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THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES

THE INSTITUTE OF CHARTERED SECRETARIES AND

ADMINISTRATORS

International Qualifying Scheme Examination

CORPORATE GOVERNANCE

MAY 2013

Suggested Answer

The suggested answers are published for the purpose of assisting students in their

understanding of the possible principles, analysis or arguments that may be identified

in each question

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SECTION A

1. Gold Billion Properties Limited is principally engaged in the property development

business and is listed on the main board of the Hong Kong Stock Exchange. Samuel

Tan, a businessman, has recently acquired a majority stake in the company. Following

the change of control of the company, Samuel became the new chairman. With the

assistance of a major human resources consultancy firm, he recruited William Tso to be

the new chief executive officer (CEO). The board of directors comprises six persons

including Samuel, William, the chief financial officer (CFO) and three independent

non-executive directors.

William has extensive experience in property acquisition and development. He managed

to grow the company via a number of property acquisitions in China and the United

States in the first two years after joining the company. With such rapid expansion, the

company has successfully expanded its property portfolio and its share price has

increased two-fold. Samuel, as the controlling shareholder, is happy to see the

increasing return to his equity investment in the company as a result of the increase in

share price.

At a recent board meeting held the week before, William pushed through another

property acquisition, this one in Shanghai. As usual, having sought the prior

endorsement of Samuel, William presented the board papers on the acquisition proposal

to the board members one day prior to the discussion at the board meeting. The

independent non-executive directors have asked for a due diligence report to be done on

the acquisition target and for a cash flow analysis, as these have not been included in the

board papers. However William explained to the directors at the meeting that he would

take care of the due diligence and cash flow for the acquisition; the board then approved

the proposal without further questions.

Behind William’s aggressive strategy for rapid business expansion is the incentive driven

by his remuneration package. William’s executive pay is mainly determined by Samuel

and the remuneration committee simply acknowledges and endorses it. Although

William’s base salary is low, his bonus is generous and awarded only when the company

has achieved an annual 20% increase in its profits. As part of the remuneration package,

substantial share options have also been granted to him and other key executives upon

joining the company. These share options are vested six months after the date of the

grant. Share options have boosted William’s pay considerably as a result of the

substantial increase in the company’s share price following the announcement of a

series of property acquisitions over the past two years.

To finance the rapid growth via various acquisitions, the company is already at a high

gearing level. Recently, William has conspired with the CFO to adopt some off-balance

sheet financing schemes to hide the company’s debts through some vehicle companies

which are not intended to be consolidated into the financial statements. Some creative

accounting measures are also being used to disguise operating expenses as capitalised

expenditure so as to make the profitability of the company look good. As a result of these

moves, William and the CFO can look forward to being awarded substantial bonuses

based on the improved financial results.

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The external auditor has noted such creative accounting measures, but is hesitated to

report this to the audit committee as he is afraid of losing this client. The internal auditor

has recently joined the company and needs time to find out what is happening and to

establish what best to do.

REQUIRED:

1. (a) Identify and analyse the corporate governance issues regarding the

company, the board and its committees as presented in this case.

Ans (a) Corporate governance issues:

Lack of checks and balances at board

With powerful CEO and weak INEDs, despite INEDs comprising one-half of

board members

Dominant influence from Chairman/substantial shareholder on CEO, e.g.

acquisition proposal was endorsed by Samuel before William sending it to the

board

Powerful CEO

Dominates the decision-making process

Pursues aggressive business strategy for self-serving purpose – to boost the

share price through acquisitions and benefit from share option gains

Uses creative accounting measures to boost profitability to secure a high

bonus

Weak diligence from INEDs

INEDs fail to constructively challenge the proposals presented by

management

INEDs fail to exercise due diligence and peruse adequate information before

giving approval of acquisition proposals

Failure of board committees to perform oversight roles

Failure of audit committee to perform oversight role effectively on risk

management and internal control systems, including the financial reporting

process

Failure of remuneration committee to review and monitor the remuneration

package of CEO

Appointment of William as CEO/Executive Director was determined by the

Chairman without going through any formal approval procedure from any

nomination committee

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Adequate and timely information not provided

Chairman fails in his duty to procure timely information – board papers are

presented to the board members only one day prior to board meeting.

