7.1.2 CORPORATE GOVERNANCE • Corporate governance refers to the internal control mechanisms that regulate and protect the corporation from its human managers • “The framework of rules and practices by which a board of directors ensures accountability, fairness, and transparency in a company's relationship with all its stakeholders (financiers, customers, management, employees, government, and the community)” • The key roles and responsibilities of the board of directors are to ensure accountability, fairness and transparency in its interactions with the *stakeholders
Transcript
7.1.2 CORPORATE GOVERNANCE
• Corporate governance refers to the internal control
mechanisms that regulate and protect the corporation from
its human managers
• “The framework of rules and practices by which a board of
directors ensures accountability, fairness, and transparency
in a company's relationship with all its stakeholders
(financiers, customers, management, employees,
government, and the community)”
• The key roles and responsibilities of the board of directors
are to ensure accountability, fairness and transparency in
its interactions with the *stakeholders
What is the goal of corporate governance?
• The primary goal of corporate governance is to protect
companies from the humans that lead and manage them
How do we protect companies from their managers?
• We create a Board to represent the best interests of the
*stakeholders (including shareholders) and ensure that
managers take decisions and actions that are not in their
own best interests
How do Boards provide checks and balances?
• Board must consist of a majority of non-executive and
independent Directors because they are better able to
protect *stakeholders’ interests because they have no
conflict of interest between what is best for themselves v
what is best for the stakeholders
PERSONAL VALUES
• Era (time in history)
• Parents / primary caregivers
• Religion VALUES
• Culture
• Sense of right & wrong
“SOCIAL” ETHICS
• Legislation
• Profession
• Codes of Conduct ETHICS
• Insurance requirements
• What you’re paid to do
ROLE OF THE BOARD IN RISK MANAGEMENT
• The role of the board in managing risk is particularly
important considering the perception held by the public and
in some governments that excessive risk-taking is
responsible for the global economic crisis that began in
2008 and resulted in the recession
• The risk oversight function of the board of directors has
never been more critical and challenging than it is today
• Boards must keep ahead of corporate governance trends
by becoming more self regulatory
• **An example of this is the increasing pressure to ensure
that the board of directors remains separate from the
management of the corporation so that it can, if
necessary, challenge the CEO
**CHAIRMAN & CEO?? Enrichment Material
• UK – UK Code of Corporate Governance, 2010; e.g.
separates Chairman from CEO;
• US – The Sarbanes-Oxley Act, 2002; e.g. allows Chairman
and CEO to be the same person
• **Luxembourg – The X Principles of Corporate
Governance, 2013; e.g. separates Chairman from CEO
• Principle 1, Recommendation 1.3:-
• “The Executive Management of the company shall be
entrusted to a management body, headed by an individual
other than the Chairman of the Board.
• The Board shall make a clear distinction between the duties
and responsibilities of its Chairman and of the Chief
Executive Officer and set this out in writing”
• RSA – King IVtm Code separates Chairman and CEO:
• Principle 7, Recommended Practices 31 and 34:-
• The governing body should elect an independent non-executive member as chair to lead the governing body in the objective and effective discharge of its governance role and responsibilities
• The CEO of the organisation should not also chair the governing body, and the retired CEO should not become the chair of the governing body until three complete years have passed after the end of the CEO’s tenure
Note: “Chairman” is derived from the Latin “manus” and means “the hand that chairs the meeting”
• Literal meaning = “hand”, as in “manual”, etc.
• Implied meaning in ancient Roman law = “power over people”
WHY SEPARATE CHAIRMAN FROM CEO??
