Using the OECD Principles of Corporate G

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ANGLIA RUSKIN UNIVERSITY

Using the OECD Principle of Corporate

Governance as an International Benchmark: A

Comparative Analysis of Corporate Governance

Legislation in the UK, US and South Africa

PAUL CHU NGUM

A Dissertation in partial fulfilment of therequirements of Anglia Ruskin University for thedegree of Master of Law (LL.M International and

European Business Law)

Submitted: January 2009


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ABSTRACT

Adopting corporate governance practises has been a great concern to the academia,

professionals and policy makers. This concern might be partially triggered by the

realization of the importance of an official corporate governance regime, which provides

a platform for market integrity and efficiency, as well as facilitating economic growth.

Formulating effective corporate governance measures is a complex task for legislators.

The purpose of this paper is to provide an in depth analysis and comparison of the

corporate governance legislative frameworks in three countriesthe UK, US and South

Africa. In 2004, the Organization for Economic Cooperation and Development (OECD),

in conjunction with national and international governmental organizations, finalized auniversal set of corporate governance principles. Although non-binding, the OECD

Principles 2004 are a serious attempt to strengthen every aspect of corporate governance

and, accordingly, have been utilized in this paper as an international benchmark.

Emphasis is placed on South Africa as an emerging economy and because of its

international links with Anglo-American corporate governance and domestic pursuit of

socio-economic development. The ultimate objective of this paper is to formulate a

number of detailed and specific recommendations to the South African Government.

This paper is organized as follows; the first chapter sets out an introductory explanation

of the concept of corporate governance in an attempt to reach a well-tuned concept

comprising the origin, importance and theoretical aspects that influence corporate

governance development. The second Chapter provides a detailed discussion of the

corporate governance principles formulated by the OECD. The process began in 1999

and was completed in 2004 after extensive revision and consultation. The third chapter

examines the background and development of corporate governance practices in the UK,

US and South Africa. Chapter four, the core part of the paper, presents a comparative

analysis of the implementation of the OECD principles in the UK, US and South Africa.

The last chapter provides a summary of analysis and sets out a list of recommendations to

the South African Government.


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TABLE OF CONTENTS

ABSTRACT1

TABLE OF CONTENTS..2

Introduction..5

CHAPTER 1 The Concept of corporate governance.10

1.1 What is Governance.................................................................................................101.2 What is Corporate Governance?..............................................................................10

1.3 Origin of corporate Governance .....12

1.4 Importance of corporate Governance...16

1.5 Theoretical Aspects of corporate Governance ....17

1.5.1 Agency Theory..17

1.5.2 Stakeholder Theory...20

1.5.3 Stewardship Theory...21

CHAPTER 2 The OECD Principles of corporate

Governance..24

2.1. Historical Background..24

2.2 How the principles work26

2.3 Reasoning behind the Principles.28

2.4 OECD Principles (1999)Critical Content....29

2.4.1 Core Standards..29

(a) Fairness.29

(b) Responsibility..30

(c)Transparency30


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(d) Accountability..31

2.5 OECD Principles (2004)..32

I. Ensuring the basis for an effective corporate governance framework...34

II. The Rights of Shareholders...35

III. Equitable Treatment of Shareholders..36

IV. The Role of Stakeholders in Corporate Governance...37

V. Disclosure and Transparency39

VI. Responsibility of the Board.40

CHAPTER 3 An Overview of Corporate Governance in

United Kingdom, United States AND South Africa..433.1 Background and development of corporate Governance in the UK43

3.1.1The Cadbury Report 1992..43

3.1.2 The Greenbury Report 1995.....45

3.1.3 The Hampel Report 1998..46

3.1.4 The Combined Code 1998 and Beyond....47

3.2 Background and development of Corporate Governance in the US.......50

3.2.1Sarbanes Oxley..52

3.2.2 The NYSE and NASDAQ54

3.3 Background and development of Corporate Governance in SA.55

3.3.1The King Report I and II56

CHAPTER 4 Implementation of the OECD Principles

2004 in the United Kingdom, United States AND South

Africa.60


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Comparative Analysis .60

4.1 Framework of Analysis60

4.2Content of Analysis..60

4.2.1 Ensuring the Basis for an effective Corporate Governance Framework..61

4.2.2 The Rights of Shareholders and Key Ownership Functions.65

4.2.3 Equitable Treatment of Shareholders............................75

4.2.4 The Role of Stakeholders in Corporate Governance....79

4.2.5Disclosure and Transparency.82

4.4.6Responsibility of the Board...84

CHAPTER 5 Conclusion and Recommendations87

5.1 Conclusion.87

5.2. Recommendations91

Final Remarks..92


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INTRODUCTION

Governance is a word that barely existed 20 years ago. Now it is in common use not just

in companies but also in charities, universities, local authorities and National Health

Trusts. It has become shorthand for the way an organization is run, with particular

emphasis on its accountability, integrity and risk management. The corporation has a vital

role to play in promoting economic development and social progress. It is the engine of

growth internationally and is increasingly responsible for providing employment, public

and private sector services, goods and infrastructure.1The efficiency and accountability

of the corporation is now a matter of both private and public interest, and corporate

governance has thereby come to the head of the international private enterprise agenda.2

The corporate collapses, which have taken, place in the US, UK and around the world in

the recent years (2001-2004), and their disastrous consequences, have been generating

far-reaching effects at governmental level and at an academic level. On the one hand, the

corporate collapses have brought corporate governance at the top of the reform agenda of

Governments all over the world. Not surprisingly, in the aftermath of these collapses, the

OECD published in 2004 a revised version of its Principles of Corporate Governance,

first published in 1999 and which represent a common basis that OECD member

countries consider essential for the development of good corporate practices.

These Principles evidence the overriding concern that should guide the development of

the corporate governance framework, the impact on overall economic performance,

irrespective of the legal environment in which companies operate (common law or civillaw) and irrespective of the companys ownership structure. They serve as a benchmark

for identification of good elements of corporate governance, though there is no single

1 Mallin C, Corporate Governance: An International Review (2004).2 Center for International Private Enterprise, Strengthening Corporate Governance (2004).


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model of good corporate governance. The OECD principles cover five aspects of

governance: (a) the rights of shareholders; (b) the equitable treatment of shareholders; (c)

the role of stakeholders in corporate governance; (d) disclosure and transparency; and (e)

the responsibilities of the board

It is interesting to note that there are variations in the corporate governance systems in the

US, UK and South Africa. The key distinction between US and UK corporate governance

lies in the regulatory methods and styles adopted by each country. The more prescriptive

regulatory approach of the US that is based on a formal legalism in the context of a

litigation culture3stands in contrast to the principles-based approach of the UK.

