T OPIC I T HE N EED OF C ORPORATE G OVERNANCE
Agency
Arises from the separation of management and ownership in public companies
Principal (shareholders) – appoints agents (directors) to act on his or her behalf
entrusts the agents with the task of acting in their interests (most likely, with the
aim of maximizing the value of the company and thereby their investments) Agent (directors) – accountable to the principals for the stewardship (i.e. taking care
of something which is owned by someone else) of their investment in the company (agency responsibility)
entrusted with running the company and ensuring strategies and controls are in
place to achieve the objectives set by the principal
Agency Costs
Cost incurred by the shareholders in monitoring the activities of company agents (i.e.
directors)
Arise because of:
(1) compromised trust in agents (directors); and
(2) information asymmetry (imperfect information).
Consequence: either
selling its holding; or
incur increased monitoring costs to ensure that shareholders’ interests are
adequately represented.
Corporate Governance
Definitions:
the way (practices and procedures) in which companies are governed and run in
such a way that it achieves its objectives;
the system by which companies are directed and controlled(Cadbury Report,
1992)
a set of relationships between the management, the Board of Directors, the
shareholders as well as other stakeholders to the corporation (HKICPA, 2006) Necessary due to principal-agent problem (potential conflict of interest)
Corporate governance concepts:
Organisation for Economic Co-operation and Development (OECD ) Principles of Corporate Governance (updated in November 2015): Ensuring the basis for an effective corporate governance framework;
The rights and equitable treatment of shareholders and key ownership functions; Institutional investors, stock markets and other intermediaries; The role of stakeholders in corporate governance; Disclosure and transparency; The responsibilities of the board.
Arguments in favour of a strong corporate governance regime:
Eliminate risk of misleading or false financial reporting ;
Prevent companies from being dominated by self-seeking chief executives or chairmen ;
More likely to achieve commercial success with good governance and good leadership;
More likely to develop strong reputation (less exposed to reputational risk);
Encourage investors to hold shares for longer term.
R EPUTATION
I NTEGRITY - straightforward dealing and completeness
P ROBITY AND H ONESTY - telling the truth - not misleading
F AIRNESS - taking into account everyone’s interests in the
I NDEPENDENCE - free from conflicts - promote interests of all parties
J UDGEMENT - decision making with conceptual
skills
R ESPONSIBILITY AND A CCOUNTABILITY - monitoring directors’ behaviour
O PENNESS AND T RANSPARENCY - not concealing information
Relationship between corporate governance, risk management and internal control
T OPIC II B OARD OF D IRECTORS
Accountability:
The requirement for a person in a position of responsibility to justify, explain or
account for the exercise of his/her authority and his/her performance or actions.
Composition of the Board: Executive and Non-executive Directors Executive Directors (“ED”):
full time members of staff;
have management positions in the organisation;
part of the executive structure;
typically have industry or activity-relevant knowledge or expertise, which is
basis of value to the organization
Non-executive Directors (“NED”):
engaged part-time by the organisation;
typically occupy positions in the committee structure;
bring relevant independent, external input and scrutiny to the board
Roles of NEDs
(1) Strategy role (applicable to executive directors):
contribute to the strategic success of the organization for the benefits of
shareholders
formulate strategy and guiding policy
(2) Scrutinising or performance role:
hold executive colleagues to account for decisions taken and company
performance
(3) Risk role (applicable to executive directors):
ensure the company has an adequate system of internal controls and systems of
risk management in place
(4) “people” role:
oversee a range of responsibilities with regard to the management of the
executive members of the board
Number of Independent Non-executive Directors (“INEDs”)
Rules 3.10(1) and 3.10(2) of the Rules Governing the Listing of Securities on the Stock
Exchange of Hong Kong Limited (“Listing Rules”) requires the following: every board of directors of a listed issuer must include at least three independent
non-executive directors (Rule 3.10(1)); and
at least one of the independent non-executive directors must have appropriate
professional qualifications or accounting or related financial management expertise (Rule 3.10(2)).
Rule 3.10A further requires that INEDs represent at least 1/3 of the board
Independence of INEDs
“Independence” is crucial for INEDs as:
It affects the ability to express/reach a point of view in the best interests of the
company, being unaffected in any way by personal gain or personal interests or motives;
Decision-making of INEDs should not be subject to the influence of another
person.
Rules 3.13(1) to 3.13(8) stipulates the assessment of the independence of a
non-executive director, for example:
Whether the director holds more than 1% of the total issued share capital of the
listed issuer;
Whether he/she is, or has at any time during the two years immediately prior to
the date of his proposed appointment been, an executive or director of the company;
Whether he/she has been holding the office for a long-period of time(too
familiar with the executive directors);
Is or was connected with a director, the chief executive or a substantial
shareholder of the listed issuer within two years prior to the date of his/her appointment
Criticisms of non-executive directors
Lack of knowledge about the business operations of the company
Insufficient time
Overriding influence of executive directors
Roles of chairman in corporate governance
(1) Management of the board members:
Leader of the board of directors;
Ensure the board’s effectiveness as a unit;
Extend to coordinating the contributions of NEDs and facilitate good
relationships between NEDs and EDs.
(2) Management of board meetings:
Agree and, if necessary, set the board’s agenda;
Ensure that board meetings take place on a regular basis;
Ensure that directors receive relevant information in advance of board meetings.
(3) Public image:
Represents the company to investors and other outside stakeholders (the public
face of the organisation;
Communication with shareholders (annual report, AGM, EGM).
Separation of roles of Chief Executive and Chairman
Frees up the chief executive to fully concentrate on the management of the
organisation without the necessity to report to shareholders or otherwise become distracted from his or her executive responsibilities
If the same person is in charge of the management of the board and day-to-day
management of the company’s operations and business, there is a risk that one SINGLE person can dominate the company with too much power concentrated in him/her (Principle A.2, Code on Corporate Governance Practices, Listing Rules) Separating the two roles provides further checks and balances at the board level
to avoid any individual running the company for his/her own benefits
Retirement by rotation
Arrangement in a directors’ contract that specifies his or her contract to be limited to
a specific period (typically three years) after which he/she must retire from the board or offer himself (being eligible) for re-election
Advantages of the mechanism:
Reduces the cost of contract termination for underperforming directors
Encourages directors’ performance(assessed by shareholders and reconsidered
every three years)
Opportunity to replace the board membership whilst maintain medium term
stability of membership