Basic principle:
• The role of corporate governance is to protect the company from the humans who manage it
Problems with humans:
• Those who rise to the top of the corporate world tend to have strong, confident, even dominant personalities
Problems with dominant personalities:
• They can “railroad” (push through) plans based on
• Criminal intent / greed
• Hubris
• The Board is toothless when it loses its oversight function
TWO PROBLEMS
Criminal intent / greed
• Perpetrator knows he’s harming the company and the
people it employs / services for the sake of his own private
benefit
• Case studies = Enron and Worldcom
Hubris
• Perpetrator believes he’s doing something good for the
company (which will also show the world, “again”, just how
brilliant he is)
• Case study = Royal Bank of Scotland
“HUBRIS”
• Hubris describes a personality quality of foolish pride or dangerous overconfidence
• Hubris often indicates a loss of contact with reality and an overestimation of one's own competence, accomplishments or capabilities
• Contrary to common expectations, hubris is not necessarily associated with high self-esteem but with highly fluctuating or variable self-esteem, and a gap between inflated self perception and a more modest reality
• Characteristics of hubris include long service with the company, excellent knowledge of the industry, and an increasing association between the “self” and “business”
• Also known as the “King Midas Syndrome” – “Everything I touch turns to gold …”
LIMITED LIABILITY
• “The basic principle of limited liability is that the company
has a legal personality separate and distinct from its
members’. Each can own their own assets and incur their
own liabilities … As such, creditors who have claims
against the company may look only to the corporate assets
for the satisfaction of their claims as creditors and generally
cannot proceed against the personal (separate) assets of
the members … A company’s separate existence is, by way
of metaphor, described as a “veil”. This veil is said to
separate the company from its members and protect the
members from those who deal with the company”
Cohen, J. 2006. A critical study on the doctrines of limited liability and
piercing the corporate veil. Ll.M. Dissertation: UCT.
STANDARDS OF CONDUCT
• A Director is required to exercise his powers and perform his functions in *good faith and for proper purpose
• A Director must have adequate general knowledge, skill and experience to act competently
• A Director must exercise the *care, skill and diligence that may reasonably be expected of any and all Directors
• A Director may rely on senior employees, legal counsel, external auditors, etc.
• A Director may not abuse power by using position or information to gain a personal advantage, and must always act in the best interests of the company
• *Personal liability
PERSONAL LIABILITY (Sec 77 of CA, 2008)
FIDUCIARY DUTY AND DELICT
• Fiduciary – A person (“steward” or “trustee”) into whose
care another person (“owner”) has placed any person or
property of value
• Fiduciary duty – the fiduciary has a high duty to sacrifice
his/her own self-interest and carefully and consistently act
in the best interests of the owner
• Delict – The circumstances in which one person can claim
compensation from another for harm that has been suffered
as a result of the other person’s wrongful and blameworthy
conduct
(1) COMPANIES ACT & REGULATIONS
• Companies Act No. 71 of 2008 (as amended)
• *Chapter 2 Part F: Governance of companies
• Shareholder meetings
• Board meetings
• Sub-committees of the board
• Liability
• Chapter 3 Part C: Auditors
• *Chapter 3 Part D: Audit committees
• Companies Regulations, 2011
BOARD COMMITTEES
• Sec 72 of CA, 2008 allows the Board to appoint any number of committees. Sec 94 prescribes the only compulsory one: The audit committee (which can be further delegated with risk) (must be elected at the AGM for public companies)
• Board committees can help advance the business of the board efficiently, while not mitigating the duties and responsibilities of the board and its directors
• Board committees can give detailed attention to specific areas of their duties and responsibilities in a more comprehensive evaluation of issues such as:-
• Audit and internal control;
• Risk management; Remuneration;
• Social and ethics; etc.
THE AUDIT COMMITTEE
• The audit committee is the principal governance watchdog
and is obligatory in many countries (including South Africa)
• One third of the members of the audit committee must have
qualifications and experience in economics, law, corporate
governance, financial, accounting, etc.
• All members must be independent (no other relationship)
• The audit committee must nominate the external auditor
and approve their fees and terms
• Receive and investigate complaints about accounting
practices, internal audit, internal financial controls, etc.
• Report on their activities in the corporate governance
section of each annual report
• Oversee risk management (if delegated)
SHARE OWNERSHIP BY NON-EXECUTIVES?
• Advantages: The Directors are personally linked to the fortunes of their company, so they will be awake, apply their minds, and really interrogate what is best for the business, etc.
• Disadvantages: The Directors will have more alignment to the shareholders rather than all stakeholders equally; they might be tempted to allow unethical practices if they believe it will inflate the share price (and thus their own net worth), etc.
• Executive Directors: In the case of some famous collapses, especially Enron, the executive Directors deliberately / fraudulently / criminally practiced unethical business in order to inflate the Enron share price and thus their own net worth, etc.