The regulation of corporate governance in the UK is provided by a number of differentrules, regulations and recommendations, namely: Common law rules (e.g. directors'

fiduciary duties), Statute (notably the Companies Act 1985)4. A company's constitutional

documents (the memorandum and articles of association), The Listing Rules, which apply

to all companies that are listed on the Official List (or AIM Rules, as appropriate), The

Combined Code on Corporate Governance (the provisions of the Code are not mandatory

but listed companies are required to include a statement in their annual reports as to

whether or not they comply with the Code and give reasons for non-compliance). The

Code is supplemented by: the Turnbull Guidance (relating to the internal control

requirements of the Code), the Smith Guidance (on audit committees and auditors) and

suggestions of good practice from the Higgs Review, Non-legal guidelines issued by

bodies that represent institutional investors (such as the Association of British Insurers

(ABI), the National Association of Pension Funds (NAPF) and the Pensions &

Investment Research Consultants (PIRC). These guidelines apply to listed companies and

although they are informal, some institutional investors may oppose any corporate actions

that contravene them. In the context of takeovers of public companies, the City Code on

Takeovers and Mergers and the rules of the Takeover Panel apply. The Financial

3 Kagan, R. A. (2001). Adversarial Legalism: The American Way of Law. Cambridge, MA: HarvardUniversity Press.4 The Companies Act 2006 has now effectively replaced existing company legislation by re-writing,updating and modernising company law. The 2006 Act received Royal Assent on 8th November 2006. Allreferences will be to the 2006 Act unless expressly stated


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Services Authority's Code of Market Conduct (relating to the disclosure and use of

confidential and price sensitive information and the creation of a false market).

In the U.S., corporate governance is determined predominantly by legislation in the form

of the Sarbanes-Oxley Act of 2002 ("SOX") and detailed regulations which SOX

required the Securities and Exchange Commission ("SEC"), New York Stock Exchange

("NYSE") and NASDAQ to draw up.

The UK "comply or explain" approach to corporate governance varies significantly from

the general approach taken by SOX. Although SOX-related regulations use the "comply

or explain" method in some instances5, in most other instances, U.S. regulation tends to

rely on the legislation and fines and imprisonment penalties for violating the

requirements of SOX.

Kelemen and Sibbitt6argue that the adversarial style of the US regulatory approach

undermines insider networks, which might in turn make this approach incompatible with

informal co-operative processes that facilitate and support social partnerships. This

difference between the US and UK approaches is not new, but it has been made more

pronounced with the enactment of new legislation in the wake of recent US corporate

scandals.

On the other hand, South Africas colonial legacy and resultant ties with the UK and US

has shaped the countries approach to corporate governance to lean towards the traditional

Anglo-America model.7 Corporate governance has been a reasonably well-developed

concept in South Africa since the establishment of the King Committee on Corporate

Governance in 1992, at the instigation of the Institute of Directors of Southern Africa

(IoD) and the release of the first King Report in November 1994. It was not stimulated by

any significant crisis in the corporate sector at that time; rather it concerned the

5For example, in relation to whether a company has a "code of ethics" or its audit committee has a"financial expert"),6 Kelemen, R. D., & Sibbitt, E. C. (2004). The Globalization of American Law. International Organization,58(1), 103-136.7 Reed, D. (2002). Corporate governance reforms in developing countries. Journal of Business Ethics, 37,223-247.


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competitiveness of the South African private sector following the re-admission of the

country to the global economy following its transition to a fully-fledged democracy after

the collapse of apartheid.

The first Kind Report on corporate Governance (King I) was released on the 29 thof

November 1994. The purpose of King I was to promote the highest Standards of

corporate governance in SA. The King Committee issued a detailed report on corporate

governance, a series of recommendations and a code of Good Corporate Practices and

Conduct. A number of the recommendations in King I were superseded by legislation in

the social and political transformation in SA. Further, a dominant feature of business

since 1994 was the emergence of information technology. In light of these factors, as well

as many others, the king committee reviewed corporate governance standards and

practices for SA against developments that took place after publication of King I. The

code of corporate Practices and Conduct in King II replaced the code of Good Corporate

Practice and Conduct in Kind I, with effect from 1 march 2002. In January 2009, King

Report III will appear in South Africa, having been written by a committee of 90

members.

This paper serves to provide an analysis and comparison of the systems of corporategovernance in the UK, US and South Africa measured against the principles of corporate

governance recently formulated by the OECD as an international benchmark. The

ultimate objective of this paper is to formulate a number of detailed and specific

recommendations to the South African Government

This paper is organized as follows; the first chapter sets out an introductory explanation

of the concept of corporate governance in an attempt to reach a well-tuned concept

comprising the origin, importance and theoretical aspects that influence corporate

governance development. The second Chapter provides a detailed discussion of the

corporate governance principles formulated by the OECD. The process began in 1999

and was completed in 2004 after extensive revision and consultation. The third chapter

examines the background and development of corporate governance practices in the UK,


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US and South Africa. Chapter four, the core part of the paper, presents a comparative

analysis of the implementation of the OECD principles in the UK, US and South Africa.

The last chapter provides a summary of analysis and sets out a list of recommendations to

the South African Government


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CHAPTER 1

The Concept of corporate governance

1.1 What Is Governance

The concept of "governance" is not new. It is as old as human civilization. The term

governance in itself derives from the Latingubernare,meaning to steer, usually

applying to the steering of a ship.8A dictionary definition of the word governance yields

the following: The act, manner, function, or power of government.

9

Governance in itswidest sense refers to how any organization, including a nation, is run. It includes all the

processes, systems, and controls that are used to safeguard and grow assets.10Governance

can be used in several contexts such as corporate governance, international governance,

national governance and local governance. When applied to organizations that operate

commercially, it is often termed "corporate governance

1.2

What Is Corporate Governance

Corporate governance has succeeded in attracting a good deal of public interest because

of its apparent importance for the economic health of corporations and society in general.

However, the concept of corporate governance is poorly defined because it potentially

covers a large number of distinct economic phenomenon11

. As a result different people

have come up with different definitions depending on the viewpoint of the policy maker,

8 Jill Solomon & Aris Solomon (2004): Corporate Governance and Accountability John Wiley & Sons,Ltd9 Websters New World Dictionary, Simon and Schuster.10 Te Puni Kkiri (Wed, 25 Oct 2006) Effective Governance [online]http://governance.tpk.govt.nz/why/index.aspx[accessed 13/08/2008]11 Encycogov.com, The Encyclopedia about corporate Governance,http://www.encycogov.com/WhatIsGorpGov.asp[accessed 14/08/08]
http://governance.tpk.govt.nz/why/index.aspxhttp://www.encycogov.com/WhatIsGorpGov.asphttp://www.encycogov.com/WhatIsGorpGov.asphttp://governance.tpk.govt.nz/why/index.aspx


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practitioner, researcher or theorist.12There is therefore no single accepted definition of

the concept. Some take a narrow view, seeing governance as a fancy term for the way

in which directors and auditors handle their responsibilities towards shareholders. Others

expand the concept to explain a firms relationship to society, often blurring the

distinction between corporate governance and corporate social responsibility. Be that as it

may, it seems that existing definitions of corporate governance either adopt a narrow

view where corporate governance is restricted to the relationship between a company and

its shareholders (agency theory), or a broader view where corporate governance maybe

seen as a web of relationships, not only between a company and its owners (shareholders)

but also between a company and a broad range of other stakeholders: employees,

customers, suppliers, bondholders (stakeholder theory)13Cadburys definition is

illustrative of the former view

Corporate governance is the system by which companies are directed and controlled.

Boards of directors are responsible for the governance of their companies. The

shareholders role in governance is to appoint the directors and the auditors and to

satisfy themselves that an appropriate governance structure is in place. The

responsibilities of the board include setting the companys strategic aims, providing the

leadership to put them into effect, supervising the management of the business and

reporting to shareholders on their stewardship. The boards actions are subject to laws,

regulations and the shareholders in general meetings14

The OECD provides the most authoritative functional definition of corporate governance

that tally with the latter view.

