Question 1:

Discuss the advantages and disadvantages of allowing one individual to act as both
chairman and chief executive of a quoted company.

Ans: A major issue of corporate governance is to analyze whether the Chief Executive Officer of a
quoted company should be allowed to act as a chairman. It has become a questionable argument in
the moving world. In the recent years, there have been substantial collapses of several large
corporations which have forced the organizations to modify the configuration of their corporate
governance.

The dual role of CEO means that the Chief Executive Officer of a firm will also act as the Chairman of
the board of directors (Boyd 1995). Various surveys carried out between 1999 and 2005 shows
that in the United States of America (USA) between 60 and 80 per cent of all major corporations
have the same person act as both the CEO and Chairman, whereas British, Canadian and Japanese
companies has only about 10 to 20 per cent of the combined role (Brownbill 2010).

The Agency theory and Stewardship theory give us a clear idea on whether the CEO duality role
helps the firm to perform effectively or it obstructs the firm’s performance.

Agency Theory
The agency theory can be described as the relationship between the principal (Stakeholders) to its
agent (Management). This theory suggests that to achieve the goals of the organization, the roles of
Board of Directors (BOD) and CEO must be separated. Agency theory highlights that the person
who has a dual role as the BOD and CEO should not lead a company. It means that the board is
elected by the shareholders and then the very board elects the management team whose
responsibility is to execute the routine regular business decisions (Abdullah and Valentine, 2009).
This theory also suggests that the agency cost will be reduced if the roles of BOD and the CEO is
separated.

Stewardship theory
This theory is opposite the agency theory where the base is psychology and sociology. It describes
such a corporate structure where the stewards (management) are very keen and inspired to work
in the greatest interest of their shareholders (Davis et al., 1997). This theory supports the dual role
of CEO in a company which is a clear contradiction to the agency theory that describes the negative
impacts of dual role of CEO. This theory concentrates on dual role of CEO of a company. To reduce
the supervising and controlling costs is the main purpose of this theory as there is no need to hire a
CEO from outside the BOD by paying too much if a Board of Director plays the role of CEO.
Unlike the agency theory, it holds that management are responsible agents who always want to
make such type of decisions that are benefited for the entire organization rather than personal
indulgence (Abels & Martelli 2011). It is believed by the supporters of this theory that when the
same person plays both the role of CEO and Chairman, he or she can ensure the work to be done
more efficiently and effectively. It creates some sort of harmony the company’s managers and board
of directors, which ultimately makes the CEO enabled to serve the shareholders more appropriately
(McGrath 2009). Several studies have shown that the shareholders of the company get more return
where the combined role of CEO and Chairman exist that justifies the stewardship theory.

Advantages of allowing one individual to act both as CEO and Chairman:

The advantages of allowing a single individual to act both as CEO and Chairman are very obvious
when we consider the day-to-day operations of a corporation.

The CEO, as the manager of the corporation, has a superior knowledge of the operations of the
business. When that role is unified with his role as Chairman of the Board, one person occupying
both of these roles may better be able to lead the corporation and to identify any problems that may
arise. This can provide superior knowledge to the board and increase the information available to
it. This unified leadership structure creates efficiency by allowing the unified executive to operate
in both capacities at once. The other board members can have confidence that their Chairman/CEO
is fully aware of the corporation’s strengths and weaknesses, along with what issues need to be
addressed moving forward.

Clear direction of a single leader

A BOD who also serves as CEO certainly has enormous power within a company. The advantage to
be gained by the presence of CEO duality is a clear direction of a single leader, this happens because
of all the activities undertaken by the company only rely on one person. This is of course will
provide a clear direction from the CEO to their managers, stakeholders, and their subordinates
regarding the strategy and business decisions that exist within the company.

Efficiency and Effectiveness

In the CEO duality, efficient means the company does not need to spend more money to hire CEOs
from outside so that it will certainly provide efficiencies for the company in minimizing their
expenses. On the other hand, effective in the presence of CEO duality means substantial power as
the BOD and CEO provide the effectiveness of the company in making a decision to reach the goals
of the company; this is because in CEO duality does not require a long process in making a decision,
so it will save more time.

Disadvantages of CEO Duality:

Misuse the power
A strong power in the CEO duality actually is good because it can create a clear direction of a single
leader, but on the other hand it is also a disadvantage of CEO duality. This is because if a person has
enormous power within a company, he/she can misuse the power.

Lack of transparency
This happen because of the strong power possessed by the CEO duality provides an opportunity to
hide whatever is in the company which resulting in lack of transparency of the company.

Executive Compensation
An increase in executive pay generally gets the attention of company shareholders. Increases come
at the expense of shareholder profits, although most understand that competitive pay helps to keep
talent in the business. However, it is the board of directors that votes to increase executive pay.
When the CEO is also the chairman, a conflict of interest arises, as the CEO is voting on his or her
own compensation. Although a board is required by legislation to have some members who are
independent of management, the chair can influence the activities of the board, which allows for
abuse of the chair position.