Chairman fails in his duty to procure adequate information for directors prior to

making important decisions – information about due diligence of acquisition

target and cash flow is not provided.

CEO dominates the decision-making process and chairman fails to encourage

INEDs to give their views at board meetings.

CEO executive pay issues

Base pay may be too low and this contributes to an aggressive business

strategy for expansion to secure generous bonus and share option gains.

Share options and bonuses are largely based on short-term achievements,

such as share price growth or profitability, and insufficient attention is given to

longer-term consideration.

Short-term performance measures are themselves unreliable and often open

to manipulation by management, such as adopting creative accounting

measures.

Share-based incentives are not linked to performance over the longer term:

preferable for vesting to be based on performance conditions measured over

a long period, say three years.

Overall issues: structure of executive pay package encourages CEO or

executives to undertake a higher risk business strategy, or to focus on

short-term profit or manipulate the financial figures, using aggressive

accounting treatments to make the company performance seem better.

Inadequate risk management and internal control

High risk arising from aggressive business strategy – over expansion will lead

to cash flow problems and corporate collapse

Weakness in internal control system to detect aggressive accounting

practices, which might hide the true financial position and affect the reliability

of the financial statements

Internal audit not functioning effectively to identify accounting malpractices

and report to the audit committee

Weakness in communication between external auditor and audit committee

about issues on appropriate accounting treatment or policy

Weakness in safeguard procedure to ensure that there is no threat to the

objectivity and independence of the external auditor who can report audit

issues on the financial statements to the audit committee without fear of losing

his contract

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1. (b) Suggest what procedures or processes the board or its committees should

strengthen in order to address the issues mentioned in this case.

Ans (b) To put in place checks and balances in the board

The monitoring role of INEDs should be strengthened to counteract the

dominant influence of the CEO

INEDs must exercise independent judgment and ensure accountability and

consideration of shareholders’ interests

INEDs must demand timely and proper information when it is not forthcoming

and must strongly challenge management proposals before reaching

unanimous decisions

INEDs who are members of the audit committee and remuneration committee

must perform their oversight roles over risk management and internal control

and executive pay issues

To strengthen boardroom practices

To send board papers to directors in a timely manner, at least three days

before the meeting

A.7.1 of CG Code: An agenda and accompanying board papers should be

sent in full to all directors in a timely manner and at least three days before the

intended date of a board or board committee meeting (or such other period as

agreed).

To provide adequate information about proposed acquisitions

A.2.3 of CG Code: The chairman should be responsible for ensuring that

directors receive adequate information, which must be complete and reliable,

in a timely manner.

Chairman to brief directors and encourage INEDs to give their views

A.2.2 of CG Code: The chairman should ensure that all directors are properly

briefed on issues arising at board meetings.

A.2.6 of CG Code: The chairman should encourage all directors to make a full

and active contribution to the board’s affairs and take the lead to ensure that

the board acts in the best interests of the issuer. The chairman should

encourage directors with different views to voice their concerns, allow

sufficient time for the discussion of issues and ensure that board decisions

fairly reflect board consensus.

INEDs to actively participate in the discussion and bring an independent

judgment to the discussions before arriving at a decision

A.6.8 of CG Code: Non-executive directors should make a positive

contribution to the development of the issuer’s strategy and policies through

independent constructive and informed comments.

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To conduct board evaluation regularly to assess the performance of the board

and its committees to identify weaknesses for improvement

To conduct continuous professional training program for directors to refresh

their skills and knowledge so as to enable them to perform their duties

effectively

To establish nomination committee to oversee the appointment of directors

and CEO and to assess the independence of INEDs

To strengthen the oversight role over executive pay

The remuneration committee needs to review the structure of the CEO’s

remuneration package, taking into account the relevant principles:

CG Code B.1 Principle: Remuneration levels should be sufficient to attract

and retain the directors needed to run the company successfully, but

companies should avoid paying more than is necessary for this purpose.