"Corporate governance is the system by which business corporations are directed and

controlled. The corporate governance structure specifies the distribution of rights and

responsibilities among different participants in the corporation, such as, the board,

12 Lannoo (1995) states in this context: the notion of Corporate Governance is perceived differentlyfrom one country to anotheritsometimes refers to distinctly different matters for different persons andinstitutions, depending on the circumstances.

13 See generally Jill Solomon & Aris Solomon (2004): Corporate Governance and Accountability JohnWiley & Sons, Ltd pg 1214 Cadbury Report 1992 (The Financial Aspects of Corporate Governance) pg 14, 2.5


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managers, shareholders and other stakeholders, and spells out the rules and procedures

for making decisions on corporate affairs. By doing this, it also provides the structure

through which the company objectives are set and the means of attaining those objectives

and monitoring performance"15

Some writers16in defining corporate governance go as far as establishing a fiduciary

relationship between directors and shareholders:

Corporate Governance could be thoughtof as the combined statutory and non-

statutory framework within which boards of directors exercise their fiduciary

duties to the organizations that appoint them.

The key issue is that directors owe to shareholders, or perhaps to the corporation, two

basic fiduciary duties: the duty of loyalty and the duty of care17

One thing is clear from both definitions however, they tend to share certain

characteristics, paramount of which is the notion of accountability: either to shareholders

specifically or to shareholders and other stakeholders.

1.3 Origin of Corporate Governance

The etymology of the words corporate governance is derived from the ancient Greek and

Latin (though there are similar words in most languages). The word corporate derives

from the Latin word corpusmeaning body, and comes from the Latin verb corporareto

form into one body, hence a corporation represents a body of people that is a group of

people authorized to act as an individual.18The word governance is from the Latinized

Greekgubernatiomeaning management or government, and comes from the ancient

15 OECD April 1999.16 Alan Calder, Corporate Governance (2008), A Practical Guide to the Legal Frameworks andInternational Codes of Practice Kogan Page Limited, pg 317 Professor Bernard S Black, Stanford Law School, Presentation at Third Asian Roundtable on CorporateGovernance, April 2001.18 Clarke, T. 2007, International Corporate Governance: A Comparative Approach, Routledge, London pg1


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Greek,kybernaoto steer, to drive, to guide, to act as a pilot.19This etymological origin of

the concept of corporate governance captures a creative meaning of collective endeavor

that defies the contemporary inclination to place a passive and regulatory emphasis on the

phrase. Adrian Cadbury cites Cicero in conveying the original meaning of this contested

concept

Governance is a word with a pedigree that dates back to Chaucer and in his day

the word carried with it the connotation wise and responsible, which is

appropriate. It means either the action of governing or the method of governing

and it is in the latter sense it is used with reference to companiesA quotation

which is worth keeping in mind in this context is He that governs sits quietly at

the stern and scarce is seen to stir.20

Corporate governance has been practised for as long as there have been corporate entities

developed to resolve group relations in religious and social communities. These medieval

elements were transformed by the application of corporate ideas and practices of the

business enterprises that came later21Among these devices was the idea of incorporate

person-the interpretation of companies as legal persons with rights and duties.

In many ancient and modern organisations legal transactions had to be carried out and

duties incurred by the succession of joint holders of an office on behalf of a number of

people who were interested in carrying out a common purpose or object. There therefore

arose the need from the point of view of both private and public law to replace the vague

group by something more definite- an artificial person. Such corporate bodies recognised

by common law were applied to business organisations in England and Holland when

charters were granted to incorporate trading companies.

The problem of corporate governance actually arose with the formation of the first

trading company, where the distinction between ownership and leadership gave rise to

19 Id.20 Cadbury 2002: 121 Clarke, T. 2007, International Corporate Governance: A Comparative Approach, Routledge, London pg3,citing Redmond 2005:28


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the so-called agency problems between the ownership/shareholder on the one hand and

the manager/business manager on the other hand. It is believed that this occurrence took

place around 1602, with the formation in the United East India Company.22Investors

were disillusioned as they found their capital locked into a company only publishing its

accounts every ten years, and which insisted on paying dividends in spices (pepper, mace

and nutmeg)23LHeliasalso sees the origin of corporate governance in the distinction

between ownership and leadership24which she refers to as a societal schism.

However the study of the subject corporate governance is less than half a century old.

Indeed, the phrase 'corporate governance' was scarcely used until the 1980s. According to

Monks & Minow25the concept is one, which has only emerged in the last 10 years:

Whereas the systematic development and application of improved management

practices has been going on now for 100 years, the term Corporate Governance

has been in use for not much more than 10.26

Adam Smithin 1776 in The Wealth of Nations27made a comment on company

management that would echo through the ages: Being managers of other peoples money

than their own, it cannot well be expected that should watch over it with the same

anxious vigilance with which the partners in a private co-partnership frequently watch

over their ownNegligence and profusion, therefore, must always prevail more of less in

the management of the affairs of a joint stock company.

With the industrial revolution, there was advancement in technology and hence a wider

diffusion of ownership of many large companies owing to the fact that no individual,

22 Weimer, J., Pape, J.C. (1999), "A taxonomy of systems of corporate governance", Corporate

Governance: An International Review, Vol. 723 Clarke, T. 2007, International Corporate Governance: A Comparative Approach, Routledge, London pg3,citing Frentrop 2003: 75-7624 The pioneering work of Berle & Means (1932) looks closely at the consequences of this division for thegovernance and management of the enterprise.25 Robert A.G Monks and Nell Minow, Corporate Governance 1996, Blackwell Publishing26 For a general discussion on this, See Prof. dr. Lutgart Van Den Berghe & Liesbeth De Ridder:International Standardisation of Good Corporate Governance; BestPractice for the Board of Diractors,Kluwer Academic Publishers 199927 Smith 1976: 264-265


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family or group of managers could provide sufficient capital to sustain growth.

Columbian University professorsAdolf Berleand Gardiner Means coined the phrase the

separation of ownership and control in their landmark 1932 book The Modern

Corporation and Private Property, and it remains the most widely used expression in the

voluminous literature on corporate governance. It refers to their observation that during

the 1920s the structure of ownership in large corporations changed from the traditional

arrangements of owners managing their own companies to one in which shareholders had

become so numerous and dispersed that they were no longer willing or able to manage

the corporations they owned. They therefore basically made management decisions of the

corporation and claimed profits thereof. (These claims are sometimes called residual

claims to reflect that they accrue after all costs and fixed claims have been satisfied). In a

large publicly held corporation, the shareholders own residual claims but lack direct

control over management decision-making. Correspondingly, managers have control but

possess relatively small (if any) residual claims.

The influence ofBerle and Meanswork cannot be underestimated: it has coloured

thinking about the way companies are owned, managed, and controlled for over seventy

years, and represents the reality in many US and UK companies. Monks (2001)28states

The tendency during this period [the twentieth century] has been the dilution of the

controlling blocks of shares to the present situation of institutional and widely dispersed

ownershipownership without power.

