorgan Chase. Of the major banks, only Citigroup and Bank of America do not have a unified CEO/Chairman. Prior to the financial crisis, several failed banks such as Lehman Brothers and Bear Stearns

employed unified Chairman and CEOs, a fact which has led to criticism of the unified roleUnified and Separate Role ProsUNIFIED ROLE

• Secured Leadership• Operate in both Capacities at once• Issues addressed easily• Superior knowledge

SEPARATE ROLE• Independent source of authority• Effectively addresses their roles• Avoidance of abusive dual roles• Safeguard of shareholder’s interest

II. Issues surrounding Compensation

CEO Pay-Firm Performance Relationship- Backdating

Allows the recipient to purchase stock at yesterday’s price, resulting in immediate wealth increase.

- Spring-LoadingGranting of a stock option at today’s price, but with the inside knowledge that stock’s value is improving.

- Bullet DodgingDelaying of a stock option grant until right after bad news.

Excessive CEO Pay- Say on Pay

Evolved from concerns over excessive executive compensation.- Claw back provisions

Compensation recovery mechanisms that enable a company to recoup CEO pay, typically in the event of a financial restatement or executive’s misbehavior.

James Dimon is chairman, president and chief executive officer of JPMorgan Chase, largest of the Big Four American banks, and previously served on the Board of Directors of the Federal Reserve Bank of New York.

Executive Retirement Plans & exit Packages- Retirement Packages have come under scrutiny.

o $210 million to Robert Nardelli when he was ousted from Home Depot.

o $125 million to outgoing Bank of America CEO, Ken Lewis

- In contrast, many of today’s workers do not have a retirement plan.

- Those who do generally have a defined contribution plan, rather than a defined benefit plan.

Outside Director Compensation- Paying board members is a recent idea.- Today, outside board members are paid.- From 2003-2010, their median pay rose about a third, from

$175,800 to $233,800.- Controversy over whether directors should be paid at all,

and whether they are paid enough.

Transparency; SEC Rules- Exec compensation packages may include deferred pay,

Severance, pension benefits, & other perks over $10,000- SEC Rules require disclosure of executive compensation- Such disclosures may have a moderating impact prior to

implementation.

Emerging issues- Systematic Problems

Demand for information: In order to influence the directors, the shareholders must combine with others to form a voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting.Monitoring costs: A barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional

answer to this problem is the efficient-market hypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are efficient), which suggests that the small shareholder will free ride on the judgments of larger professional investors.Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process.

- Philippines SEC Code of Corporate GovernanceA recent study finds that countries’ quality of public securities enforcement is unrelated to stock market development. In contrast, countries’ quality of disclosure is strongly related to their stock market development. This study suggests that securities laws do matter but probably not as much as many of us would have thought. In any case, we find that the SEC is an important corporate monitor. Empirical work required: Relationship between quality of public securities enforcement and stock market development; Relationship between quality of disclosure and stock market development.

“I don’t believe in taking right decisions. I take decisions and make them right” –Ratan Tata

INDIVIDUAL AND SITUATIONAL INFLUENCES ON ETHICAL BEHAVIOR

In a survey of 300 companies across the world, over 85% of senior executives indicated that the following issues were among their top ethical concerns.

Employee conflicts of interests Inappropriate gifts Sexual harassment Unauthorized payments

INFLUENCES ON ETHICAL BEHAVIOR

Individual influence - unique characteristics of the individual making the relevant decision

Given at birth Acquired by experience and socialization

Situational influence - particular features of the context that influence whether the individual will make an ethical or unethical decision

Work context The issue itself including: Intensity and ethical framing

Individual Factors Personal values and morals Family influences Peer influences Life experiences

Stages of Moral Development

Individual undergo two stages of moral development The minor or prepubescent stage The adulthood stage

Moral development is the process through which children develop proper attitudes and behaviour toward others in society, based on social and culture, norms, rules and laws

Personality Values and Personality A key personality variable which may affect the ethical behavior of

an individual is his/her “LOCUS OF CONTROL” which was developed by Julian B. Rotter

An individual has an INTERNAL LOCUS OF CONTROL if he/she believes that he/she can control the events in his/her life

An individual with an EXTERNAL LOCUS OF CONTROL believes that fate or luck or other people affect his life.

Family Influences Individuals start to form ethical standard as children in response to

their perception of their parent’s behavior.

Peer Influences Colleagues who are always around us in conducting our daily work

affect the ethical behavior of an individual.

Life Experience Whether positive or negative, key events affect the lives of

individuals and determine their ethical beliefs and behavior.

Situational Factors Issue Related Context Related Authority Systems of Rewards Work Roles Organizational Norms and Culture

How Ethical Behavior are justified

Authority •People do what they are told to do – or what they think they’re being told to do

Systems of RewardsAdherence to ethical principles and standards stands less chance of being repeated and spread throughout a company when it goes unnoticed and unrewarded

Work roles•Work roles can encapsulate a whole set of expectations about what to value, how to relate to others, and how to behave•Can be either functional or hierarchical

Organizational Norms and Culture

•Group norms delineate acceptable standards of behaviour within the work community