CG Code B.1.7: A significant proportion of the executive director's

remuneration should be structured so as to link rewards to corporate and

individual performance.

Base pay should be competitive and reflect the contribution of the executives

concerned, taking into account salaries paid by comparable companies.

Performance-based bonus/incentive measurement should be carefully

defined, setting annual versus long-term performance targets

Vesting of share options should be based on performance conditions

measured over a period (not less than and possibly more than three years)

appropriate to the strategic objectives of the company.

To strengthen the risk management and internal control system

To strengthen the oversight role of the audit committee over risk management

and internal control system

To strengthen the oversight role of the audit committee in reviewing the

financial statements and ensure the integrity and reliability of financial

reporting

To strengthen internal audit function to review risk assessment and control

and to detect fraud or error in the financial reporting process

To establish or strengthen whistle-blowing procedure for reporting fraud and

malpractices

To strengthen the communication process between the internal auditor,

external auditor and audit committee, with meeting held at least annually

without presence of management

To formulate code of ethics to guide executives and employees on ethical

behaviour

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1. (c) Critically evaluate the roles that the internal auditor and the external auditor

can play to contribute to sound governance in this case.

[Where appropriate, candidates may refer to the Corporate Governance Code of

Hong Kong].

Ans (c) Role of internal auditor:

- Reviews the adequacy of the risk management system and internal control

systems

- Reports to the audit committee and management on issues relating to risk

management and internal control

- Provides assurance on compliance with corporate policies, legislation and

regulations

- Alerts management and the audit committee about fraud or other internal

control failures or weaknesses that might occur

In this case, the internal auditor should investigate into the off-balance sheet

financing schemes and creative accounting measures and report on them to

the audit committee

He should assess the risk profile regularly and report to the audit committee

about the high financial risk attached to the aggressive business expansion

strategy adopted by the CEO.

To perform the role effectively, he should function independently of the CFO and

have direct access to the audit committee, and also familiarise himself with the

business operations, policies and procedures of the company as soon as possible

in the case.

Role of external auditor:

- to perform an audit on the financial statements and give an independent

opinion on whether they provide a true and fair view about the company’s

financial position and whether they comply with accounting standards and

relevant laws

- to provide assurance that the financial statements are objective and can

be relied upon by shareholders or investors

- In this case, the external auditor should assess the impact of the

off-balance sheet financing schemes and creative accounting measures

which might disguise the company’s true financial position and affect the

reliability of the financial statements.

- He should report to the audit committee about the accounting malpractices

which might involve fraud and breach of accounting standards

- He should uphold his independence and integrity, without fear of losing the

client

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SECTION B

2. The United States has a corporate governance structure that promotes stricter statutory

rules while the United Kingdom and other European countries emphasise voluntary

compliance with corporate governance codes and practices.

REQUIRED:

2. Discuss the rule-based approach and the principle-based approach to corporate

governance, including an analysis of each approach’s merits and drawbacks.

Ans Rule-based approach to corporate governance

In the US, the emphasis has been on statutory regulation and enforcement of the

rules.

In the US, a stricter statutory regime was introduced by the Sarbanes-Oxley Act

2002 in response to the collapse of Enron.

The Sarbanes-Oxley Act contains various specific requirements and directs the

Securities and Exchange Commission to issue rules implementing its measures

relating to corporate governance, including the powers to investigate and punish

auditors that certify inaccurate financial statements and criminal penalties for a

range of corporate crimes.

This approach requires companies to adopt specific corporate governance

practices by legislation or regulation.

Legal systems and regulatory frameworks have an important role to play in

corporate governance. Statutory rules offer certain degrees of protection for

investors.

Merits:

Investors’ or stakeholders’ rights are better protected by the basic mechanism of

laws accompanied by predictable legal enforcements.

Prescriptive rules have the advantages of relative certainty and enforceability –

companies need to follow and support good governance.

