CORPORATE GOVERNANCE

An Introduction

1

Definition2

According to OECD:Corporate Governance is the system by which

business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as,

the board, managers, shareholders and other stakeholders, and spells out the rules and

procedures for making decisions on corporate affairs. By doing this, it also provides the

structure through which the company objectives are set, and the means of attaining these objectives and monitoring performance.

Another Definition 3

According to LaPorta et al., (2000), Corporate governance is a set of mechanisms through which outside

investors protect themselves against expropriation by the insiders. They

define “the insiders” as both managers and controlling shareholders.

Yet Another Definition 4

Corporate governance refers to the direction & oversight provided for

conducting the affairs of a corporate body

in a manner that ensures thatthe individual and collective interests

of all stakeholders are served and protected.

(Safdar A Butt)

Governance andManagement

5

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

Governance & 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

6

Governance7

Strategic Setting Objectives Devising plans to achieve these

objectives Setting rules or parameters Not directly concerned with routine

affairs Protection of Interests of all stakeholders

Management8

Current Affairs Implementing the Plans Developing Suggestions and Alternatives Operational Matters

What is a Corporate Body? 9

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

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

Greatest emphasis is on those that are controlled by closed groups.

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

Stakeholders in a Company 10

Management and Employees Lenders Suppliers and Clients Shareholders Society at large (this includes

government)

Opportunity to protect individual interests

11

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

Suppliers and Clients essentially go by each transaction or contract.

Lenders and Shareholders are most vulnerable.

Society depends entirely on law

Shareholders12

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

Controlling Groups13

If in Majority: Can protect their interest easily Need monitoringIf in Minority: Can protect their interest easily Need highest degree of monitoring

Outsider Shareholders14

Institutional Investors Have some means of protecting their

interest but still require protectionIndividual or General Public They require the greatest degree of

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

Lenders15

Institutional Investors Have some means of protecting their

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

Individual or General Public They require the greatest degree of

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

Society at Large16

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

How do we ensure that these stakeholders get their dues?

Corporate Hierarchy17

1. Shareholders2. Board of Directors3. Management

• CEO• Executive Directors• Senior Managers

4. Employees

Key Players18

Shareholders (Voting power) Board of Directors (Represents interests) CEO (Delegated executive powers) Senior Managers (Delegated executive

powers)

Scope 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

19

Individual

Interests

20

Different Board Types: The Good, Bad, and Ugly

‘Yes-men’ Board‘Rubber Stamp’

Board

‘Country Club’ Board

‘Good Old Boys’ Board

‘The Real Thing’

‘Paper’ Board

?‘Trophy’ Board

Responsibilities of the Board

21

Oversight Directional Advisory

The Oversight Function22

Approving and monitoring Company’s Strategic Plans.

Approving annual budgets and plans. Engaging outside auditors. Ensuring integrity of financial statements Review of major operational activities.

The Directional Functions23

Setting Mission Statement, Vision Statement and Value Statement.

Appointment of CEO / Senior Managers Planning for succession of these

managers as well as outside directors Appointing various committees Prescribing code of conduct for the

management.

The Advisory Function24

General guidance to management. What is happening in the rest of the

world. Specialized input in certain areas

Responsibilities of CEO & Senior Management

25

Operating the company in an effective and ethical manner.

Drawing the strategic plans Drawing annual plans and budgets Selection of managerial and other staff Identifying business risks Financial reporting Internal Controls Code of Conduct for all staff

Tools Available to the Board 26

Composition of the Board Independence Committees Incentives External Help Government Intervention

Balance on the Board27

Balance of talents Finance, Marketing, Production, Law, etc.

Balance of representation As many stakeholders as possible on the

board Balance of power

Distribution of power between directors Balance of views

Different temperaments and views

Independence28

Independent from those who appointed them (?)

Management Stakeholders No special interests (linked

directorships) Meeting in absence of CEO or Chairman

The Concept of Independent Directors

29

Relatively a new concept in Pakistan Only public sector companies have tried

it Private sector companies rarely appoint

independent directors No pool of professional directors

available Regulators trying to popularize the

concept

The Role of Independent Directors

30

Providing Independent Professional View point

Protecting the interest of all stakeholders

Serving on Independent Committees

Committees31

Audit Committee (only independent directors)

CG Committee (only independent directors)

Other Committees      Ad hoc Committees (e.g. investigation)

       Permanent Committees (e.g. HR)

Functions of C G Committee 32

Compliance with CG Regulations Nominating Independent directors Monitor and Safeguard the

independence of directors Review of all information to the Board

from Management Drawing up CG Policy and processes

Incentives to the Board33

Financial (Carrots) Others (Carrots) Legal Obligations (Sticks)

Code of Corporate Governance

34

Constitution of Board – element of independence

Conduct of Meetings – how, when and what Management and Corporate Reporting –

contents and frequency Committees – so far only Audit Committee

is mandatory External Auditor All common sense, should be done even if

not required by law

Objectives of CCG 35

Protect the interest of all stakeholders Infuse some independence in the Boards Bring Transparency in conduct of

meetings Improve reliability of financial reporting Introduce Professionalism in BoDs Reduce undue influence of controlling

groups Develop a corporate culture