TRENDS IN CORPORATE GOVERNANCE AND THE RELEVANCE … King.pdf · What are common sense principles of corporate governance in this changed corporate world? I C R A F T It must be company

TRENDS IN CORPORATE GOVERNANCE AND THE

RELEVANCE FOR DIRECTORS AND INVESTORS

UN PRI 21 November 2018

Presented by Mervyn E King SC

Corporate Legal Advisers

17TH - 19TH CENTURIES

17th century unincorporated entities

With unlimited liability

Wealthy families baulked against it

Politicians wanted to create more jobs

By middle of 19th century question debated

Create an artificial person with limited liability?


ACADEMIC OPPOSITION

An individual with immortality lacks a soul to be punished by the Almighty

Negative reaction by society to a person not being a creature of the Almighty

Lacks a body

Is a person without a conscience

“No soul to be damned and no body to be kicked.” Lord Thurlow 1844

The limited liability act was passed in the UK in the middle of the 19th century


INCAPACITATED PERSON

Young healthy individual, soul and heart in the body

Incapacitated of mind

Artificial person no heart, mind or soul

Directors become the heart, mind and soul

Content to a director’s duties of good faith, care, skill and diligence

Conscious companies have conscious leaders


“OWNERSHIP” – A SOCIAL CONSEQUENCE

Wealthy families provided the equity capital

Members of the families directors

Seen as “owners” of the company

Primacy of the shareholder developed

Public discourse of shareholders’ “ownership”

Focus on financial capital


THE PRIMACY OF SHAREHOLDERS REINFORCED

The Dodge Brothers vs Henry Ford 1919 – minority shareholder

Ford wanted to use profits to pay better wages

Court ordered Ford to discharge its primary duty to shareholders and pay a special dividend

So thinking was directors had to act in the best interests of the shareholders - primacy

Corporate success was equated with profit, share price and dividends


OWNERSHIP?

Shareholders are “the owners of the business” and the responsibility of the corporate executive is to “conduct the business in accordance with their designs, which generally will be to make as much money as possible while conforming to the basic rules of society …. There is one and only one responsibility of business – to use its resources and engage in activities designed to increase its profits as long as it stays within the rules of the game ….” Friedman

Tacit – company not part of society

Principal (shareholders) agent (directors and managers)


OWNERSHIP

Entitles one to consume, waste or destroy a thing

Shareholders have shares

They own the shares – not assets of the company

Evidence of a conglomeration of important incorporeal rights – purpose, vote, dividends

They do not own the company

The company, a sovereign person


TRANSIENT SHAREHOLDERS

IPOers

Secondary market traders

Transient shareholders

Have a claim to a future stream of income if company can pay its debts on due date and/or has readily realisable assets to pay its debts

On bankruptcy shareholders stand at the back of the queue

Shareholders self-protection - can disperse investment by investing in the equities of other companies

Stakeholders such as employees or managers cannot disperse these risks in other companies


THE ERROR OF CORPORATE LEADERS

Duty to the company not shareholders

Agency theory requires directors to obey

Independence of mind fettered

A company’s health not its shareholder’s wealth

Time has come to challenge maximising shareholder value

Distracts boards from building the company’s health

Professors Stout (Cornell) and Paine (Harvard)


UNTIL THE END OF THE 20TH CENTURY

Company and its activities seen through a financial lens

Corporate reporting was only financial

Backward looking

In automotive terms a car with rear view mirrors and no windscreen

20th century unsustainable development

21st century one of sustainable development

The SDGs of 2015

COMPONENTS OF MARKET VALUE

Source: OCEAN TOMO LLC

January 1,2015


INTANGIBLE ASSETS – OPPORTUNITY – INFORMED OVERSIGHT

Ecological overshoot and population explosion

Strategy – long term value creation

Reputation – perceptions of stakeholders

Supply chain – legitimacy of operations

Human rights – child labour

Stakeholder relationships – civil society

Positive and negative impacts on triple context

The quality of governance of the organisation

How does the company make its money?


INNOVATIONS IN CORPORATE REPORTING AT BEGINNING OF 21ST CENTURY

Enhanced business reporting

Balanced score cards

Triple bottom line – theory - context

Sustainability reporting

Each trying to communicate value creation


BEYOND FINANCIAL REPORTING

Triple context – dimensions – SDG’s

Reporting in monetary terms

FR critical but not sufficient

SR critical but not sufficient

The two in silos divorced from reality


SECOND DECADE OF 21ST CENTURY

2009 – UNCTAD and IFAC at Geneva

Chatham House Rules

Financial reporting critical but not sufficient

2010 – IIRC formed at St James’ Palace

IRC SA IR guidelines

SASB formed

2013 – December, IIRC Framework

2015 - SDGs


Financial Manufactured Human Intellectual Social Natural

THE SIX CAPITALS


AN ORGANISATION’S VALUE CREATION PROCESS

18


W F E

88% of member exchanges

Embrace ESG initiatives

18 exchanges planning incorporation of TCFD

Exchanges now offering green or climate bonds

FSCA draft ESG disclosures


FROM PROFIT TO VALUE CREATION

From Friedman’s “free” economy profits

21st century value creation by a company

Historically book value – the difference between total assets and total liabilities

Book value greater or less than the market value

Value of money – the present value of discounted future cash flows

All through a financial lens


VALUE TODAY

How does the company make its money?