Rules are specific and can normally be applied with no dispute (certainty)

Mandatory regulations are the means to achieving the appropriate corporate

governance standards in the public interest, especially when market failure has

been revealed.

Drawbacks:

Rule-based approach is an one-size-fits-all approach and one standard might not

suit all circumstances of companies with different size, nature and culture.

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Mandatory regulation is rigid and cannot accommodate grey areas, resulting in

compliance only with the letter rather than the spirit of the law.

It leaves open the question of what to do when there is no specific rule to apply to a

given situation and so it requires continual growth of rules to cover new situations

It takes a lengthy legislative process to amend rules to suit changing circumstances.

There may be conflicting rules emanating from different hierarchical governing

mechanisms and this requires another set of rules to help decide what to do.

The cost of compliance with the rules and laws might be burdensome to small

companies which have limited resources

Principle-based approach to corporate governance

In the UK and Europe, the response to corporate crisis has been to examine and

emphasise the principles of good governance.

The Cadbury Code and the OECD Principles, in particular, have each played a

major role in the development of corporate governance codes around the world.

In the UK, the development of corporate governance principles and best practices

began with the Cadbury Code in 1992. This identified many of the key issues,

including the balance of power on the board and the need for INEDs, the

transparency of financial reporting, the role of the external auditor and the need for

risk management.

Principles of good corporate governance have also been issued by some

international bodies, notably the OCED and the Commonwealth Association. These

principles are intended to provide guidelines for individual countries in formulating

their own national codes and guidelines.

Under this approach, companies are allowed to design and determine the specific

corporate governance practices that best suit their circumstances subject to

appropriate disclosures.

A comply-or-explain approach is adopted where companies are expected to comply

with, but may choose to deviate from, the code provisions. Companies have to give

considered reasons for any deviations from the code provisions and make

appropriate disclosures.

Merits:

Codes aim to provide boards with a checklist against which to review their

governance structures and processes and to provide investors with an agenda for

their dialogue with boards.

There is no universal or one-size-fits-all approach to promoting good corporate

governance. Codes allow for flexibility in implementation and are not framed as rigid

rules.

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They are to be followed by companies in the light of their own particular

circumstances relating to their size, complexity and operations.

Codes are not statutory rules and are therefore easier to update without lengthy

legislative process

Voluntary compliances with codes and principles involves less costs than

mandatory rule-based approach

Drawbacks:

Weak enforcement - non-statutory codes are voluntary, without binding force and

have no teeth; there can be a lack of incentives or resources to enforce standards.

Codes are followed by the well-intentioned and ignored by the less conscientious.

Compliance with codes might be a box-ticking exercise, without meeting the spirit of

the codes.

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3. Should the chief executive officer also be the chairman of the board? Discuss and

present your arguments for both sides with the application of corporate

governance principles.

Ans The role of chairman is to provide leadership for the board and ensure that the

board works effectively and performs its responsibilities, and that all key and

appropriate issues are discussed by it in a timely manner.

The role of CEO is to manage the day-to-day operation of the business of the

company and formulate and implement the business strategies

Most codes of corporate governance practices recommend that the roles of

chairman and CEO should be held by different people.

Hong Kong Corporate Governance Code

Principle A.2: There are two key aspects of the management of every issuer – the

management of the board and the day-to-day management of business. There should

be a clear division of these responsibilities to ensure a balance of power and authority,

so that power is not concentrated in any one individual.

Code Provision A.2.1: The roles of chairman and chief executive should be separate

and should not be performed by the same individual. The division of responsibilities

between the chairman and chief executive should be clearly established and set out in

writing.

Or

UK Corporate Governance Code

Main Principle: There should be a clear division of responsibilities at the head of the

company between the running of the board and the executive responsibility for the

running of the company’s business. No one individual should have unfettered powers of

decision.

Code Provision A.2.1: The roles of chairman and chief executive should not be

exercised by the same individual. The division of responsibilities between the chairman

and chief executive should be clearly established, set out in writing and agreed by the

board.