The call ofBerle and Meansfor an increase in the recognition and scope of fiduciary

duties of those who controlled corporations influenced legal thinking for much of the

century. If this view fell from favour in the rampant opportunism of the 1980s and 1990s,

the importance of the principle of fiduciary duty has re-emerged with a vengeance in the

reaction to the revelations of managerial irresponsibility that were exposed in the US and

UK after the major corporate bankruptcies.Berle and Meansleft an enduring legacy in

their work written during the depths of the 1930s Great Depression, concerning the need

to enforce accountability and the responsible management of corporations, arguments

28 Robert A.G Monks and Nell Minow, Corporate Governance 1996, Blackwell Publishing


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that shaped the US Securities Acts of the 1930s that remain the basis for federal securities

law today29

1.4 Importance of Corporate Governance

We have come across companies which apparently were very efficiently managed but

which came to grief because the governance was not all right. Corporate governance is a

matter of high importance in the Company and is undertaken with due regard to all of the

Company's stakeholders and its role in the community. Good corporate governance is a

fundamental part of the culture and the business practices of any nation and its controlled

entities.Monks & Minow (1996)30affirms the fact that good governance is of national

importance by stating The government must explicitly adopt the policy that commercial

competiveness is a national priority and that an effective governance system is a

necessary precondition.Bain and Band (1996)31are of the same opinion and point out

that directors are thinking along the same lines: Companies and other enterprises with a

professional and positive attitude to governance are stronger and have a greater record of

achievement.

During the last decade, policy makers, regulators, and market participants around the

world have increasingly come to emphasize the need to develop good corporate

governance policies and practices. An increasing amount of empirical evidence shows

that good corporate governance contributes to competitiveness facilitates corporate

access to capital markets, and thus helps develop financial markets and spur economic

growth.

Today, both domestic and foreign investors place an ever-greater emphasis on the way

that corporations are operated and how they respond to their needs and demands.

29 Clarke, T. 2007, International Corporate Governance: A Comparative Approach, Routledge, London pg3,citing Holderness 200330 Robert A.G Monks and Nell Minow, Corporate Governance 1996, Blackwell Publishing31 Corporate Governance, Class materials in Corporate Governance and Shareholder Remedies,CGSR.4/900(SG), Faculty of Law, University of Hong Kong, 26 December 2000


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Investors are increasingly willing to pay a premium for well-governed companies that

adhere to good board practices, provide for information disclosure and financial

transparency, and respect shareholder rights. Well-governed companies are also better

positioned to fulfil their economic, environmental, and social responsibilities, and

contribute to sustainable growth.

Corporate governance is a key element in enhancing investor confidence, promoting

competitiveness, and ultimately improving economic growth. It is at the top of the

international development agenda as emphasized by James Wolfensohn, President of the

World Bank:

The governance of companies is more important for world economic growth than the

government of countries.

Improvement in corporate governance practices can improve the decision-making process

within and between a companys governing bodies, and should thus enhance the

efficiency of the financial and business operations. Better corporate governance also

leads to an improvement in the accountability system, minimizing the risk of fraud or

self-dealing by company officers. An effective system of governance should help ensure

compliance with applicable laws and regulations, and further, allow companies to avoidcostly litigation. Also, Russian companies should stand to benefit from a better reputation

and standing, both at home and in the international community.

Sound corporate governance is therefore very essential to the wellbeing of an individual

company and its stakeholders, particularly its shareholders and creditors. It ensures that

constituencies (stakeholders) with a relevant interest in the companys business are fully

taken into account. In addition, good governance can make a significant contribution to

the prevention of malpractice and fraud, although it cannot prevent them absolutely.

1.5 Theoretical Aspects of corporate governance


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There are several diverse and well-established theories associated with corporate

governance. They approach corporate governance in different ways using different

terminology. They each attempt to analyse the same problems but from different

perspectives. Tricker (1996:31) states:

Stewardship theory, stakeholder theory and agency theory are all essentially

ethnocentric. Although the underlying ideological paradigms are seldom

articulated, the essential ideas are derived from Western thought, with its

perceptions and expectations of the respective roles of individual, enterprise and

the state and of the relationships between them.

1.5.1 Agency Theory

Agency theory argues that in the modern corporation, in which share ownership is widely

held, managerial actions depart from those required to maximise shareholder returns.32

The agency relationship is a contract under which one party (the principal) engages

another party (the agent) to perform some services on their behalf. As part of this, the

principal will delegate some decision-making authority to the agent. Jensen and Meckling

argue that, the agency theory rests upon this contractual view of the firm.

The agency problems basically arise because of the impossibility of perfectly contracting

for every possible action of an agent whose decisions affect both his own welfare and the

welfare of the principal. Arising from this problem is how to induce the agent to act in the

best interests of the principal.

The essence of the agency problem is the separation of management and finance.

Managers raise funds from investors to put them to productive use or to cash out their

holdings in the firm. Financiers need the managers specialised human capital to generatereturns on their funds.33A contract is signed in principle wherein both parties specify

32 Berle, A. and Means, G (1932) The Modern Corporation and Private Property, New York. AND Jensen,M. C. and Meckling, W. H. (1976) Theory of the Firm: Managerial behaviour, agency, costs and

ownership structure, Journal of Financial Economics, 3, October 305-360.33 Thomas Clarke: Theories of Corporate Governance The Philosophical Foundations of corporateGovernance, Taylor & Francis ltd, pg 5


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what the mangers do with the funds, and how the returns are divided between them and

the financiers. The problem that arises as a result of this system of corporate ownership is

that the agents do not necessarily make decisions in the interests of the principal.34

Agency theory offers shareholders a pre-eminent position in the firm legitimized not by

the idea that they are the firms owners, but instead its residual risk takers. Fama35

emphasises the irrelevance of ownership:

Ownership of capital should not be confused with ownership of the firm. Each

factor in a firm is owned by somebody. The firm is just the set of contracts

covering the way inputs are joined to create outputs and the way receipts from

outputs are shared among inputs. In this nexus of contracts perspective,

ownership of the firm is an irrelevant concept.

In the context of corporations and issues of corporate control, agency theory views

corporate governance mechanisms, especially the board of directors, as being an essential

monitoring device to try to ensure that any problems that may be brought about by the

principal-agent relationship are maximized. Blair (1996) states:

Managers are supposed to be the agent of a corporations owners, but

managers must be monitored and institutional arrangements must provide some

checks and balances to make sure they do not abuse their power. The costs

resulting from managers misusing their position, as well as the costs of

monitoring and disciplining them to try to prevent abuse, have been called

agency cost

The total agency cost arising from the agency problem has been summarised as

comprising of: the sum of the principals monitoring expenditures; the agents bonding

34 See generally Jill Solomon & Aris Solomon (2004): Corporate Governance and Accountability JohnWiley & Sons, Ltd pg 1735 Fama, E. F. (1980) Agency problems and the theory of the firm, Journal of Political Economy, 88,288-307


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expenditures; and any remaining residual loss36. It is contended that risk sharing is one

of the main reasons that the desired actions of principal and agent diverge.37This is

because of their different attitudes toward risk38

A basic conclusion of agency theory is that the value of a firm cannot be maximised

because managers possess discretions, which allow them to expropriate value to

themselves. In an ideal world, managers would sign a complete contract that specifies

exactly what they could do under all states of the world and how profits would be

allocated. The problem is that most future contingencies are too hard to describe and

foresee, and as a result, complete contracts are technologically unfeasible.

1.5.2 Stakeholder Theory

The definition of stakeholderis not set in stone. Indeed, there are almost as many

varying definitions of what a stakeholder is and who can be characterised as a

stakeholder as there are individuals who have written about stakeholders in corporate

governance.

One very broad definition of a stakeholder is any group or individual which can affect or

is affected by an organization." Such a broad conception would include suppliers,

customers, stockholders, employees, the media, political action groups, communities, and

governments. A more narrow view of stakeholder would include employees, suppliers,

customers, financial institutions, and local communities where the corporation does its

business. But in either case, the claims on corporate conscience are considerably greater

than the imperatives of maximizing financial return to stockholders.

