Corporate governance

Corporate Law: Law principles and practice

Defining corporate governance

In the UK, the Cadbury Report of 1992 referred to corporate governance as ‘the system by which companies are directed and controlled’.

Corporate governance is also said to be ‘concerned with the way in which corporations are governed and in particular in the United Kingdom the relationship between the management of a company and its shareholders’.

Corporate Law: Law principles and practice

The parameters of corporate governance

Corporate governance, to a certain extent, is determined by international standards or benchmarks.

Good governance is assessed based on the performance of Australian companies, and within individual companies .

Corporate Law: Law principles and practice

Corporate governance cont …

Corporate governance involves the relationship between three groups:

• the chief executive officer (CEO) and senior employees

• the board of directors• the shareholders as owners.

Corporate Law: Law principles and practice

Corporate governance cont …

Therefore, the focus of corporate governance is on:

• controlling the actions of the ‘insiders’, such as the CEO, senior managers and directors, and ensuring they are acting in the company’s, and by extension the shareholders’, best interests.

• instituting a check and balance system.

Corporate Law: Law principles and practice

Elements of corporate governance

Legal regulationCorporations Act 2001 (Cth)

Codes of conduct, guidelines and statements of best practiceThese are voluntary guides adopted by the company itself.

Corporate Law: Law principles and practice

Elements of corporate governance cont …

Business ethicsBusiness ethics requires a super requirement of doing the ‘right thing’, as well as meeting all of the legal requirements.

Triple bottom line reporting and corporate social responsibility: triple bottom line reportingprovides a model for companies to consider three measures of performance—financial, social and environmental—rather than just the narrow traditional financial measure.

Corporate Law: Law principles and practice

Stakeholders—a critical concept

Stakeholders are those groups within and outside a company who have an interest, stake or entitlement in how the firm is managed and controlled. Stakeholders of a company would include:

• within the company, the employees and shareholders• external to the company, the suppliers and customers• in terms of the business environment, any competitors• more generally, regulators and other government

agencies• more nebulous is the social and environmental impact

of the company and the company’s attitude, as an organisation, to ‘the future’ itself.

Corporate Law: Law principles and practice

Stakeholders—a critical concept cont …

In the business context, the regulators and relevant government agencies include:

• the Australian Securities and Investments Commission (ASIC)

• the Australian Competition and Consumer Commission (ACCC)

• the Australian Prudential Regulation Authority (APRA)

• the Australian Tax Office (ATO).

Corporate Law: Law principles and practice

Matters concerning corporate governance

Competition issues:• compliance with regulation

Internal stakeholders:• members/shareholders• employees

Examples of key issues:• accountability• transparency• due process in decision-making• regard for minority shareholders by the majority

Corporate Law: Law principles and practice

Matters concerning corporate governance cont …

External stakeholders:• customers• regulators• competitors• corporate social responsibility: sustainability,

environment and ‘the future’

Examples of key issues:• rules of the market• compliance with regulation• a fair market• profitable• well managed• satisfied shareholders

Corporate Law: Law principles and practice

Current and future trends in corporate governance 

• the adoption by the ASX of the Principles of Good Corporate Governance and Best Practice Recommendations (a form of self-regulation)

• the introduction of the Corporate Law Economic Reform Program (CLERP), adding to legal regulation

• potential regulation about aligning a director’s pay with company performance and giving greater voice to shareholders in general meetings.

Corporate Law: Law principles and practice

Remuneration of directors

See Executive Remuneration in Australia, released in January 2010. The Productivity Commission considered:

• trends in director and executive remuneration in Australia and internationally

• the effectiveness of the existing framework for the oversight, accountability and transparency of director and executive remuneration practices

• the role of institutional and retail shareholders in the development, setting, reporting and consideration of remuneration practices

• any mechanisms that would better align the interests of boards and executives with those of shareholders and the wider community

• the effectiveness of the international responses to remuneration issues arising from the global financial crisis.

Corporate Law: Law principles and practice

Corporate governance for ASX companies 

ASX principles of best practiceThe Principles of Good Corporate Governance and Best Practice Recommendations, published by the ASX, are a form of self-regulation.

The report observed that corporate governance is ‘the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations’.

It encompasses the mechanisms by which companies, and those in control, are held to account.

Corporate Law: Law principles and practice

The evolving nature of corporate governance

In Australia and overseas, corporate governance evolves within a company and is tailored to suit its needs. There is no one model of corporate governance.

Corporate Law: Law principles and practice

The fundamentals of corporate governance Principle 1: a company’s corporate governance requires that the board of directors and senior executives are clear on their roles, which take into account the following principles

Principle 2: that they demonstrate a balance of skills, experience and independence on the board appropriate to the nature and extent of company operations

Principle 3: that those who determine the company’s strategy and financial performance must make responsible and ethical decisions that comply with the law and are in the interests of all stakeholders

Corporate Law: Law principles and practice

The fundamentals of corporate governance cont …

Principle 4: that they meet the information needs of the investment community to ensure the integrity of company reporting

Principle 5: that these processes provide a timely and balanced picture of all material matters

Principle 6: that the rights of shareholders need to be recognised and upheld

Corporate Law: Law principles and practice

The fundamentals of corporate governance cont …

Principle 7: that every business carries some uncertainty and this must be managed through effective oversight and internal control

Principle 8: that appropriate rewards are required to attract the skills necessary for the performance expected by members.