Separation of roles will help:

provide checks and balances to ensure a balance of power at the board

establish a clear division of responsibilities at the head of the company, between

the running of the board and the executive responsibility for the running of the

company’s business

avoid concentration of power in the hands of one individual so that he does not

have unfettered powers to dominate decision making

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reduce the risk of an all-powerful individual taking on excessive and inappropriate

risk or taking self-serving action for his own interest rather than the interests of the

shareholders and the company

allow the burden of responsibilities at the head of a business to be shared

Family businesses may benefit from bringing in an outside chairman in terms of

objectivity in relation to family issues and his/her experience in other fields.

Different mixes of ability and experience are required for the two posts. The two

posts call for somewhat different qualities and strengths and need to be performed

by different persons.

There is increasing pressure from outside investors for companies to enhance

corporate governance standards. The chairman and the CEO should play distinct

roles in developing and maintaining a sound corporate governance structure.

The UK Corporate Governance Code does recognise that in some circumstances a

single leader may be inevitable; in this case, it calls for a strong group of non-executives

on the board with their own appointed leader.

The Hong Kong and UK Corporate Governance Codes allow for deviation from the code

provisions by providing an explanation for the combination of the two roles in the

corporate governance report.

There are circumstances under which the combination of the roles of chairman and

CEO is justified:

In the US, the roles of chairman and CEO are typically combined and held by a

powerful individual who leads the company in both managerial and governance

matters.

It is common practice, especially where the companies are started from

family-owned business; it is the way which companies are run by their founders,

and it provides undisputed leadership internally and externally.

The combined role may have advantages particularly for small high-growth firms

that require strong direction and leadership to grasp business opportunities.

The two posts are naturally combined in one person in the formative stages of a

company’s development, but should split as the company grows and leadership

responsibilities increase.

The combination is justified when particularly strong leadership is needed quickly at

a time of crisis or financial difficulties to turn around.

When two persons of different personalities or characters work together, there may

be conflict or disagreement among them and that may lead to inefficient decision

making. Combination of the two roles can reduce such conflict.

Chairman normally focuses on long term strategy planning while CEO normally

focuses on short term profitability. Long term goals might be in conflict with short

term goals. It is difficult for the same person to perform both roles at the same time.

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Same person may not have sufficient time and expertise to perform both roles at the

same time

Both Chairman and CEO assume important roles and represent the company from

time to time. General public will be confused if there are two spokesmen for the

company.

Decision over whether the two posts should be separate or combined depends on

circumstances of individual companies.

The question is which is preferable: a dominant leader who enhances performance; or

shared responsibility, which reduces risk?

The success of separation of the two roles depends on the way in which the two

individuals share power between them and build a relationship of trust.

Where the chairman is also the CEO, it is essential that there should be a strong and

independent element on the board – need counterbalance provided by the other board

members.

more INEDs may be appointed to the board or

a deputy chairman may be appointed to deal with issues where potential conflict of

interests arises (UK Combined Code)

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4. You are the company secretary of a listed company in Hong Kong. One of your

independent non-executive directors suggests to your chairman that the company should

carry out a board performance evaluation.

REQUIRED:

4. (a) Advise the chairman of the importance of board performance evaluation

Ans (a) Importance of board evaluation:

Good corporate governance involves a strong effective board that

understands its own roles and its own accountabilities. Board evaluation is

part of good corporate governance

Recommended best practice B1.9 of Corporate Governance Code

B.1.9. The board should conduct a regular evaluation of its performance.

Principle A1

The board should regularly review the contribution required from a director to

perform his responsibilities to the issues and whether he is spending sufficient

time to perform them.

Focus board members' attention on their roles and duties and identify areas

for improvement

The evaluation process will be used constructively as a mechanism to improve

board effectiveness, maximise strengths and tackle weaknesses

Useful in boosting board performance

Board evaluation enables the company to link remuneration to performance.