The stakeholder theory was first presented by Freeman39, who proposed a general theory

of the firm, incorporating corporate accountability to a broad range of stakeholders. It is

a theory of organisational management and business ethics that addresses morals and

36 Hill, C. W. and Jones , T. M. (1992) Stakeholder-agency theory, Journal of Management Studies,29,134-13537 ibid 5 at pg 1738 Shankman, N. A.(1999) Reframing the debate between agency and stakeholder theories of the firm,Journal of Business Ethics, 19, 319-33439 Freeman, E. (1984) Strategic Management: A stakeholder Approach, Pitman Press, Boston


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values in managing an organisation.40The stakeholder theory takes account of a wider

group of constituents rather than focusing on shareholders. .

In the UK the Corporate Report (ASSC, 1975) was a radical proposal for its time, which

suggested that companies should be made accountable for their impact on a wide group

of stakeholders. The way that the Corporate Report hoped to achieve this was by

encouraging companies to disclose voluntarily a range of statements aimed for

stakeholder use, in addition to the traditional profit and loss account and balance sheet.

This was the first time that such an all encompassing approach to financial reporting was

considered seriously by a professional UK accounting body.41

An interesting development in relation to the stakeholder theory is that put forward by

Jensen, who state s that traditional stakeholder theory argues that the managers of a firm

should take account of the interests of all stakeholders in affirm but, because the theorists

refuse to say how the trade-offs against the interests of each of these stakeholder groups

might be made, there are no defined measurable objectives and this leaves managers

unaccountable for their actions. Jensen therefore advocates enlightened value

maximisation, which he says is identical to enlightened stakeholder theory: Enlightened

value maximisation utilises much of the structure of stakeholder theory but accepts

maximisation of the long-run value of the firm as the criterion for making the requisite

trade-offs among its stakeholdersand therefore solves the problems that arise from

multiple objectives that accompany traditional stakeholder theory.

1.5.3 Stewardship Theory

The stewardship theory was propounded by Donaldson and Davis42who cautioned

against accepting agency theory and argued a view of managerial motivation alternative

to the agency theory and which was termed stewardship theory. In the stewardship

40 Phillips, R. Robert Edward Freeman (2003). Stakeholder Theory and Organisational Ethics. Berrett-Koehler Publisher41 ibid 5 at pg 2442 DONALDSON, L.; DAVIS, J.H. (1991). Stewardship Theory or Agency Theory: CEO governance andshareholder returns. Australian Journal of Management. Vol.16, 1, pp.49-64.


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model, 'managers are good stewards of the corporations and diligently work to attain high

levels of corporate profit and shareholders returns'.43

They state that the owners-managers relationship depends on the behaviour adopted

respectively by them. Managers choose to act as agent or as steward according to certain

personal characteristics and their own perceptions of particular situational factors.

Principals choose to create a relationship of one type or the other depending on their

perceptions of the same situational factors and of their managers psychological

mechanisms.

The executive manager, under this theory, far from being an opportunistic shirker,

essentially wants to do a good job, to be a good steward of the corporate assets. The

executive managers pro-organisational actions are best facilitated when the corporate

governance structures give them high authority and discretion.

Thus, stewardship theory holds that there is no inherent, general problem of executive

motivation. Given the absence of an inner motivational problem among executives, there

is the question of how far executives can achieve the good corporate performance to

which they aspire. Thus, stewardship theory holds that performance variations arise from

whether the structural situation in which the executive is located facilitates effective

action by the executive. The issue becomes whether or not the organisation structure

helps the executive to formulate and implement plans for high corporate performance.

Structures will be facilitative of this goal to the extent that they provide clear, consistent

role expectations and authorise and empower senior management.

Stewardship theory stresses the beneficial consequences on shareholder returns of

facilitative authority structures which unify command by having roles of executive

director and chair held by the same person. The safeguarding of returns to shareholders

may be along the track, not placing management under greater control by owners, but by

empowering managers to take autonomous executive action.

43 Id


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It is therefore been seen that the above theories have influenced the development of

corporate governance The preceding chapters will cover the OECD principles of

corporate governance which will in tend be used as a benchmark to see how they are

being used and complied with in the UK, US and South


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CHAPTER 2

The OECD Principles of corporate Governance

2.1 Historical Background

The OECD grew out of the Organisation for European Economic Co-operation (OEEC),

which was set up in 1948 with support from the United States and Canada to co-ordinate

the Marshall Plan for the reconstruction of Europe after World War II

The OECD is a unique forum where the governments of 30 market democracies work

together to address the economic, social and governance challenges of globalisation as

well as to exploit its opportunities.

The Organisation provides a setting where governments can compare policy experiences,

seek answers to common problems, identify good practice and co-ordinate domestic and

international policies. It is a forum where peer pressure can act as a powerful incentive to

improve policy and which produces internationally-agreed instruments, decisions and

recommendations in areas where multilateral agreement is necessary for individual

countries to make progress in a globalised economy.

The OECD principles of corporate governance were developed as a result of f inancial

crises and a series of corporate scandals and failures that began in East Asia and rapidly

spread to Russia44Investors in the affected countries watched helplessly as their

investments crashed due to systematic failures of investor protection mechanisms,

combined with weak capital market regulation.45These financial crisis and the corporate

scandals raised serious concerns about the stability of the international financial market

and further focused the minds of governments, regulators, companies, investors and the

44 Gregary H, The Globalisation of Corporate Governance (2002), 245 Jesover F and Kirkpatrick G, The revised OECD Principles of Corporate Governance and theirrelevance to Non-OECD Countries (2004), 2


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public on weaknesses in corporate governance systems.46This situation created some

awareness on the need for good corporate governance and the importance of an official

corporate governance regime, which could underpin market confidence, integrity and

efficiency as well as assist in the strengthening of economic growth47.

In response to the growing awareness of the importance of good corporate governance

and a model of corporate governance applicable to all countries, the OECD was asked by

Ministers in 1998 to develop a set of standards and guidelines for presentation to

Ministers by May 199948, which became known as the OECD principles of corporate

governance

At a council meeting in May 1999 the Ministers agreed and adopted principles, which

have been referred to as the first initiative by an inter-governmental organisation to

develop the core elements of a good corporate governance regime.

Since the principles were agreed in 1999, they have formed the basis for corporate

governance initiatives in both OECD and non-OECD countries alike. The OECD

Principles 1999 provided the landscape for the establishment of regional corporategovernance roundtables in cooperation with the World Bank and the International

Monetary Fund.49In fact the international monetary fund adopted the OECD Principles

as a benchmark instrument for their member countries and surveillance procedures.50

Moreover, they have been adopted as one of the Twelve Key Standards for Sound

46 Ibid47 Chee L, Corporate Governance: An Asia-Pacific Critique (2002), 55. See also Kirkpatrick G, ImprovingCorporate Governance Standards: The Work of the OECD and the Principles (2005).48 To fulfil the Ministerial mandate, the OECD established an AD-Hoc Task Force, comprised of allMember governments: the European Commission; four international organisations (the World Bank,International Monetary Fund, Basle Committee on Banking Supervision, and the international Organisationof Securities Commission); the OECDs Business and Industry Advisory Committee (BIAC) and TradeUnion Advisory Committee (TUAC); and representatives from selected other private sector organisations.49 Ibid 42 at 1850 Ibid


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Financial Systems by the Financial Stability Forum. Accordingly, they form the basis of

the World Bank/IMF Reports on the Observance of Standards and Codes (ROSC).51

The principles were however revised in 2004 following high-profile cases of Corporate

Governance failure. There was therefore the need to take into account new developments

and concerns

2.2 How the Principles Work

Generally, the OECDs way of working consists of a highly effective process that begins

with data collection and analysis and moves on to collective discussion of policy, then

decision-making and implementation. Mutual examination by governments, multilateral

surveillance and peer pressure to conform or reform are at the heart of OECD

effectiveness in areas such as corporate governance.

