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An IntroductionAn Introductionto Corporate to Corporate GovernanceGovernance

Ahmed Ullah ShahAhmed Ullah Shah

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What is it about?What is it about?

CorporateCorporate

A legal entity that is separate and distinct from its owners.A legal entity that is separate and distinct from its owners.

enjoy most of the rights and responsibilities that an enjoy most of the rights and responsibilities that an individual possesses e.gindividual possesses e.g

enter into contracts, loan and borrow money, sue and be enter into contracts, loan and borrow money, sue and be sued, sued, hire employees, own assets and pay taxes.hire employees, own assets and pay taxes.

limited liabilitylimited liability

GovernanceGovernance refers to "all processes of governing, whether refers to "all processes of governing, whether

undertaken by a government, market or undertaken by a government, market or network, whether over a family, tribe, formal or network, whether over a family, tribe, formal or informal organization or territory and whether informal organization or territory and whether through laws, norms, power or language.through laws, norms, power or language.

It relates to "the processes of interaction and It relates to "the processes of interaction and decision-making among the actors involved in a decision-making among the actors involved in a collective problem that lead to the creation, collective problem that lead to the creation, reinforcement, or reproduction of social norms reinforcement, or reproduction of social norms and institutionsand institutions

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

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

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

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

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DefinitionDefinition

According to OECD:According to OECD:Corporate Governance is the system by which Corporate Governance is the system by which

business corporations are directed and business corporations are directed and controlled. The corporate governance structure controlled. The corporate governance structure specifies the distribution of rights and specifies the distribution of rights and responsibilities among different participants in responsibilities among different participants in the corporation, such as, the board, managers, the corporation, such as, the board, managers, shareholders and other stakeholders, and spells shareholders and other stakeholders, and spells out the rules and procedures for making out the rules and procedures for making decisions on corporate affairs. decisions on corporate affairs.

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Another DefinitionAnother Definition

According to LaPorta et al., (2000),According to LaPorta et al., (2000),

Corporate governance is a set of mechanisms Corporate governance is a set of mechanisms through which outside investors protect through which outside investors protect

themselves against expropriation by the insiders. themselves against expropriation by the insiders. They define They define ““the insidersthe insiders”” as both managers as both managers

and controlling shareholders. and controlling shareholders.

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Yet Another DefinitionYet Another Definition

Corporate governance refers to the manner Corporate governance refers to the manner

in which the affairs of a corporate body should be in which the affairs of a corporate body should be conducted conducted

in order to serve and protect in order to serve and protect

the individual and collective interests the individual and collective interests

of all stakeholders.of all stakeholders.

((Safdar A ButtSafdar A Butt))

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CompanyCompany

Characteristics of a CompanyCharacteristics of a Company Types of CompaniesTypes of Companies

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Characteristics of a CompanyCharacteristics of a Company

Ownership in sharesOwnership in shares Freely transferable sharesFreely transferable shares Separate entity apart from shareholdersSeparate entity apart from shareholders Liability of shareholdersLiability of shareholders Indefinite lifeIndefinite life Board of directorsBoard of directors

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Types of CompaniesTypes of Companies

Limited or UnlimitedLimited or Unlimited Limited by shares or by guaranteeLimited by shares or by guarantee Private or PublicPrivate or Public Listed or UnlistedListed or Unlisted

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Hierarchy of a CompanyHierarchy of a Company

ShareholdersShareholders Own the company, do not run it.Own the company, do not run it.

Board of DirectorsBoard of Directors Elected by and reporting to shareholdersElected by and reporting to shareholders

ManagementManagement Appointed by and reporting to directorsAppointed by and reporting to directors Includes executive directorsIncludes executive directors

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Top Players Top Players

Shareholders: Voting powerShareholders: Voting power Chairman: Chairman:

May be executive or non-executiveMay be executive or non-executive

DirectorsDirectors May be executive or non-executiveMay be executive or non-executive

Chief Executive OfficerChief Executive Officer May or may not be a directorMay or may not be a director

Senior Managers:Senior Managers: May or may not be directorsMay or may not be directors

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Classification of StakeholdersClassification of Stakeholders

OwnersOwners LendersLenders EmployeesEmployees Business AssociatesBusiness Associates

Suppliers and CustomersSuppliers and Customers

SocietySociety Includes governmentIncludes government

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Opportunity to protect Opportunity to protect individual interestsindividual interests

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

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

Lenders and Shareholders are most vulnerable.Lenders and Shareholders are most vulnerable. Society depends entirely on lawSociety depends entirely on law

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Classified on Classified on basis of Rolebasis of Rolein the Companyin the Company

Classified on basis of opportunity to protect individual interestsClassified on basis of opportunity to protect individual interests

Those with Those with Full OpportunityFull Opportunity

Those with aThose with aPartial OpportunityPartial Opportunity

Those withThose withVirtually No opportunityVirtually No opportunity

Minority and individualMinority and individualshareholders with no boardshareholders with no boardRepresentationRepresentation

ControllingControllingShareholdersShareholders

Institutional InvestorsInstitutional Investorswith Board representationwith Board representationOwnersOwners

Financial institutionsFinancial institutionswith elaborate lendingwith elaborate lendingContractsContracts

Buyers of listed bondsBuyers of listed bondswith trustee arrangementswith trustee arrangementsLendersLenders Other lendersOther lenders