The remuneration committee may determine the remuneration packages of

individual directors based on their performance

Through board evaluation, the composition of the board will be reviewed to

see if the existing mix of skills and knowledge of the board members is

appropriate and what kind of additional skills, knowledge and experience is

necessary for the requirements of the company's business. It helps ensure

that the directors continue to contribute to the board and determine if there is a

need to appoint new director or remove an existing director

Board evaluation helps identify the training needs of individual directors based

on their performance. If a director is unable to perform his duties well by his

existing knowledge and skill, the company can arrange for the professional

training and development for the director.

Undertaking board evaluation may improve accountability. By conducting

board evaluation, the board is demonstrating to shareholders that they are

serious about fulfilling their fiduciary obligations

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4. (b) Suggest criteria for evaluating the performance of the board as a whole and

of individual directors.

Ans (b) Criteria for performance evaluation of the board:

Overall performance

How well has the board performed against any performance objectives that

have been set?

What has been the board's contribution to the testing and development of

strategy?

What has been the board's contribution to ensuring robust and effective risk

management?

How has the board responded to any problems or crisis that have emerged

and could or should theses have been foreseen?

Are the matters specifically reserved to the board the right ones?

How well does the board communicate with the management team, company

employees and others? How effectively does it use mechanisms such as the

AGM and the annual report?

Is the board as a whole up to date with latest developments in the regulatory

environment and the market?

Board structure

Is the size of the board appropriate taking into account the size and complexity

of business of the company?

Is the composition of the board and its committee appropriate, with the right

mix of knowledge and skills to make quality decision and maximise

performance?

Are INEDs enough and genuinely independent? This means ensuring that the

INEDs have no relationships with the company that could affect the exercise of

genuinely object judgment?

Are the posts of chairman of the board and CEO separate so that there is no

concentration of power in one individual?

Board process

Is the board getting appropriate, timely and unbiased information, of the right

length and quality?

Are sufficient board and committee meetings of appropriate length held to

enable proper consideration of issues? Is time used effectively?

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Are board procedures conducive to effective performance and flexible enough

to deal with eventualities?

Board leadership

Is the chairman demonstrating effective leadership of the board?

Are the processes for setting the agenda working! Do they enable board

members to raise issues and concerns?

Are all directors allowed or encouraged to participate fully in board

discussions?

Are relationships and communications within the board constructive?

Are relationships and communications with shareholders well managed?

Is the company secretary being used appropriately and to maximum value?

Board committees

Does each board committee have adequate and appropriate written terms of

reference?

How effective are the board's committees? Do such committees have the right

composition? How do they interact with the main board? Do they fulfill their

roles?

Criteria for evaluation of performance of individual directors:

How well prepared and informed are they for board meetings and is their

meeting attendance satisfactory?

Have they devoted sufficient time and effort to understanding the company

and its business?

How successfully have they contributed to strategy development and risk

management?

How effectively have they tested the information and assumptions with which

they are provided?

How resolute are they in maintaining their own views and resisting pressure

from others?

How effectively and proactively have they followed up on any areas of

concern?

Does their performance and behaviour engender mutual trust and respect

within the board?

Do they have specialist legal, financial, marketing or other skills critical to the

performance of the company?

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How actively and successfully do they refresh their knowledge and skills? Are

they up to date with market and regulatory developments?

Are they able to present their views convincingly yet diplomatically? Do they

listen and take on board the views of others?

Do they constructively challenge management's proposals in meetings?

Do they generate a supportive environment for management in meetings?

Do they work well with other fellow directors?

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5. Discuss how institutional investors can help improve corporate governance

standards of the companies in which they invest and the factors determining the

extent to which they are effective in their activism or interventions.

Ans Institutional investors are organisations that have large amounts of funds to invest and

put much of these funds into company shares. They include pension funds, insurance

companies, collective investment institutions and private equity funds.

In the wake of various corporate collapses and financial scandals in recent years,

institutional investors become more proactive in trying to ensure that the companies in

which they invest deliver the best available shareholder value. Vigorous shareholder

activism can lead to better corporate governance.

Institutional investors help improve corporate governance through the following

interventions with investee companies:

Dialogue with invested companies

To be more active in making their views known to the companies they invest in by

engaging in an active dialogue with the board of directors in the hope of influencing

its decisions.