The principles offer broad guidance for governments to follow when reviewing whether

their corporate governance framework is compatible with establishing the corporate

governance they want. Policy makers are encouraged to develop the governance

framework with a view to its impact on overall economic performance, market integrity

and incentives it creates for market participants and the promotion of transparent and

efficient markets. This should help reduce the risk of costly over-regulation and minimise

the unintended consequences of policy measures. To underpin market integrity, the legal

and regulatory requirements that affect corporate governance practices should be

consistent with the rule of law, transparent and enforceable

The OECD principles of corporate governance are Non-binding. They are principle-based

and non prescriptive and are intended to assist OECD and non-OECD governments, and

to provide guidance for stock exchanges, investors, corporations and others related to

Corporate Governance. It is up to governments and market participants to decide how to

apply these Principles in developing their own frameworks for corporate governance,

taking into account the costs and benefits of regulation.The non prescriptive nature of the

51 Using the OECD Principles Of Corporate Governance: A Boardroom Guide. OECD 2008


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principles is its principle success as the principles retain their relevance in varying legal,

economic and its social contexts

The Principles focus on publicly traded companies, both financial and non-financial.

However, to the extent they are deemed applicable, they might also be a useful tool to

improve corporate governance in non-traded companies, for example, privately held and

state owned enterprises. The Principles represent a common basis that OECD member

countries consider essential for the development of good governance practices.

Since 1999, the OECD Corporate Governance Principles have become the globally

recognised benchmark in the area of corporate governance. They have been used as a

basis for development of regulatory frameworks in many countries. They have also been

endorsed by the Financial Stability Forum as one of twelve key standards considered

essential for financial stability. In addition, the IMF and World Bank have been using the

Principles as a benchmark in their country Reports on the Observance of Standards and

Codes.

Equally very importantly is the fact that the principles are used as the reference point by

the private sector. It is believed that today there is hardly any initiatives that do not use

the OECD Principles as the reference point or benchmark. This is the attraction of the

Principles. They provide a common language and a shared aspiration that everyone can

understand and relate to.52

52 Veronique Ingram, Speech to ICGN Annual Conference. Rio De Janiero8 JULY 2004. Online athttp://www.midcgroup.com/j_libry/2_ICGN%E5%B9%B4%E6%AC%A1%E5%A4%A7%E4%BC%9A%E3%82%B9%E3%83%94%E3%83%BC%E3%83%81%EF%BC%88%E5%8E%9F%E6%96%87OECD%20VI%20jun04%EF%BC%89.pdf accessed 09/09/2008


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2.3 Reasoning behind the Principles

As has been seen earlier, as a consequence of corporate scandals53, the minds of

governments, regulators, companies, investors and the general public were focused on

weaknesses in corporate governance systems and the need to address this issue.

The OECD principles of corporate governance were therefore developed not as a panacea

to this but as guidance to policymakers, regulators and the market participants in

improving the legal, institutional and regulatory framework that underpins corporate

governance, with a focus on publicly traded companies. The principles are meant to

provide practical suggestions for stock exchanges, investors, corporations and other

parties that have a role in the process of developing good corporate governance.

The Principles are intended to assist OECD and non-OECD governments in their efforts

to evaluate and improve the legal, institutional and regulatory framework for corporate

governance in their countries and to provide guidance and suggestions for stock

exchanges, investors, corporations, and other parties that have a role in the process of

developing good corporate governance. They are intended to be concise, understandable

and accessible to the international community. They are not intended to substitute for

government, semi-government or private sector initiatives to develop more detailed bestpractice in corporate governance.

54

The original text of the OECD Principles basically evolved to be a statement of existing

good corporate governance practices in OECD countries. It served to provide a non-

binding statement of the key elements essential for good corporate governance just the

basic necessities. The Principles were designed to assist policy advisers in evaluating and

improving the legal, regulatory and institutional framework underpinning corporate

governance. As such, the Principles have served as a guide to governments, regulators,

stock exchanges, directors, investors and other market participants regarding good

practice.

53 For example, the collapse of Enron, Tyco and WorldCom in the United Sates, Maxwell and BCCI in theUnited Kingdom;54 Preamble OECD principles of Corporate Governance 2004


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2.4 OECD Principles (1999) Critical Content

The Principles address governance problems that result from the separation of ownership

and control in the modern corporation. They identify the critical elements required for

good governance. They describe the basic elements of an effective corporate governance

framework for corporations that seek to attract capital from equity investors.

Specifically, they focus upon:

Rights of Shareholders

Equitable Treatment of Shareholders

Role of Stakeholders in Corporate Governance

Disclosure and Transparency

The Responsibilities of the Board

2.4.1 Core Standards

According to the Millstein Report (1998)55, corporate governance takes place within the

corporation and as such it depends very much on investors, boards and managements for

its successful implementation. The report noted that for corporate governance to be

effective in attracting capital, it must focus on four important areas. The OECD

Principles 1999 were built on these core standards: fairness, transparency, accountability,

and responsibility.

(a) Fairness

In relation to this core concept, two separate principles were developed. The first

principle states that the corporate governance framework should protect the rights of

shareholders. This includes both their proprietary as well as their participatory rights.

Effective corporate governance depends on laws, procedures and practices that protect

their property right and ensure the security of ownership as well as the unfettered

55 Millstein, I.M. (1998). The Evolution of Corporate Governance in the United States, Remarks to theWorld Economic Forum, Davos, Switzerland (February 2, 1998).


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transferability of shares. This principle also recognizes their participatory rights on key

corporate decisions such as the election of directors and the approval of major mergers or

acquisitions.

The second principle states that the corporate governance framework should ensure the

equitable treatment of all shareholders including the minority and foreign shareholders

and that all shareholders should have the opportunity to obtain effective redress for

violation of their rights. This means that the legal framework should include laws that

protect the rights of the minority shareholders against misappropriation of assets or self-

dealing by the controlling shareholders, managers or directors.

(b) Responsibility

The third principle states that the corporate governance framework should recognize the

rights of stakeholders as established by law and encourage active cooperation between

corporations and stakeholders in creating wealth, jobs and the sustainability of financially

sound enterprises. This means that corporations must abide by the laws and regulations

of the countries in which they operate. However, laws and regulations impose only

minimal expectations as to conduct and corporations should be encouraged to act

responsibly and ethically with special consideration for the interests of stakeholders

particularly the employees. It is now acknowledged that socially responsible corporate

conduct is consistent with the principle of shareholder wealth maximization. In numerous

countries around the globe, the practice of corporate social responsibility accounting is

now well established with corporations going beyond the legal requirements to provide

health care and retirement benefits, financially supporting education and formulating and

adopting environmentally friendly technologies. Similarly other companies strive to

avoid practices, which are socially undesirable even if not prohibited under the law.

