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TOPIC 5 – CORPORATE GOVERNANCEUNIT -LEARNING OBJECTIVESOverall unit objectives

4. define corporate governance and assess the effectiveness of various corporate governance mechanisms

6. critically evaluate contemporary a external company reporting practices

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TOPIC 5 –CORPORATE GOVERNANCETOPIC LEARNING OBJECTIVES 1. define corporate governance and assess the

effectiveness of various corporate governance mechanisms

2. apply concepts from agency and stakeholder theories to explain corporate governance;

3. list various corporate governance mechanisms

4. describe the minimum corporate governance mechanisms recommended by the ASX

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TOPIC 5 –CORPORATE GOVERNANCE LEARNING OBJECTIVES5.explain and evaluate the use of

independent directors as means of achieving corporate governance;

6.explain and evaluate the use of executive compensations packages as means of achieving corporate governance;

7.describe the annual report and other disclosure requirements related to corporate governance;

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TOPIC 5- STUDY TIME

Study learning materials 2 hrsRead supplied readings 12 hrsUndertake activities and review Activities 10 hrs 24hrs

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BASIC CORPORATE GOVERNANCE

Its board of directors!

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DEFINITION OF CORPORATE GOVERNANCE #1 “NARROW”

Agency Theory Perspective

“… the process of supervision and control intended to ensure that the company's management acts in accordance with the interests of the shareholders “

(Parkinson (1994) as quoted in Table 1 Solomon 2007, page 13).

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DEFINITION OF CORPORATE GOVERNANCE #2 “BROAD”

Adopted by Solomon

“… the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity. “

(Solomon 2007 (reading 5.1), page 14).

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DEFINITIONS OF CORPORATE GOVERNANCE #3

ASX

“the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations”.

(ASX Corporate Governance Principles and Recommendations (reading 5.2), page 3)

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DEFINITIONS OF CORPORATE GOVERNANCE

“Effective corporate governance structures encourage companies to create value, through entrepreneurialism, innovation, development and exploration, and provide accountability and control systems commensurate with the risks involved”.

(ASX Corporate Governance Principles and Recommendations (reading 5.2), page 13)

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THEORIES OF CORPORATE GOVERNANCE

Agency theory.

Stakeholder theory.

Solomon suggests that these frameworks share commonalities and overlap theoretically

(covered in reading 5.1, Solomon 2007, chapter 1)

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AGENCY THEORY

“…competition would take care of corporate governance.”

Disclosures and practices based on business reasons.

However, markets are not perfectly competitive.

Which has lead to the intervention by regulators and the development in Australia and internationally

- policy documents- codes of best practices

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STAKEHOLDER THEORY – ETHICAL BRANCH

Accountability to a broad range of stakeholders.

Impact of companies on :

Employees, customers, suppliers, local community and environment.

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STAKEHOLDER THEORY

“…may be viewed as a conceptual cocktail, concocted from a variety of disciplines and producing a blend of appealing sociological and organisational flavours”

(Solomon 2007, page 23)

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STAKEHOLDER THEORY – ETHICAL BRANCH

Normative theory

Companies should have a sound system of corporate governance to ensure they uphold their responsibility to a broad range of stakeholders

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AGENCY AND STAKEHOLDER THEORIES

Agency theory – principal agent relationship is a subset of the more general

Stakeholder theory where the agency relationships extend the concept

To the relationships between

the entity as a whole and the broader society in which it operates

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CORPORATE GOVERNANCE MECHANISMS

1. Independent Directors

2. Audit Committees

3. Executive Compensation

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CORPORATE GOVERNANCE MECHANISMS- INDEPENDENT DIRECTORS

What is an independent (outside) director ?1. Is a non-executive director2. Not a member of management3. Free of any business or other relationship that could

materially interfere with or could reasonably be perceived to materially interfere with the independent exercise of their judgement.

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CORPORATE GOVERNANCE MECHANISMS- INDEPENDENT DIRECTORS Roles Chair of the board should be an independent directors

(ASX 2.2)Majority of the board should be independent directors

(ASX 2.1)Pitfalls Jensen and Murphy (2004, reading 5.5) recommend to

limit number of independent directors (R-15 p55) outside CEO’s bring expertise to the boardMay view the board through CEO eyes and not challenge

the CEO on day to day issues– with the exception of serious problems

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CORPORATE GOVERNANCE MECHANISMS

Board sub-committees -Nomination committee (ASX 2.4)Comprising majority of independent directorsChaired by independent directorHave at least 3 members examine the selection and appointment practices of the

company Charter setting out the roles and responsibilities Formal and transparent process for appointment and re-

election of directors

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CORPORATE GOVERNANCE MECHANISMS

Board sub-committees- Independent audit committee (ASX 4.1)

Focus on issue relevant to the integrity of the companies financial reporting

Assess the performance of external auditors and internal audit function

Examine the provision of non-audit servicesHave a charter, reports to the board

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CORPORATE GOVERNANCE MECHANISMS

Board sub-committees- Remuneration Committee (ASX 8.1)

Review and recommendations to board onRemuneration, recruitment, retention, and termination policies

and procedures for senior executivesSenior executives remuneration and incentivesSuperannuation arrangementsRemuneration framework for directorsRemuneration by gender

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EXECUTIVE COMPENSATION

ASX Principle 8 – Remunerate fairly and responsibly, states

“Companies should ensure that the level and composition of remuneration is sufficient and reasonable and that its relationship to performance is clear.”