To have a policy in place for meeting an investee company’s board and senior

management to exchange views and information.

Considered use of votes

To attend general meetings where appropriate and practicable and take steps to

ensure their voting intentions are translated into practice.

To vote on all their shares held directly or on behalf of clients at general meetings

wherever practicable to do so.

To make positive use of their voting rights, to bring about changes when necessary

to improve the standards of corporate governance.

Proactively monitoring investee companies

To review annual reports and accounts, circulars issued by companies and general

meeting resolutions.

To raise questions about investee companies’ affairs at their general meetings

To take a positive interest in the composition of board of directors and exercise

voting rights to elect directors, with particular reference to the checks and balances

and the appointment of non-executive directors of necessary calibre, experience

and independence.

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Evaluation of governance disclosures

To evaluate disclosure of corporate governance practices by invested companies to

ensure compliance with the corporate governance code, which may be laid down by

the regulators or institutional investors.

To take a reasoned and flexible approach when judging the compliance of

companies with corporate governance requirements:

When evaluating company disclosures on corporate governance, particularly

those relating to board structure and composition, institutional shareholders

should give due weight to all relevant factors drawn to their attention.

Institutional shareholders should carefully consider the explanations given by

companies for any departure from the code provisions of corporate governance

code and make a reasoned judgment in each case.

If they do not accept the company's positions, they should explain their views in

writing to the company, and be prepared to enter into a dialogue on this matter if

necessary.

They should avoid a box-ticking approach to checking compliance with the

corporate governance code and to assessing a company's corporate

governance.

Setting strategies on intervention

To exercise their votes and, where necessary, intervene objectively and in an

informed way.

To nominate board representation to the investee companies, where necessary.

To set out the circumstances (e.g. poor company performance, internal control

failure, inadequate succession planning) when they will actively intervene and what

the nature of that intervention might be.

If boards do not respond constructively when institutional shareholders intervene,

then they will consider on a case-by-case basis whether to escalate their action, for

example, by making a public statement in advance of the AGM or an EGM or

requisitioning an EGM, possibly to change the board, to dispose of their

shareholding or to launch litigation.

To monitor and evaluate the effects of their activism.

Factors affecting the activism or interventions:

Active shareholders require a majority vote for their activism to be effective.

Institutional investors, because of the larger shareholding that they own, are in a

better position to monitor the company’s performance.

Institutional investors may have different concerns of their own and it is difficult to

organise a group of dissident shareholders into a voting majority.

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Cost concerns – there are numerous costs and risks for institutional investors who

are willing to be actively involved in the corporate governance affairs of the investee

companies.

Institutional investors aim to achieve their business goal rather than to protect the

minority shareholders’ interest. They may also have a business interest in or

business connection with the company concerned and therefore want to avoid

criticising its management.

Institutional investors may lack the capability and have little or no experience in

directly monitoring a company’s management.

Institutional investors may lack incentives to actively monitor because of the

free-rider problems among themselves in monitoring managers of their investee

companies.

Institutional investors may not have sufficient information to actively monitor the

company’s operations even though they have the information required to make their

investment decisions.

Institutional investors may not want to sacrifice investment liquidity in order to

achieve a greater voice in the activities of the investee companies. In particular,

board membership in a company brings too many responsibilities.

Highly-liquid stock markets diminish large shareholders’ incentives to monitor their

investee companies as the liquidity allows them to exit their investments easily.

Where institutional shareholders intervene, whether the board of directors of the

investee companies is willing to react positively can hinder the effectiveness of

intervention.

Where the institutional investors actively intervene, they should be aware that they

should not become too much involved in the invested company as they could

probably receive any information which is not publicly disclosed. They would be

likely liable for insider dealing under SFO if they make use of such information for

share dealing purpose.

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6. You are the company secretary of a large pharmaceutical company.

REQUIRED:

6. (a) Identify and discuss the economic, social and environmental

responsibilities that the board of directors of your company should have to

your shareholders and stakeholders.