INTRODUCTION
• “The 21st Century has been characterised by fundamental changes in both business and society ... and have influenced both [King IV’s] content and approach.
• New global realities are testing the leadership of organisations on issues as diverse as inequality, globalisedtrade, social tensions, climate change, population growth, ecological overshoot, geopolitical tensions, radical transparency and rapid technological and scientific advancement.
• The United Nations Sustainable Development Goals … the Africa 2063 Agenda and the SA National Development Plan 2030 have a common theme of value creation that is accomplished in a sustainable manner. This is a fundamental concept of King IV”.
(IODSA King IV, 2016: 3)
THE CHANGED WORLD
• “Financial instability is one driver of these changes.
Financial crises arising out of capital crisis in the United
States of America and the Sovereign Fund crisis in the
European Union have not been resolved. Brexit
created further uncertainty for financial systems
• Another change driver is climate change. Even those who
are skeptical about the scientific evidence for climate
change, or who question whether climate change is
attributable to human agency or simply part of a longer-
term cycle, have to acknowledge that the world has
experienced extreme weather conditions that pose new
risks in the last several years”
(IODSA King IV, 2016: 3)
• “It is a reality that organisations and individuals are using
assets faster than nature is regenerating them. This
ecological overshoot will be exacerbated by continued
population growth on the African and Asian continents. The
global population is currently at 7.6 billion, and could reach
9.3 billion by 2046 according to the United Nations …
• Ubiquitous social media platforms are creating a world
characterised by radical transparency. Corporations can no
longer conceal their actions or secrets. Technological
advances, including the emergence of the Internet of
things, are generating huge amounts of data; more
importantly, sophisticated analytics is converting that data
Into deep insight into the behaviour of humans and their
organisations”
(IODSA King IV, 2016: 3)
• “Millennials have shown that they are concerned about the global environmental crunch much more than the global financial crises. They are consequently attracted to companies who have integrated the six capitals into their business models (financial, manufactured, human, intellectual, natural and social and relationship capital)
• In a similar vein, it is now accepted that organisations operate in the triple context of the economy, society and the environment. How they make their money does have an impact on these three elements and, in turn, they impact on organisations.
• In the context of all the above, governing bodies have the challenge of steering their organisations to create value in a sustainable manner, making more but with less to meet the needs of a growing population and the reality of dwindling natural resources.
(IODSA King IV, 2016: 3 – 4)
TRIPLE BOTTOM LINE
• With the obvious objective of making a profit, business
models should also consider the economic, social, and
environmental factors influenced by their business plans
• People
• Planet
• Profit
• This is called “the triple bottom line”, and is increasingly to
be found (under various labels) in more and more
companies’ integrated annual reports
• However, the problem is not defining the triple bottom line,
but determining how to measure it
KING IVTM HELPS YOU CATCH THE BIG FISH!
• “Regulation 28(2)(c)(ix) of the Pension Funds Act: “before
making an investment in and while invested in an asset [the
fund and its board must] consider any factor which may
materially affect the sustainable long-term performance of
the asset including, but not limited to, those of an
environmental, social and governance (“ESG”) character”
• Principle 1 of the Code for Responsible Investing in South
Africa (CRISA): institutional investors “should incorporate
sustainability considerations, including ESG issues, into
their investment processes as part of the delivery of
superior risk-adjusted returns to the ultimate beneficiaries”
(IODSA King IV, 2016: 33)
BOARD DIRECTORS ARE KEY
• Corporate governance: The primary goal of corporate governance is to protect companies from the humans that lead and manage them
• Purpose of Board: The purpose of the Board is to represent the best interests of the stakeholders (including shareholders) and ensure that managers take decisions and actions that are not in their own best interests
• Skills / qualifications: Individual Directors should have necessary skills, experience and/or qualifications in various fields within business leadership and management
• African Bank: According to the findings of the MyburghCommission, one significant factor contributing to the collapse of African Bank was that it had a strong CEO and a weak Board, especially the executive Directors (e.g. alcoholic Chief Risk Officer), etc. who failed to question the business model, strategic plans, etc.
7.4.1 INTRODUCTION TO RISK MANAGEMENT
• All business ventures involve risk
• The requirements of risk management need to be fairly
evaluated against the legitimate need to take calculated
risks in the business environment in order to maintain
innovation and retain and increase profits
• So there are:-
• Considered risks; and
• Reckless risks.