Corporate Governance
One of the board's main roles is to monitor the operations of the company and to ensure that it is
being run in conjunction with the mandate of the company and the will of the shareholders. As the
CEO is the management position responsible for driving those operations, having a combined role
results in monitoring oneself, which opens the door for abuse of the position. A board led by an
independent chair is more likely to identify and monitor areas of the company that are drifting from
its mandate and to put into place corrective measures to get it back on track.
Audit Committee Independence
In 2002, the Sarbanes-Oxley Act, legislated as a response to several high-profile corporate failures,
set out stronger regulations for corporate oversight, including a requirement that the audit
committee consist of only external board members. This means that no member of management
can sit on the audit committee. However, because the committee is a sub-group of the board of
directors and reports to the chair, having the CEO in the chair role limits the effectiveness of the
committee.

From the analysis, it can be concluded that there is no right or wrong board structure but generally
shareholders and stakeholders are more inclined towards separation of the roles to promote
independence and transparency. Although duality or separation may not have any direct linkage to
firm performance, separation model promotes a healthier balance to the overall corporate
governance of an organization.

References:

Boyd, B. K. CEO Duality and Firm Performance: A Contingency Model.

Strategic Management Journal, 16, pp. 301-312, 1995.

Brownbill, N. Should the CEO also be the Chairman? The duality debate,
2010.

Abdullah, H. & Valentine, B. ‘‘Fundamental and ethics theories of corporate

governance’’. Middle Eastern Finance and Economics, 4(4), pp. 88-96, 2009.

Davis, J., Schoorman, F. and Donaldson, L. Toward a stewardship theory of

management. Academy of Management Review, 22(1), pp. 20-47, 1997.

Abels, P. B., & Martelli, J. T. CEO Duality: How many hats are too many?
Emerald Group Publishing Limited, 13(2), pp. 135-147, 2013.

McGrath, J. (2009), ‘‘How CEOs work’’, How Stuff Works, available at:
http://money.howstuffworks.com/ceo.htm.

Question 3:

What do you believe are the main lessons that can be drawn from the collapse of Polly Peck?
Answer:

Polly Peck’s financial troubles were not just caused by fraud and theft. They were also rooted in a
very simple accounting trick that investors at the time should have spotted – and it’s something we
can all still learn from today.

Polly Peck had a very good position in the stock market; its price had soared and it was loved by
everybody. And then overnight it collapsed – a £2bn company disappeared – and what is interesting
about it is twofold. The first thing is an awful lot of people knew that there was something wrong
with it because there were a lot of people who were saying how does this business model work?
How does a company in that business make so much money? And how does a company making that
much profit never have any cash? So there were a lot of people who were going there is something
not right here. Apparently some of the executives on the Board of Polly Peck were saying we don’t
understand how it makes its money. So the lesson we can learn from it is if you don’t understand
how it makes its money, it is up to you to do some digging – or at least not take it for granted.

In Poly Peck Asil Nadir had the authority to authorize things and write cheques without very many
checks and balances on him. This kind of phenomenon can lead to things going wrong in a company.
After the incident of Poly Peck, the Cadbury Committee was formed which looked at corporate
governance in UK companies. Cadbury reported in 1992; from Cadbury we had very good corporate
governance codes which have been exported throughout most of the year. And the two big things
that Cadbury brought in was first of all strengthening the role of non-executive directors to try and
get some sort of control over the board. And second of all, splitting up at the top of the company, the
role of the CEO and the role of the Chairman – again to get some checks and balances in.

The lesson to learn here is that , the balance sheet is the most important statement a firm produces.
Here are three more balance-sheet warning signs to watch out for.

1. Rapidly increasing current assets

A firm’s short-term balance-sheet assets are called “current”. These are assets needed to run a
business, such as cash, stock for resale, and amounts owed by customers. Usually these move in line
with sales. If a business boosts sales by 10% in its profit-and-loss account, with the same terms of
trade with its customers and suppliers, stock and receivable balances should move up by around
10% too. When there is a big unexplained jump in stock for resale or receivables with no
corresponding change in sales, then it has to be watched out. It suggests the firm is either struggling
to shift stock or not managing customer collections properly.

2. A shrinking balance sheet

As the Polly Peck collapse showed, a combination of rising profits and a shrinking balance sheet is a
disaster waiting to happen. So the most important, test is to take a look at the net assets total in the
balance sheet. This sums up all a firm’s assets, both long and short term (what it owns and is owed
by other people) and deducts all liabilities (what it owes other people, whether trade suppliers,
banks or whoever) to give a net position. In effect this is a snapshot of the firm’s overall wealth. If
this number is getting smaller over time, it is a matter of concern. A successful firm should not only
show rising profits each year, but it should also have a bigger and bigger balance sheet.