(c) Transparency

The fourth principle states that the corporate governance framework should ensure that

timely and accurate disclosure is made on all material matters regarding the corporation

including the financial situation, performance, ownership and governance of the

company. This is in recognition of the fact that both investors and shareholders need


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information regarding the financial and operating performance of the company as well as

information about their corporate objectives and material risk exposures. This

information should be prepared in accordance with internationally acceptable accounting

and auditing standards and should be subject to an independent audit, which is conducted

annually. The use of internationally accepted accounting standards would enhance

comparability and assist both investors and analysts in comparing corporate performance

and decision-making based on their relative merits. Likewise information about the

companys governance such as share ownership, voting rights, identity of board

members, key executives and executive compensation is also a critical component of

transparency.

(d) Accountability

The fifth principle states that the corporate governance framework should ensure the

strategic guidance of the company, the effective monitoring of management by the board

as well as the boards accountability to the company and the shareholders. This principle

implies a legal duty on the part of the directors to the company and its shareholders. The

directors are said to have a fiduciary relationship to both the shareholders and the

company, which requires that they avoid self-interest in their decision-making and act

diligently and on a fully informed basis. This principle also recognizes the duty of the

board to oversee the professional managers who have been entrusted to run the company

and who are accountable to the board for the use of firm assets. Thus the board acts as a

mechanism for minimizing the agency problem inherent in the separation of ownership

and control. If the board is to be an effective monitor of managerial conduct it must be

suitably distinct from the management in order to be objective in its assessment of

management. This requires that some of the directors are neither members of the

management team nor closely related to them through family or business ties. A critical

aspect of effective corporate governance is the quality of the directors. Objective

oversight therefore necessitates the participation of professionally competent non-

executive and independent directors on the board. The latter must have the capability,

fiduciary commitment and objectivity to provide strategic guidance and monitor

performance on behalf of the shareholders. In order for the board to be able to play their


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roles effectively, they should meet often, at least once every three months and if possible

more often. Additionally, for the non-executive directors to be effective and to ensure

that independent oversight has meaning, they must have access to important information

in advance of board meetings. In the developed countries, board committees have played

an important role in performing detailed board work. In these countries, it is common to

rely on an audit committee, remuneration committee and a nomination committee staffed

either wholly or primarily with non-executive or independent directors.

2.5 OECD Principles (2004)

In 2004, at a Council Meeting at Ministerial Level, the OECD agreed to survey

developments in OECD countries and to assess the Principles in light of developments in

corporate governance. This task was entrusted to the OECD Steering Group on Corporate

Governance, which comprises representatives from OECD countries.56Review

committees were established and, in some countries, significant policy initiatives were set

in motion. Further, the OECD implementation process continued in developing and

transition countries. However, systemic corporate failures and scandals57

continued to

occur and undermine confidence in the integrity of corporations, financial institutions and

the market generally. Accordingly, the OECD Ministerial Council formally launched areview process in 2002 which resulted in the call for a reassessment of the OECD

Principles 1999 by 2004.58

The OECD Steering Group on Corporate Governance was entrusted with the task of

undertaking a survey and consultations with member countries highlighting the key

features of corporate governance arrangements and requesting comments on some

significant issues that had not been addressed in the OECD Principles 1999.59

Consultations were also made with experts from a large number of countries which took

56 OECD Principles of Corporate Governance 2004, 957 For example, the collapse of Enron, Tyco and WorldCom in the United Sates, Maxwell and BCCI in theUnited Kingdom58 Trade Union Advisory Committee (TUAC) to the OECD, The OECD Principles of CorporateGovernance: An Evaluation of the 2004 Review by the TUAC Secretariat, (2004) 659 Ibid


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part in the Regional Corporate Governance Roundtables that the OECD organized in

Russia, Asia, South East Europe, Latin America and Eurasia with the support of the

Global Corporate Governance Forum and others, and in co-operation with the World

Bank and other non-OECD countries as well.60There was also some participation of

leading business and labor representatives, including the OECDs Business Industry

Advisory Committee61and Trade Union Advisory Committee.62

A draft of the revised Principles was later in January 2004 made public by putting them

up on the OECD website for comment. This attracted a number of responses. Based on

these responses and comments from the general public it was concluded that the 1999

Principles should be revised to take into account new developments and concerns.63It

was agreed that the revision should be pursued with a view to maintaining a non-binding

principles-based approach, which recognises the need to adapt implementation to varying

legal economic and cultural circumstances. It is worthy of note that the revised principles

thus build upon a wide range of experience not only in the OECD area but also in non-

OECD countries.64

The new OECD principles of corporate governance focused primarily on public

companies and on developing corporate governance in emerging countries.65The OECD

recognises that one size does not fit all, that is, there is no single model of corporate

governance that is applicable to all countries. However the principles represent a certain

common characteristics that are fundamental to good corporate governance.66The

Principles build on these common elements and are formulated to

60 OECD Principles of Corporate Governance 2004, 961 The Business Industry Advisory Committee to the OECD is an independent organisation officiallyrecognised by the OECD as being representative of the OECD business community. Its members are themajor industrial and employers organisations in the 30 OECD member countries. The principal objective

of the Committee is to ensure that business andindustry needs are adequately addressed in OECD policyinstruments.62 The Trade Union Advisory Committee to the OECD is an interface for labour unions with the OECD. Itis an international trade union organisation which has consultative status with the OECD and its variouscommittees.63 OECD Principles of Corporate Governance 2004, 1064 OECD Principles of Corporate Governance 2004, 1065 Alan Calder: 2008 Corporate Governance A practical Guide to the Legal Frameworks andInternational Codes of Practice, Kogan Page66 Christine A. Mallin: Corporate Governance2007 Oxford University Press, second Edition


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embrace the different models that exist. They provide solutions to governance problems

that stem from the separation of ownership and control, and suggest methods of dealing

with complex issues relating to shareholders, employees, boards, management, and

decision-making.There are six high level principles each supported by a number of

recommendations.67

I. Ensuring the basis for an effective corporate governance framework

This is an innovation from the previous 1999 OECD principles of corporate governance.

It deals with the basis for ensuring an effective enforcement of the principles. To ensure

an effective corporate governance framework, it is important to improve the enforcement

of existing laws and regulations. It is necessary to put in place an appropriate and

effective legal, regulatory and institutional foundation is established upon which all

market participants can rely in establishing their private contractual relations. The

drafters of the OECD principles therefore established the fact that it was very necessary

for an effective mechanism to be put in place in overseeing the enforcement of the

principles.

The corporate governance framework should promote transparent and efficient markets,

be consistent with the rule of law and clearly articulate the division of responsibilities

among different supervisory, regulatory and enforcement authorities.68

A. The corporate governance framework should be developed with a view to its impact

on overall economic performance, market integrity and the incentives it creates for

market participants and the promotion of transparent and efficient markets.

B. The legal and regulatory requirements that affect corporate governance practices in a

jurisdiction should be consistent with the rule of law, transparent and enforceable.

C. The division of responsibilities among different authorities in a jurisdiction should be

clearly articulated and ensure that the public interest is served.

67 Ibid68 OECD principles of corporate governance 2004 at pg 17


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D. Supervisory, regulatory and enforcement authorities should have the authority,

integrity and resources to fulfill their duties in a professional and objective manner.

Moreover, their rulings should be timely, transparent and fully explained.

II. The Rights of Shareholders

It is a generally accepted principle of good corporate governance that organizations

should respect the rights of shareholders and help shareholders to exercise those rights.

