Corporate GovernanceCorporate Governance

Week 1Week 1

Have you heard about!Have you heard about!

NICL Scam (Pakistan)NICL Scam (Pakistan) Mehran Bank (Pakistan)Mehran Bank (Pakistan) EnronEnron Satyam ComputersSatyam Computers

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Corporate Governance – An IntroductionCorporate Governance – An Introduction

Corporate – related with corporationsCorporate – related with corporations Governance- derived from Latin Governance- derived from Latin

‘gubernare’- meaning to ‘steer’‘gubernare’- meaning to ‘steer’

The way in which companies are directed The way in which companies are directed and controlled (Cadbury Report 1992)and controlled (Cadbury Report 1992)

Recent examples of massive collapses Recent examples of massive collapses resulting from weak systems of CG have resulting from weak systems of CG have highlighted the need to improve and highlighted the need to improve and reform CG at international level.reform CG at international level.

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Corporate Governance – An IntroductionCorporate Governance – An Introduction

Some recent reforms:Some recent reforms:• USA issued Sarbane-Oxley Act (2002)USA issued Sarbane-Oxley Act (2002)• Higgs and Smith Reports (2003) UKHiggs and Smith Reports (2003) UK• SECP guidelines in PakistanSECP guidelines in Pakistan• OECD guidelines in European continent.OECD guidelines in European continent.

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Corporate Governance – An IntroductionCorporate Governance – An Introduction

There are different perspectives of CG and There are different perspectives of CG and the same is evident from the definitions as the same is evident from the definitions as well.well.

One approach of CG adopts a narrow viewOne approach of CG adopts a narrow view, , where CG is restricted to the relationship where CG is restricted to the relationship b/w a company and its shareholders.b/w a company and its shareholders.

In an other approach, In an other approach, CG has broader CG has broader spectrum beyond shareholdersspectrum beyond shareholders extending extending that to stakeholders such as employees, that to stakeholders such as employees, customers, suppliers, governments etc.customers, suppliers, governments etc.

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Corporate Governance – An IntroductionCorporate Governance – An Introduction

Some Definitions of CG are:Some Definitions of CG are:““the process of supervision and control intended to the process of supervision and control intended to

ensure that the company’s management acts in ensure that the company’s management acts in accordance with the interests of shareholders accordance with the interests of shareholders (Parkinson 1994)(Parkinson 1994)

““the governance of an enterprise is the sum of those the governance of an enterprise is the sum of those activities that makeup the internal regulation of activities that makeup the internal regulation of the business in compliance with the obligations the business in compliance with the obligations placed on the firm by legislation, ownership and placed on the firm by legislation, ownership and control. It incorporates the trusteeship of assets, control. It incorporates the trusteeship of assets, their management and their deployment (Cannon their management and their deployment (Cannon 1994)1994)

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Corporate Governance – An IntroductionCorporate Governance – An Introduction

Some Definitions of CG are (Contd):Some Definitions of CG are (Contd):According to Solomon & Solomon (2004: 14) CG is According to Solomon & Solomon (2004: 14) CG is ““the system of checks and balances, both internal the system of checks and balances, both internal

and external to companies, which ensures that and external to companies, which ensures that companies discharge their accountability to all companies discharge their accountability to all their stakeholders and act in a socially responsible their stakeholders and act in a socially responsible way in all areas of their business activity.”way in all areas of their business activity.”

This definition perceives that companies can This definition perceives that companies can maximize value creation over the long term by maximize value creation over the long term by discharging their accountability to all of their discharging their accountability to all of their stakeholders and by optimizing their system of CGstakeholders and by optimizing their system of CG

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Corporate Governance – An IntroductionCorporate Governance – An Introduction

The same outcome was identified by The same outcome was identified by different independent researches such as different independent researches such as the reports of UK Investment Institute of the reports of UK Investment Institute of the Higgs report found that:the Higgs report found that:

Companies that demonstrate a commitment to a Companies that demonstrate a commitment to a broad range of stakeholders are likely to show broad range of stakeholders are likely to show better management skills and increase in better management skills and increase in accountability can maximise the sustainable accountability can maximise the sustainable wealth creation.wealth creation.

