The Future of Corporate Governance

Lesson 13
 Topics

➢ the frontiers of corporate governance

➢ beyond the frontiers of corporate governance
➢ new corporate governance policies & practices
➢ society’s changing expectations
Corporate Governance is defined as:

“The process & structure used to direct & manage the

business & affairs of the company towards promoting
business prosperity & corporate accountability with the
ultimate objective of realising long-term shareholder value,
whilst taking into account the interests of other
stakeholders.”

(MCCG, 2017)
 CG frontiers – some unresolved issues

The paradox of the unitary board

Corporate governance involves 2 countervailing responsibilities:

– performance: strategy formulation & policy making
– conformance: executive supervision & accountability

These 2 responsibilities potentially conflict

– “marking their own examination”

The 2 tier board resolves the dilemma with 2 boards:

– the executive board responsible for performance
– the supervisory board responsible for conformance
 CG frontiers – some unresolved issues

The paradox of the unitary board

The dilemma met in unitary boards by having independent

directors:
– with independence strictly defined to exclude any
interests
– able to take an objective, independent view
– providing a counterweight to the executive directors
– independent directors also form the audit committee

They are not part of executive team

 CG frontiers – some unresolved issues

A paradox

• The greater a director's independence the less he is

likely to know about the company
• The more an INED knows about the company, the
greater his potential contribution, the less his perceived
independence
 CG frontiers – some unresolved issues

In unitary board countries:

- CG codes call for independent non-executive directors
- The codes define 'independence' in detail

But can any director be genuinely independent? when INEDs:

- nomination came from existing members of that board
- had the approval of CEO & chairman
- feel commitment & loyalty to them
- have to form an effective team with the CEO & the other
directors
- work closely with executive directors on strategic & other
issues
- determine the issues they are supposed to be monitoring
- become enmeshed in the board culture
This person is connected to 39 board
members in 9 different organizations
across 11 different industries.

This person is connected to 71 board

members in 5 different organizations
across 10 different industries.

This person is connected to 34 board

members in 8 different organizations
across 25 different industries
 CG frontiers – some unresolved issues

Can outside directors be genuinely independent?

In 2-tier board countries:

• supervisory board consists entirely of outside directors
• but members of supervisory boards represent the interests
of stakeholder groups

So how can a supervisory board member apply independent

judgement if:
• their allegiance is to the groups they represent
• their interests may be in conflict
• the relationships within the board can be adversarial
 CG frontiers – some unresolved issues

This is the dilemma:

• The more independent directors are, the less they are likely
to know about the company, its business & its industry.
• Conversely, the more directors know about the company’s
business, organisation, strategies, markets, competitors, &
technologies, the less independent they become.
• Yet such people are exactly what top management needs,
to contribute strategy, policy making & enterprise risk
assessment.
 CG frontiers – some unresolved issues

Should CG be based on principles or rules?

In the United States:

- listed companies must obey SOX Act rules, SEC &
stock exchange regulations
- US accounting standards also rule-based

In the UK, the Commonwealth & 'OECD-code' countries:

- listed companies follow country’s CG principles
(comply with code or explain why not) & international
accounting standards

The rules versus principles debate has a long way to go.

 CG frontiers – some unresolved issues

Should CEO ever be board chairman?

In the United States -

- chairman & CEO of listed companies frequently a single individual
- independent directors provide constraints

In the UK, the Commonwealth & 'OECD-code' countries:

- codes require roles of chairman & CEO to be separated
- avoids domination & risk-taking by a powerful individual

Which is preferable?
- a leader providing single-minded leadership to enhance
performance
- shared responsibility with reduced risk
The duality question remains unanswered
 CG frontiers – some unresolved issues

Should a retiring CEO ever become chairman of the board?

FOR allowing a retiring CEO to become chairman:

- Accumulated experience
- CEO known by fellow directors & senior managers
- CEO known & trusted by investors, customers, employees etc.
- Personal qualities - integrity, leadership, other skills - known
- Risks with a new chairman reduced

AGAINST allowing a retiring CEO to become chairman:

- Chairing the board different from being CEO
- Success as CEO does not guarantee success as chairman
- Past experience quickly decays in rapidly changing world
- Problems establishing good relations with the new CEO

The answer remains ambiguous

 CG frontiers – some unresolved issues

How should directors’ remuneration be determined?

• Top management of large listed corporations wield

enormous power.
• Some claim directors pursue their own agendas & extract
huge rewards.
• Major investors & investigative media have challenged
director rewards.
• Concern that some rewards are excessive
– particularly when not related to performance.
• Some even apparently rewarded for failure.
 CG frontiers – some unresolved issues

Should shareholders be able to nominate directors?

In 19th century, shareholders nominated directors.

Now in listed companies shareholders' interests vary.
• Directors choose new directors
• Shareholders' approve but do not nominate
• Recent proposals in US & UK for shareholders to propose
candidates
• Suggestion not welcomed in many board rooms
• Determining who joins the board is a power base.
 CG frontiers – some unresolved issues

Should institutional investors exert power over listed

companies?

Calls for institutions to vote & “exercise power”

• Some fund managers prefer to 'vote with their feet’ by
selling shares
• Institutions first responsibility is to their investors
• Voting must be in the interests of beneficial owners
• Some regulators now require institutions to say if & how
they voted
• Institutions’ involvement in governance could increase their
risk getting locked in with falling share price
• They might be accused of receiving insider information
• Could they be held accountable if a company fails.
 CG frontiers – some unresolved issues

Can external auditors really be independent?