KING IVTM ON RISK MANAGEMENT
Principle 11:
• The governing body should govern risk in a way that
supports the organisation in setting and achieving its
strategic objectives.
Recommended Practices:
1. The governing body should assume responsibility for the
governance of risk by setting the direction for how risk
should be approached and addressed in the organisation.
Risk governance should encompass both:
a. the opportunities and associated risks to be considered
when developing strategy, and
b. the potential positive and negative effects of the same
risks on the achievement of organisational objectives.
2. The governing body should treat risk as integral to the way
it makes decisions and executes its duties.
3. The governing body should approve policy that articulates
and gives effect to its set direction on risk.
4. The governing body should evaluate and agree the nature
and extent of the risks that the organisation should be
willing to take in pursuit of its strategic objectives. It should
approve in particular:
a. the organisation's risk appetite, namely its propensity to
take appropriate levels of risk; and
b. the limit of the potential loss that the organisation has
the capacity to tolerate.
5. The governing body should delegate to management the
responsibility to implement and execute effective risk
management.
6. The governing body should exercise ongoing oversight of risk management and, in particular, oversee that it results in the following:
a. An assessment of risks and opportunities emanating from the triple context in which the organisation operates and the capitals that the organisation uses and affects.
b. An assessment of the potential upside, or opportunity, presented by risks with potentially negative effects on achieving organisational objectives.
c. An assessment of the organisation's dependence on resources and relationships as represented by the various forms of capital.
d. The design and implementation of appropriate risk responses.
e. The establishment and implementation of business continuity arrangements that allow the organisation to operate under conditions of volatility, and to withstand and recover from acute shocks.
f. The integration and embedding of risk management in the business activities and culture of the organisation.
7. The governing body should consider the need to receive periodic independent assurance on the effectiveness of risk management.
8. The nature and extent of the risks and opportunities the organisation is willing to take should be disclosed without compromising sensitive information.
9. In addition, the following should be disclosed in relation to risk:
a. An overview of the arrangements for governing and managing risk.
b. Key areas of focus during the reporting period, including objectives, the key risks that the organisation faces, as well as undue, unexpected or unusual risks and risks taken outside of risk tolerance levels.
c. Actions taken to monitor the effectiveness of risk management and how the outcomes were addressed.
d. Planned areas of future focus.
KING IVTM: EVALUATING MINIMUM DISCLOSURE
Disclosure Status
The nature and extent of the risks and opportunities the
company is willing to take should be disclosed without
compromising sensitive information?
An overview of the arrangements for governing and
managing risk?
Key areas of focus during the reporting period, including
objectives, the key risks that the company faces, as well
as undue, unexpected or unusual risks and risks taken
outside of risk tolerance levels?
Actions taken to monitor the effectiveness of risk
management and how the outcomes were addressed?
Planned areas of future focus?
KING IVTM – SHORT & SWEET
• King IV is significantly
shorter than King III (it only
has 16 principles)
• It comes packaged in 1 book
with principles, code and
sector supplements all
together
WHY SHORTER AND SIMPLER?
Universal Applicability
• “The King Committee was requested by many entities
outside the private sector to draft King IV in such a way as
to make it more easily applicable to all organisations: public
and private, large and small, for-profit and not-for-profit
• King IV has been drafted with this in mind. Thus, for
example, it talks of organisations and governing bodies,
rather than simply companies and boards of directors.
• Another innovation aimed at making it easier for all
organisations to use the King IV Report as a guide for good
governance is the inclusion of sector supplements”
(IODSA King IV, 2016: 6)
7.4.2 DEFINING RISK
• Simple:
• Anything that prevents you from achieving the goals in your
strategic plan
• Sophisticated:
• Strategic moves that cause returns to vary, that involve
venturing into the unknown, and that may result in
corporate ruin – moves for which the outcomes and
probabilities may be only partially known and where hard-
to-define goals may not be met
• Source: Internal or external environments
• Timespan: Short-term or long-term
EXAMPLES OF RISK (p 94)
• Financial risks (e.g. investments that result in losses)
• Fraud (e.g. with serious legal consequences)
• Bribery or foreign corruption (e.g. bribing a public official)