Other employeesOther employeeson regular oron regular orcontract termscontract termsEmployeesEmployees Executive DirectorsExecutive Directors Senior ManagersSenior Managers

Suppliers who sellSuppliers who sellonly on cash termsonly on cash terms

Major Suppliers andMajor Suppliers andclients with contractsclients with contracts

Smaller suppliers Smaller suppliers and smaller clientsand smaller clientsBusiness AssociatesBusiness Associates

SocietySociety GovernmentGovernment Public at largePublic at large

Classification of StakeholdersClassification of Stakeholders

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Need for Corporate GovernanceNeed for Corporate Governance

To protect and serve individual interest of each To protect and serve individual interest of each stakeholderstakeholder

To protect and serve the collective interest of all To protect and serve the collective interest of all stakeholdersstakeholders

To ensure no one benefits at the expense of To ensure no one benefits at the expense of anotheranother

To ensure no stakeholder has monopoly of To ensure no stakeholder has monopoly of decision-making.decision-making.

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Governance & ManagementGovernance & Management

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

OrOr Does Management include Governance?Does Management include Governance?

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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

resourcesresourcesOrganizingOrganizing Tasks division & Tasks division &

resource usageresource usage

Controlling managersControlling managers ControllingControlling Controlling Controlling employeesemployees

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GovernanceGovernance

StrategicStrategic Setting ObjectivesSetting Objectives Devising plans to achieve these objectivesDevising plans to achieve these objectives Setting rules or parametersSetting rules or parameters Not directly concerned with routine affairsNot directly concerned with routine affairs Protection of Interests of all stakeholdersProtection of Interests of all stakeholders

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ManagementManagement

Current & Operational AffairsCurrent & Operational Affairs Taking directions from the BoardTaking directions from the Board Implementing the PlansImplementing the Plans Developing Suggestions and AlternativesDeveloping Suggestions and Alternatives

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Approaches to Approaches to Corporate GovernanceCorporate Governance

Shareholders ApproachShareholders Approach Stakeholders ApproachStakeholders Approach Enlightened Shareholders ApproachEnlightened Shareholders Approach Which approach is best?Which approach is best?

Shareholders ApproachShareholders Approach Generally believed that the board of directors of Generally believed that the board of directors of

a company should govern the company in the a company should govern the company in the best interest of its shareholders, i.e. the owners best interest of its shareholders, i.e. the owners of the company. This approach is lent credence of the company. This approach is lent credence and weight by the fact that all the directors are and weight by the fact that all the directors are elected by and answerable to shareholders.elected by and answerable to shareholders.

Make such policy that aim at maximization the Make such policy that aim at maximization the shareholders value (Profit) often at the expense shareholders value (Profit) often at the expense of other stake holders.of other stake holders.

In Pakistan this approach is most prevalentIn Pakistan this approach is most prevalent

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Stakeholders Approach to CGStakeholders Approach to CG

Also known as Plurist Approach and considered Also known as Plurist Approach and considered as the ideal approach by the proponents of CG.as the ideal approach by the proponents of CG.

BOD formulates such policies the provides BOD formulates such policies the provides equal care of the interests of all Stakeholders. equal care of the interests of all Stakeholders.

It is not a practical approach for the simple It is not a practical approach for the simple reason that directors are elected by and reason that directors are elected by and accountable only to the shareholders.accountable only to the shareholders.

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Enlightened Shareholders Enlightened Shareholders ApproachApproach

This approach offers compromise between the This approach offers compromise between the afore-said two approaches. It requires the BOD afore-said two approaches. It requires the BOD to work for the interest of shareholders, but to work for the interest of shareholders, but without damaging the interests of the other without damaging the interests of the other stakeholders. i.e. having a fair balance of interest.stakeholders. i.e. having a fair balance of interest.

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Agency TheoryAgency Theory

What is Agency Theory?What is Agency Theory? Does it apply to companies?Does it apply to companies? Two-party and three-party modelTwo-party and three-party model Principal-Watchdog-AgentPrincipal-Watchdog-Agent

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Key IssuesKey Issues

Financial reportingFinancial reporting Directors’ remunerationDirectors’ remuneration Risk managementRisk management Effective communicationEffective communication Corporate Social ResponsibilityCorporate Social Responsibility

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Financial ReportingFinancial Reporting

AccuracyAccuracy ReliabilityReliability

Internal and external auditInternal and external audit

ComprehensivenessComprehensiveness TimelinessTimeliness

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Directors Related IssuesDirectors Related Issues

RemunerationRemuneration PowersPowers Balance between:Balance between:

executive and non-executivesexecutive and non-executives

Election and re-electionElection and re-election RepresentationRepresentation

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Risk ManagementRisk Management

Risk profileRisk profile What risks to take?What risks to take?

Avoidable and non-avoidable risksAvoidable and non-avoidable risks

What not to take?What not to take? How to handle risks taken?How to handle risks taken?

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CommunicationCommunication

TransparencyTransparency Regular communicationRegular communication With who?With who? In what format?In what format?

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Corporate Social ResponsibilityCorporate Social Responsibility

Business EthicsBusiness Ethics Being a good citizenBeing a good citizen Doing business responsiblyDoing business responsibly

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Why is CG Important?Why is CG Important?

Good reputation is good businessGood reputation is good business Protection of stakeholders’ interestProtection of stakeholders’ interest Support to capital marketsSupport to capital markets Support to societySupport to society Every one winsEvery one wins

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Thank youThank you

Dr S A ButtDr S A Butt