Body shop, Tesco, PatagoniaBody shop, Tesco, Patagonia

Governance andGovernance andManagementManagement

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How do these terms differ?How do these terms differ? Does Governance include Does Governance include

Management?Management?

OrOr Does Management include Does Management include

Governance?Governance?

Governance & ManagementGovernance & Management

GovernanceGovernance FunctionFunction ManagementManagement

Approval of PlansApproval of Plans PlanningPlanning Preparation of plansPreparation of plans

Providing overall Providing overall leadershipleadership

LeadingLeading Leading those who Leading those who implement plansimplement plans

Arranging Arranging

resourcesresources

OrganizingOrganizing Tasks division & Tasks division & resource usageresource usage

Controlling Controlling managersmanagers

ControllingControlling Controlling Controlling employeesemployees

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What is a Corporate Body? What is a Corporate Body?

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Any Company is a corporate body. However, in a Any Company is a corporate body. However, in a broader sense only public limited companies are broader sense only public limited companies are taken to be the subject matter of CG.taken to be the subject matter of CG.

So far the thrust of CG is only on listed So far the thrust of CG is only on listed companies.companies.

What about family businesses, private What about family businesses, private companies?companies?

In USA and Europe, companies are frequently run In USA and Europe, companies are frequently run by minority shareholders. Hence, they require by minority shareholders. Hence, they require even greater degree of CG.even greater degree of CG.

Please refer to Butt, S (2011), Pages: 16-18Please refer to Butt, S (2011), Pages: 16-18

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Corporate Governance – Theoretical FrameworksCorporate Governance – Theoretical Frameworks

A number of different theoretical A number of different theoretical frameworks have evolved to explain and frameworks have evolved to explain and analyze CG such as:analyze CG such as:

The Agency TheoryThe Agency Theory (Finance and (Finance and Economics)Economics)

Transaction Cost TheoryTransaction Cost Theory (Economics and (Economics and Organizational Theory)Organizational Theory)

Stakeholder TheoryStakeholder Theory (Social-oriented (Social-oriented perspective)perspective)

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Corporate Governance – Theoretical FrameworksCorporate Governance – Theoretical Frameworks

The Agency Theory:The Agency Theory: Owners (shareholders) delegate the running of the Owners (shareholders) delegate the running of the

company to managementcompany to management• Owners: PrincipalsOwners: Principals• Management: AgentsManagement: Agents

Their relationship is the agency theory. Their relationship is the agency theory. The problem is that sometime the agents take The problem is that sometime the agents take

decisions which are not in the best interests of the decisions which are not in the best interests of the principals.principals.

Due to managers ego-ism or personal objectives Due to managers ego-ism or personal objectives leading to short term profits but ignoring the long leading to short term profits but ignoring the long term sustainable profit maximisation or in other term sustainable profit maximisation or in other words ignoring the long term consequences.words ignoring the long term consequences.

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Corporate Governance – Theoretical FrameworksCorporate Governance – Theoretical Frameworks

The Agency Theory (Cont’d):The Agency Theory (Cont’d): Same is in case of risk sharingSame is in case of risk sharing Again the monitoring of agents by Again the monitoring of agents by

principals is a difficult and expensive task. principals is a difficult and expensive task.

• Usually contract (agreements) are performed to Usually contract (agreements) are performed to solve this problem.solve this problem.

• As well as the voting power of the shareholders As well as the voting power of the shareholders and their power for “Take-over” vote is useful and their power for “Take-over” vote is useful for the balancing of powers.for the balancing of powers.