Independent external auditor's role in CG is fundamental,

But can the auditor be seen to be truly independent? of the
company when:
• the company appoints the auditor
• the company pays the auditor
• the company is a client of the auditor
• the auditor may be economically dependent on the client
 CG frontiers – some unresolved issues

Can external auditors really be independent?

Auditors serve 2 masters

- the shareholders & the directors

Potential conflict of interest satisfying the interests of:

- shareholders (an external check on the directors)
- the directors (working closely with them)

Audit of large companies world-wide dominated by just 4

firms, which raises a number of concerns
 5 over-arching CG Principles

Accountability Sustainability
(communicate with (business should create value &
stakeholders in achieving it allocate it sustainably)
purpose & meeting
responsibility)

Capability
(appropriate mix
Leadership of skills,
(effective board experience)
should steer the
company in
meeting short &
long term Integrity
purpose) (conduct business in fair
& transparent manner)

Institute of Chartered Accountants, 2013

 Report of the US Commission on CG 2010

10 Core Governance Principles:

1. The board’s fundamental objective is to build long-term

sustainable growth in shareholder value
2. Successful corporate management - critical role in
corporate governance
3. Good corporate governance should be integrated with
the company’s business strategy
4. Shareholders have a responsibility to vote their shares
(engagement)
5. Over-reliance on legislation & rules may not be in the
best interests of shareholders, companies or society
(collaboration, negotiations)
 Report of the US Commission on CG 2010

10 Core Governance Principles:

6. A critical component of good governance is

transparency
7. Independence is an important attribute for board
members, but non-independent directors can add
expertise, diversity & knowledge
8. Proxy advisory firms should be transparent &
accountable
9. SEC should work with exchanges to ease the burden
of proxy voting
10. SEC and/or the NYSE should periodically assess the
impact of major governance reforms
 The Future of Corporate Governance

Drivers of change
• US influences
– SOX, SEC, NYSE, other organisations
– institutional investors, etc.
• International drivers
– OECD, World Bank, IMF, other nations
– global economic crises
• Recognition of cultural aspects
– differentiation accepted
• Influence of China, India & Russia
 The Future of Corporate Governance

Drivers of change
• Recognition of complexity of ownership chains
• Development of new organisational forms
• Right of owners to nominate directors
• Disincentive to go public
• Governance of private equity, sovereign & hedge funds
• Societal expectations & government actions
• Drive for gender diversity on boards
• Demand for genuine independence of external auditors
• New theories of corporate governance
• Need for a new paradigm of CG
• Corporate collapse & CG responses
- fraud, company domination, economic problems
 The Future of Corporate Governance

Theoretical developments - Boundaries of agency theory

New research possibilities

• inter-personal relations & board behaviour
• board as team, board style & culture
• director interpersonal networks
• CG as an information process
• psychology of boards
• politics of boards - power as measurable force
• board leadership - traits & competencies
New models, frameworks, concepts
- new insights, new thinking, better understanding
 The Future of Corporate Governance

New governance practices & processes

Board leadership recognised as fundamental

Quantifiable CG norms (beyond codes of best practice)
Reporting on compliance with norms
• to regulating authorities
• to all stakeholders likely to be affected
Information & control systems
• directors better access to knowledge
• stakeholders better access to information
• greater transparency
• data, information, knowledge
 The Future of Corporate Governance

New governance practices & processes

Director performance
- better measurement linked with remuneration
Better protection for investors
21st century board
- more flexible less formal & rigid
- more transparent less secretive
- more transient, more participative, less bounded
New ways to govern
CG applied to SMEs, partnerships, joint ventures
 The Future of Corporate Governance

Society’s changing expectations of entities

• Society expects more corporate entities to drive CG

• Balance performance with conformance
- need for entrepreneurial risk-taking whilst protecting
stakeholders
• Measure corporate governance
- CSR KPIs as well as long-term $ profit
• Sustainability
- UN sustainability initiatives too diffuse
- taken up at country level
 The Future of Corporate Governance

Society’s new expectations of directors

• Higher levels of professionalism

• Continuous learning & personal development
• New focus on trust
- honesty, integrity, openness
- balance CSR with wealth creation
• Corporate leadership
- in governing body & committees
• Corporate leadership
- in society
 The Future of Corporate Governance

The Implications:

New governance New challenges

demands on for directors &
organisations boards

New ways of
working for boards
 The Future of Corporate Governance

New governance demands

Acceptable wealth generation

– meeting market & societal needs
– socially responsible
– socially accountable
– strategic risk management

Business as societal partnership between individuals,

enterprises & the state
 The Future of Corporate Governance

New ways of working for boards

New board styles

- more transient, flexible, & adaptable
New board level information systems
- new ways to access knowledge
- internal & external information
New communication systems
- between directors
- between board & management
- between organisation, investors & other
stakeholders
 The Future of Corporate Governance

New challenges for directors

Continuous learning
The learning board
Board review
- strategy for director development
Chairman’s leadership role

Continuous self-development
www opportunities – access information,
new learning opportunities, new tools
Professional developments
Learning from experience
Every director’s personal responsibility
 The Future of Corporate Governance

If the 19th century was the century of the entrepreneur,

& the 20th century was the century of management,

then the 21st century is the century of

corporate governance