Ans (a) Responsibilities of board of directors

Economic responsibility :

To maximise profit for shareholders, net asset value or return to

shareholders’ investment

To produce the goods and services that society desires, and thereby to

create sustainable economic wealth

To provide job opportunities to employees and pay comparable salaries

To ensure fair dealings with suppliers and timely payment to them for their

goods/raw materials supplied

To charge a reasonable price on quality products to customers

Environmental responsibility:

To minimise the impact of the company’s activities on the environment, e.g.

control pollution, reduce waste

To ensure that all environmental legislations and regulations are fully

complied with

Social responsibility:

To take care of the interests of the company’s stakeholders, including

employees, customers, suppliers, in particular on protection of the

environment, health and safety, e.g.

providing a healthy and safe working environment to employees

providing safe and reliable products to customers

having fair dealings with suppliers

To participate actively in the betterment of society beyond the minimum

standards set by the economic, legal, and ethical responsibilities, e.g.

donation of money or pharmaceutical products

research and development of new drugs to improve health

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6. (b) Highlight the potential benefits for your company of adopting and

implementing a policy for corporate social responsibility (CSR).

Ans (b) Benefits of adopting CSR policies

The company and its management are more likely to act in an ethical way. In

the long term, business as a whole is likely to benefit from ethical business

practices, such as honesty, integrity, fairness and transparency.

A company may acquire a favourable reputation, with the public in general

and with customers.

It may be argued that there are commercial benefits in CSR policies. There is

no clear evidence of a link between CSR policies and increased profits,

although companies with an awareness of social and environmental issues

may be more alert to possibilities for innovation and opportunities for the

development of environmentally-friendly products and services.

Many investment institutions take social, environmental and ethical

considerations into account when formulating their investment strategies.

Investors might prefer holding shares in companies that adopt CSR policies.

This helps attract investment capital and boost share price.

It could be argued that companies with CSR policies are more likely to retain

employees, especially if CSR policies include measures that improve pay or

working conditions.

Customers might prefer buying from companies with CSR policies because of

their confidence in the companies and their products.

Suppliers might prefer dealing with companies with CSR policies as such

companies will have fair dealings with them and ensure timely payment.

Banks are willing to provide loans and credits because of the reputation and

credibility of companies with CSR policies.

Adopting a CSR policy, companies are more alert on identifying different risks

associated with environmental, health and safety issues and will formulate

strategy to manage such risks and protect their reputation.,

6. (c) Draft a CSR policy for your company.

Ans (c) Sample corporate social responsibility policy

Our mission is to strive toward better health for individuals and progress in

medicine by developing superior pharmaceutical products. We strive to maintain

and improve sound business processes throughout our operations and to engage

in activities to promote a sustainable society as a good corporate citizen.

Our CSR policy defines our long-term approach to specific issues in the following

cornerstones.

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Our People

We are committed to enhancing the level of engagement, health and safety,

overall wellness and personal growth of our employees and making the company

a better place to work.

We foster a supportive and quality working environment by:

upholding employment practices that treat employees fairly and equally

safeguarding employee rights and interests

providing opportunities for training and development

ensuring a healthy and safe workplace

facilitating meaningful communication within the company

Environment

We are committed to devoting systematic efforts towards the conservation of

energy and natural resources as well as reduction of waste and emissions at both

business operation and individual levels.

We care for the environment by:

minimising the environmental impact of our activities, as well as products and services engaged

preventing pollution, reducing waste, increasing recycling and minimising natural resource use by continually improving our environmental management practices and measures

educating our employees to adopt environmentally responsible behaviour

promoting environmental protection in our supply chain and marketplace

Community

We are committed to a sustainable community by supporting local initiatives that

create effective and lasting benefits to the community through corporate

philanthropy, establishing community partnerships, and mobilising our

employees to participate in volunteer work.

We care for society by:

contributing resources to educational and research initiatives

engaging in donations or philanthropic activities

emphasising employee participation as responsible citizens

This policy shall be communicated to the company’s stakeholders, including but

not limited to its employees, shareholders, suppliers, business partners and

customers.

The policy shall be reviewed by the board of directors annually.

END