Corporate Law: Law principles and practice

Corporate governance in the prospectus

Listed companies get on to the stock market by the initial public offering (IPO) or prospectus route. They need to comply with ASX listing rules, which are part of the corporate governance matrix with which listed firms have to comply.

Corporate Law: Law principles and practice

Corporate governance for small and medium-sized enterprises

The corporate governance regime for SMEs is provided for under the Corporations Act 2001 (Cth) and, in particular, the key directors’ duties.

Corporate governance guidance is provided by the 10-page Small Business Guide in Part 1.5 of the Corporations Act 2001 (Cth), commencing at s 111J. 

Corporate Law: Law principles and practice

Competing models of the company

The Australian corporate form, whatever its size and complexity, is arranged around the interests of the shareholder.

A basic dichotomy is at play in terms of corporate models. In very broad terms, the company may be viewed as either a shareholder-focused entity or an entity that has to meet a wider array of stakeholder interests.

Corporate Law: Law principles and practice

Different models

Berle’s model: shareholder-centred model of fiduciary duties

Dodd’s model: company directors are ‘guardians of all the interests which the corporation affects and not merely servants of its absentee owners’.

Corporate Law: Law principles and practice

British and American influences

US corporate governance• based on advanced capitalist democracy• developed financial share market• shareholders are pre-eminent

UK corporate governance• based on advanced capitalist democracy• influenced by several key reports (from Cadbury 1992

to the 2010 Code)

Corporate Law: Law principles and practice

The German–Japanese model

The company:

• focuses on the rights and interests of employees• employees are first among stakeholders

Other stakeholders include:• customers• shareholders

Corporate Law: Law principles and practice

Relevant economic concepts

Agency costsThe term ‘agency costs’ refers to the inevitable costs incurred by a company in using an agent (who may use company resources to their own benefit) to act on behalf of the principal. This creates costs when applying strategies to mitigate any associated problems.

Typically, agency costs arise because of conflicts of interest between shareholders and company management.

 

Corporate Law: Law principles and practice

Relevant economic concepts cont …

Incomplete contractingIncomplete contracting refers to the gaps in the formal contractual arrangement and to all the facets of the relationship that make it work smoothly or work at all.

Asymmetric informationThe term ‘asymmetric information syndrome’ was coined by the US economist Joseph Stiglitz. Stiglitz refers to ‘the differences in information between, say, the worker and his employer, the lender and the borrower, the insurance company and the insured’.

Corporate Law: Law principles and practice

Relevant economic concepts cont …

Navigating the moral hazardsThe term moral hazard was originally used in the insurance context to refer to the tendency of people with insurance cover to paradoxically reduce the care and attention they take to avoid or reduce insured losses.

In agency cost discussions relevant to corporate governance, moral hazard arises when agents (such as managers) discover information that is valuable to the principal (the company) after the principal has contracted for the agent’s services.

Corporate Law: Law principles and practice

Relevant economic concepts cont …

Aligning the interests of managers and shareholdersThe need to align interests arises due to this misalignment of interests between shareholders (as principal) and their agents within the firm (the managers and directors) and also to incomplete contracting. The solutions are based on implementing:

• effective mechanisms for monitoring• sound accountability practices• incentive and pay schemes that optimally align

interests.

Corporate Law: Law principles and practice

Improving communication within companies Incomplete contracting, asymmetric information and moral hazard are, in reality, styles of inefficient communication.

Corporate governance in a systemic sense is aimed at developing more complete and more efficient communication.

Good governance is to keep steadily improving thecommunication mechanisms within companies to reduce the asymmetries and to continue to close the gap in matters of contract, and in so doing successfully diminish the scope of the moral hazards inherent in a wealth-generating entity.

Corporate Law: Law principles and practice

Social, cultural and other forces that determine corporate governance systems

Jonathon Charkham has noted that:

‘No system [of corporate governance] … can be understood without first looking at the salient features of the particular society in which it developed. Everyone is to some extent imprisoned by their history, social, political, and economic.’

International corporate governance developments

The UK has been the leader in developing corporate governance systems, as evidenced by:

• the number of references to British developments on leading commercial law firm websites

• the number of UK-based, but internationally operated, law firms setting up new offices in Australia

• the rapidly international nature of much commercial, corporate and resources work.

Corporate Law: Law principles and practice

Corporate Law: Law principles and practice

Developments in the European Union

The European Commission published in 2011 a corporate governance green paper titled The EU Corporate Governance Framework. This framework proposes several potential reforms, including:

• shareholder voting on executive remuneration• improvements to board diversity• better models for sustainable growth for companies• a more robust international financial and banking

system in the wake of the global financial crisis.