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Corporate Governance – Theoretical FrameworksCorporate Governance – Theoretical Frameworks

Transaction Cost Theory (Caose, R)Transaction Cost Theory (Caose, R) Talks about cost of transactions for a company and its Talks about cost of transactions for a company and its

relationship with the management’s opportunismrelationship with the management’s opportunism

Bounded rationality of managersBounded rationality of managers

Cost of transactionsCost of transactions

Managers try to organize the transactions in their best Managers try to organize the transactions in their best interests.interests.

Transaction cost theory suggests that shareholders should Transaction cost theory suggests that shareholders should have control (influence) in the decision making and have control (influence) in the decision making and managers should pursue the best interests of the managers should pursue the best interests of the shareholders rather than their own personal interests and shareholders rather than their own personal interests and there should be some institutions to mange this sort of there should be some institutions to mange this sort of transactionstransactions

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Corporate Governance – Theoretical FrameworksCorporate Governance – Theoretical Frameworks

Stakeholders TheoryStakeholders Theory Freeman (1984) proposed that corporate accountability to a Freeman (1984) proposed that corporate accountability to a

broader range of stakeholders.broader range of stakeholders.• Today you can see availability of Co information, annual reports Today you can see availability of Co information, annual reports

on different medium such as newspapers, websiteson different medium such as newspapers, websites

The role of companies in societies has received increasing The role of companies in societies has received increasing attention over time, with their impacts on employees, the attention over time, with their impacts on employees, the environment, local communities as well their own environment, local communities as well their own shareholders.shareholders.

A basic thing is that Cos are now so large and they have A basic thing is that Cos are now so large and they have impact on the society. Imagine even in KPK the role of PTC, impact on the society. Imagine even in KPK the role of PTC, Lakson on Tobacco growers!!!Lakson on Tobacco growers!!!

Some BS!!Some BS!!

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Corporate Governance – Theoretical FrameworksCorporate Governance – Theoretical Frameworks

Stakeholders Theory (Cont’d)Stakeholders Theory (Cont’d) linked to stakeholders theory is the concept of corporate linked to stakeholders theory is the concept of corporate

Social Responsibility (CSR) as well.Social Responsibility (CSR) as well.

While researches have found a positive relationship b/w While researches have found a positive relationship b/w revenues and CSR.revenues and CSR.

However, it is very difficult to balance the interests of However, it is very difficult to balance the interests of different stakeholders.different stakeholders.

However, it is expected of today’s enterprises that they will However, it is expected of today’s enterprises that they will have to cater to the needs and wants of the different have to cater to the needs and wants of the different stakeholders rather than a single stakeholder in term of stakeholders rather than a single stakeholder in term of shareholders.shareholders.

Look at Apple’s initiative or Dell and HP initiatives, Tesco etcLook at Apple’s initiative or Dell and HP initiatives, Tesco etc

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Corporate Governance – Theoretical FrameworksCorporate Governance – Theoretical Frameworks

To Conclude we can say that:To Conclude we can say that: Ignoring the stakeholders can result in Ignoring the stakeholders can result in

corporate failure while concern for corporate failure while concern for stakeholders attracts investors in the stakeholders attracts investors in the current times.current times.

And to survive companies has to look And to survive companies has to look beyond share holders to a broader range of beyond share holders to a broader range of stakeholders as well as companies should stakeholders as well as companies should have more accountability (not mere have more accountability (not mere financial but all encompassing) and more financial but all encompassing) and more control on its internal processes. control on its internal processes.

The CG FrameworkThe CG Framework

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Essential Principles of CGEssential Principles of CG

DisciplineDiscipline Transparency Transparency Independence Independence Accountability Accountability Responsibility Responsibility FairnessFairness Social responsibility Social responsibility

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Is there some global uniformity Is there some global uniformity

Converging Converging Diverging Diverging

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Stakeholders in a Company Stakeholders in a Company

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Management and EmployeesManagement and Employees LendersLenders Suppliers and ClientsSuppliers and Clients ShareholdersShareholders Society at large (this includes Society at large (this includes

government)government)

Opportunity to protect Opportunity to protect individual interestsindividual interests

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Managers and Employees have the Managers and Employees have the greatest opportunity to protect their greatest opportunity to protect their interest(s)interest(s)

Suppliers and Clients essentially go Suppliers and Clients essentially go by each transaction or contract.by each transaction or contract.