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EXECUTIVE COMPENSATION

There are numerous examples in Australia and elsewhere of excessive executive remuneration that has no correlation with the long-term value of companies. Shareholders, tax payers and other stakeholders are wearing the costs of executives’ risky behaviour.

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EXECUTIVE COMPENSATION

The purpose of remuneration is to:

- attract the right executives (at the lowest cost)

- retain the right executives and

- motivate executives to maximise long-term firm value

(reading 5.5)

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EXECUTIVE COMPENSATION

Types of remuneration- Cash as salary- Risky performance related cash- Shares- Restricted shares of share options- Retirement benefits- Non-pecuniary benefits…. (page 19)

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EXECUTIVE COMPENSATION

The effects of remuneration systems on performance and corporate governance is an area that has received much attention.

It has long been recognized that remuneration systems that correlate management’s salary with financial performance can motivate them to increase financial performance.

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EXECUTIVE COMPENSATION

However, remuneration systems can motivate incompetent and opportunistic managers to use their power to fake the earnings of the firm they manage.

Refer to “agency costs of over-valued stock” for example, (p 46).

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EXECUTIVE COMPENSATION

Forging the accounts is not possible in the long-term and because management is assumed to be incompetent in the long-term there is unlikely to be a positive correlation between financial performance and compensation.

It is naïve to think that a performance measure can correct deficiencies in corporate governance, judgement or decision analysis.

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ASX PRINCIPLES AND RECOMMENDATIONS

Not prescriptions merely guidelines

“if not why not” system (ASX)

Disclosure in a separate CG statement in the annual report

All ASX Principles and Recommendations

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ASX PRINCIPLES

Principle 1- Lay solid foundations for management and oversight

Principle 2- Structure the Board to add value

Principle 3- Promote ethical and responsible decision making

Principle 4- Safeguard integrity in financial reporting

Principle 5- Make timely and balanced disclosure

Principle 6- Respect the rights of shareholders

Principle 7- Recognise and manage risk

Principle 8- Remunerate fairly and responsibly

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DISCLOSURE (AASB 1046)

DirectorsName, Positions held, TenureChanges (new and retired) Directors Cash salary, fees and commissionsBonuses (incl. long-term incentive plans)Post-employments benefits (e.g. pensions and

superannuation)Equity compensation (e.g. value of share and options)Termination benefits

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DISCLOSURE (AASB 1046)

Directors Remuneration Cash salary, fees and commissionsBonuses (incl. long-term incentive plans)Post-employments benefits (e.g. pensions and

superannuation)Equity compensation (e.g. value of share and options)Termination benefits

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AASB 124- RELATED PARTY DISCLOSURES

A related party transaction is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.

To enable users of financial statements to form a view about the effects of related party relationships on an entity, it is appropriate to disclose the related party relationship when control exists, irrespective of whether there have been transactions between the related parties

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SHAREHOLDER ACTIVISM

How can shareholders influence CG practices and disclosures voting at AGMs; calling other meetings with senior

management; and campaign by a shareholder or a group

of shareholders to achieve change.

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SHAREHOLDER ACTIVISM-ASA

The Australian Shareholders' Association (ASA) was established as a not-for-profit organisation in 1960 to protect and advance the interests of investors.

improvements in transparency and accountability company performance executive remunerationtreatment of minority shareholders, risk management and dividend policy  

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SHAREHOLDER ACTIVISM-ASA

liaises regulators, lawmakers, industry groups and accounting bodies.

represents its members' views on a number of accounting and financial industry bodies

holds regular members' meetings conducts adult education workshops aimed at improving members' financial literacy.

Directors and other volunteers draw no fee or other remuneration for their services.

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CORPORATE GOVERNANCE RATINGS – CORPORATE MONITOR- Legal compliance - corporate governance,

trade practices, fair trading.

Instances of organised shareholder activism or complaints on behalf of shareholders.

Governance awards.

CEO Remuneration.

Non Executive Director remuneration

Auditor's remuneration for services other than auditing

Board committee structures and independence

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GLOBAL CORPORATE GOVERNANCE QUOTIENT

This corporate governance quotient was developed by the Institutional Shareholders Service (ISS) to rate publicly traded companies on the quality of their CG

Correlations have been found between good CG practices and increased shareholder value.

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GLOBAL CORPORATE GOVERNANCE QUOTIENT

board structure and composition;

•  charter and bylaw provisions;

•  audit issues;

•  anti-takeover practices;

•  executive and director compensation;

•  progressive practices such as board performance review;

•  director and officer stock ownership; and

•  director education.

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SUMMARY -TOPIC 5

Define Corporate Governance

Theories of Corporate Governance

Agency Theory

Stakeholder Theory

Corporate Governance Mechanisms

Independent Directors

Audit Committees

Executive Compensation

ASX Principles and Recommendations

AASB Disclosures

Shareholder Activism

Corporate Governance Ratings

Next Topic 6 Critical Accounting Theory

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