The positive and negative impacts on the triple aspects of the company’s business model and output – financial, social and environmental

Enhancing the positives, eradicating or ameliorating the negatives

Embedding sustainability issues into strategy

As water is critical to the beverage manufacturer

Now value is seen through a sustainable lens in a resource deprived world

In the long term better interests of shareholders


NEW THINKING

Understanding, knowing and then planning:

How the company makes it money?

How the company will sustain value creation in the long term?

Board should determine, inputs, how, outputs and outcomes


INTEGRATED THINKING

Every company dependent on relationships and sources of value creation

Mindset change at board & senior management level, including the CFO

Symphony of resources and relationships

Knowledge of stakeholders’ legitimate NIE’s

Greater stakeholder expectations

Agenda items: Inputs to outcomes

stakeholder relationships


BLACKROCK

At the beginning of February 2016, Larry Fink, CEO of BlackRock, the world’s largest investor with $6 trillion in assets under management, sent a letter to the CEOs of the S&P 500 and a number of large European companies. In his letter Mr. Fink urges CEOs to “lay out for shareholders each year a strategic framework for long-term value creation”.

He repeated that in 2017

In 2018 – what is the purpose of the company and ESG metrics in the next five years

OM open letter to CEO’s on ESG


STRATEGY – NEW CHALLENGE AND OPPORTUNITY

Strategy no longer stops at output

Board needs to be informed of stakeholder relationships, sources of value creation and how the company makes its money

Board needs an informed oversight

Hence agenda items of inputs to outcomes and

stakeholder relationships

“CFO” working with C-suite on an integrated strategy – guardian of values - CVO


CORPORATE TOOL BOX

Ethical effective leadership

Adequate and effective controls

Informed oversight

Changed agendas

Sustainability issues and outcomes embedded into strategy

Value creation in a sustainable manner

Knowledge not lost in information

Trust and confidence in the company

Legitimacy of operations


NEW CHALLENGES

Mindset changes

Capitals and stakeholder relationships

Population growth, technological advances and diminishing natural assets

Greater stakeholder expectations

Responsible investment –UNPRI

Financial capital to inclusive capital

Short term capital to sustainable capital

Outcomes based approach to governance


COMPANY CENTRIC GOVERNANCE

What are common sense principles of corporate governance in this changed corporate world?

I C R A F T

It must be company centric

Has to be in the context of value creation in a sustainable manner – the health of the company

It has to be mindful and a value add with positive outcomes for the company

Cannot be a mindless check list approach

SDG’s “indivisible and integrated” – outcomes based


NEW THINKING

Inclusive company centric model

16 basic good governance principles – King IV

To achieve four outcomes

Regimen of apply principles and explain practices

Equal consideration to the sources of value creation and stakeholder relationships in the decision making process in the best interests of the company

(King IV)


FOUR OUTCOMES

Ethical culture and effective leadership

Value creation in a sustainable manner

Adequate and effective controls/informed oversight

Trust and confidence of community and legitimacy of operations

(King IV)


QUALITY VS QUANTITY

Quality governance needs to be mindful

Quality governance needs to be a value add

Needs to achieve the four outcomes

If basic principles are practised and the four outcomes are achieved, a company has practised good governance


DIRECTOR

Century of intangible assets and sustainable development

Approve a business model

Strive for positive impacts

On all three dimensions – strategy for positive and negative impacts

CRISA – raising capital - UNPRI

BJR

Collective spends more time understanding

Report in clear, concise and understandable language


CRITICAL QUESTIONS FOR INVESTORS (1)

1. What is the purpose of the company?

2. How has this company made its money and how does it intend creating value long term in a sustainable manner?

3. Does it have a business model which will result in the long term health of the company?

4. Are the customers of the company paying up on due date?

5. What could really hurt the company in the next few years?

6. How is the company doing relative to its competitors?

7. If the CEO were headhunted tomorrow, who would assume the position as CEO?

8. How is the company going to grow – either organically or by acquisition? If by acquisition, how is it going to be financed?


CRITICAL QUESTIONS FOR INVESTORS (2)

9. Is the company living within its means?

10. How much does the CEO get paid having regard to the inequality gap between the tone at the top and the beat of the feet at the bottom? Is remuneration variable?

11. How does bad news in the company get to the tone at the top, or are the people at the top the last people to hear of bad news?

12. What are the pertinent sustainability issues?

13. Are they embedded into strategy?

14. How has company dealt with ESG issues?


INVESTORS

Representative shareholders

Due diligence changed

Four outcomes – value – business model

Financial not sufficient

FSCA on ESG for pension funds – Blackrock

Stranded assets

CRISA principle one

King IV principle 17


HELEN KELLER

“The only thing worse than being blind is having sight and no vision”


NEW CHALLENGES, OPPORTUNITIES AND THINKING The vision must be to have a company centric

governance model which moves away from yesterday’s primacy of the shareholder. It needs to be implemented mindfully to achieve the four outcomes of effective leadership, value creation in a sustainable manner, adequate controls and legitimacy of operations

We don’t have to grope in the dark

We have the light – the IIRC Framework of December 2013 and outcomes based governance as per King IV

THANK YOU

Prof Mervyn E King SC

Documents

TRENDS IN CORPORATE GOVERNANCE AND THE RELEVANCE … King.pdf · What are common sense principles of corporate governance in this changed corporate world? I C R A F T It must be company