Lenders and Shareholders are most Lenders and Shareholders are most vulnerable.vulnerable.

Society depends entirely on lawSociety depends entirely on law

ShareholdersShareholders

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Controlling Groups (Internal Equity)Controlling Groups (Internal Equity) Outsider Shareholders (External Outsider Shareholders (External

Equity)Equity)

Outsider ShareholdersOutsider Shareholders

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Institutional InvestorsInstitutional Investors Have some means of protecting their Have some means of protecting their

interest but still require protectioninterest but still require protection

Individual or General PublicIndividual or General Public They require the greatest degree of They require the greatest degree of

protection, as they have virtually no protection, as they have virtually no means of protecting their interest.means of protecting their interest.

LendersLenders

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Institutional InvestorsInstitutional Investors Have some means of protecting their Have some means of protecting their

interest through legal documentation, are interest through legal documentation, are relatively at lower risk but still require relatively at lower risk but still require protectionprotection

Individual or General PublicIndividual or General Public They require the greatest degree of They require the greatest degree of

protection, as they have virtually no protection, as they have virtually no means of protecting their interest.means of protecting their interest.

Society at LargeSociety at Large

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Government (Taxes, Law and Order)Government (Taxes, Law and Order) Clients (Value for money)Clients (Value for money) Community (Social Rights)Community (Social Rights)

How do we ensure that these How do we ensure that these

stakeholders get their dues?stakeholders get their dues?

Corporate HierarchyCorporate Hierarchy

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1.1. ShareholdersShareholders

2.2. Board of DirectorsBoard of Directors

3.3. ManagementManagement• CEOCEO• Executive DirectorsExecutive Directors• Senior ManagersSenior Managers

4.4. EmployeesEmployees

Key PlayersKey Players

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Shareholders (Shareholders (Voting powerVoting power)) Board of Directors (Board of Directors (Represents Represents

interestsinterests)) CEO (CEO (Delegated executive powersDelegated executive powers)) Senior Managers (Senior Managers (Delegated executive Delegated executive

powers)powers)

Scope of Corporate GovernanceScope of Corporate Governance

StakeholdersStakeholders Objectives / interestsObjectives / interests Tools / TechniquesTools / Techniques

ShareholdersShareholders Sustainable growth in net worth Sustainable growth in net worth

General ManagementGeneral ManagementLegal frame workLegal frame workProfessional CodesProfessional CodesIndustrial practicesIndustrial practices

LendersLenders Security / timely interest paymentsSecurity / timely interest payments

EmployeesEmployees Continued employment at good Continued employment at good termsterms

Business Business AssociatesAssociates

Continued business at good termsContinued business at good terms

SocietySociety Good citizenship by the companyGood citizenship by the company

Collective Interest of all Collective Interest of all stakeholdersstakeholders

Continued profitable existenceContinued profitable existenceStrategic ManagementStrategic ManagementRisk ManagementRisk Management

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Individual

Interests

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ReferencesReferences

Solomon, J. and Solomon, A. (2004). Solomon, J. and Solomon, A. (2004). Corporate Governance and Corporate Governance and AccountabilityAccountability. Chichester: John Wiley . Chichester: John Wiley & Sons& Sons – Pages 1-30 – Pages 1-30

Butt, S. (2011). Butt, S. (2011). Corporate Corporate Governance (Second Edition). Governance (Second Edition). Azeem Azeem Academy, Lahore – Pages 15-29Academy, Lahore – Pages 15-29