They can help shareholders exercise their rights by effectively communicating

information that is understandable and accessible and encouraging shareholders to

participate in general meetings

Chapter 2 of the 2004 principles is an amendment to chapter one of the 1999 principles.

The chapter concerns the protection of shareholders rights and the ability of shareholders

to influence the behavior of corporations. Shareholders have a right for their shares to be

registered and secured.

The Principles list some basic rights including those to: secure methods of ownership

registration, convey or transfer shares, obtain relevant and material information on the

corporation on a timely and regular basis, participate and vote in general shareholder

meetings, elect and remove members of the board and share in the profits of the

corporation.69In addition Shareholders per the 2004 principles have been empowered to

participate in, and to be sufficiently informed on, decisions concerning fundamental

corporate changes such as amendments to the statute, authorisation of additional shares,

extraordinary transactions, including the transfer of all or substantially all assets that in

effect result in the sale of the company.70

The 2004 principles further made amendments to ownership rights for all shareholders,

including institutional investors. Under the original OECD Principles 1999, there was no

mention of the need to facilitate the exercise of ownership rights by institutional

investors. The revised Chapter 2 encourages authorities to allow institutional investors to

69 OECD Principles 2004, Chapter 2, Principle A.70OECD Principles 2004, Chapter 2,.Principle B


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cooperate and consult with each other on issues of corporate governance.71 It is a

significant improvement to include a provision calling for an active ownership policy by

institutional investors. The chapter also recommends that institutional investors maintain

a good practice of disclosing information to the market.72This has been said to be

particularly important for trade unions in pre-funded retirement systems, collective

investment schemes and some activities of insurance companies.73

It is worthy of note that some of the innovations in the 2004 OECD principles have been

criticised. Union Network international74commented that it would have been more clear

and concise if the title of the chapter referred to the rights and responsibilities of

shareholders.75It is further argued that, although the chapter calls for shareholders

effective participation in the nomination of directors, it does not explain or introduce the

means by which shareholders can effectively access the nomination process, specifically,

the company material.76

On his part, George Loladze,77is to the opinion that chapter 2

should have been amended with a more specific and detailed requirement that

shareholders have the opportunity to effectively buy or sell shares.78

III. Equitable Treatment of Shareholders

Chapter 3 of the 2004 principles is an equivalent of chapter 2 of the 1999 principles

which generally calls for an equitable treatment of all shareholders, including minority

and foreign shareholders. The 2004 principles place more emphasis on minority

shareholders. It calls for their protection from abusive actions by, or in the interest of,

71 OECD Principles 2004, Chapter 2, Principle G.72 OECD Principles 2004, Chapter 2, Principle F.73 Trade Union Advisory Committee (TUAC) to the OECD, The OECD Principles of CorporateGovernance: An Evaluation of the 2004 Review by the TUAC Secretariat, (2004), 1374 For more information about the union network see www.union-network.org.75 OECD, Comments Received from Web consultations, Union Network International (UNI) (2004).76 Ibid77 He is the Chairman of the Supervisory Board of the Georgian Stock Exchange.78 OECD, Comments Received from Web consultations, George Loladze, Chair, Supervisory Board,Georgian Stock Exchange (2003).


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controlling shareholders acting either directly or indirectly, and should have effective

means of redress.79

Another innovation to this chapter was the modification of the provision relating to

disclosure to read Members of the board and key executives should be required to

disclose to the board whether they, directly, indirectly or on behalf of third parties, have a

material interest in any transaction or matter directly affecting the corporation.80Lastly a

new clause was introduced in this chapter to the effect that impediments to cross border

voting should be eliminated.81

Some commentators82are of the view that the principles do not recognise the concept of

one share one vote as best practice, as this is increasingly the case in governance

regimes around the world. This therefore means the principle will benefit one set of

shareholders at the expense of the others and will act as a deterrent to takeovers by

entrenching management. They further hold that any benefits from the dual share

structures are outweighed by the potential for abuse as identified in the Principles in

section A.2.

IV. The role of the stakeholders in corporate governance

Chapter 4 of the 2004 principles is an equivalent of chapter 3 of the 1999 principles. The

chapter recognises the rights of stakeholders as established by law and encourage active

co-operation between corporations and stakeholders in creating wealth, jobs, and the

sustainability of financially sound enterprises. The chapter also provides that the rights of

stakeholders that are established by law or through mutual agreements are to be

respected.83 Principle C84has been modified to read as performance-enhancing

79 OECD Principles 2004, Chapter 3, Principle A2.80 OECD Principles 2004, Chapter 3, Principle C.81 OECD Principles 2004, Chapter 3, Principle A4.82 OECD, Comments Received from Web consultations, Australian Pensions & Investment ResearchConsultant Ltd (PIRC) (2003).

83 OECD Principles 2004, Chapter 4, Principle A.


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mechanisms for employee participation should be permitted to develop. This

modification is important as it seeks to allow such performance mechanisms to develop,

especially in countries where they have no effective mechanisms to ensure and encourage

employees to participate in the corporate governance of the company.

Chapter 4 of the 2004 principles also call for individual employees and their

representative bodies, to be able to freely communicate their concerns about illegal or

unethical practices to the board and their rights should not be compromised for doing

this.85This new principle advocates protection for whistleblowers, including institutions

through which their complaints or allegations can be addressed and provides for

confidential access to a board member. Effective enforcement of this is covered by

principle F86of the same chapter.

The new principle was not totally satisfactory to some commentators. The FIDH87

for

instance was particularly concerned with the lack of a definition for a stakeholder.

According to the FIDH88the chapter should have included a definition of stakeholders as

given by the Norms on the responsibilities of transnational corporations and other

business enterprises with regard to human rights adopted by the Sub-Commission on

human rights in august 200389The FIDH also pointed the vagueness of the wording of

chapter 4 regarding the participation of stakeholders, pointing out that it falls short of an

objectively effective mechanism to ensure stakeholder participation. This criticism was

particularly targeted at Principles B1, C, and D. It was contended that these provisions

allow a wide margin of discretion to managers with respect to the information they agree

84 OECD Principles 2004, Chapter 4, Principle C.

85 OECD Principles 2004, Chapter 4, Principle E.86 The corporate governance framework should be complemented by an effective, efficient insolvencyframework and by effective enforcement of creditor rights.87 International Federation for Human Rights88 OECD, Comments Received from Web consultations, The International Federation for Human Rights(IFHR) (2003).89 See Norms on the responsibilities of transnational corporations and other business enterprises withregard to human r ights, (E/CN.4/Sub.2/2003/12/Rev.2) for its definition of a stakeholder


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to make public and they do not go far enough to ensuring access to judicial recourses for

affected stakeholders.90

V. Disclosure and Transparency

Chapter 6 of the 2004 principles again is the equivalent of chapter 5 of the 1999

principles. Key elements of the disclosure and transparency provision include

Major share ownership and voting rights

Material foreseeable risk factors

Full financial disclosure

Governance structure and policies, and what code if any followed

Information should be prepared audited and disclosed in accordance with high

standards of accounting, audit and non financial disclosure

Regular continuous disclosure

Full disclosure of related party transactions, usually with controlling shareholders

Some exciting additions were made to these provisions which significantly improved

standards for disclosure and auditing procedures. 91New Disclosure issues for intellectual

asset driven economy were also added to the 2004 principles.92

Another new principle

was introduced providing that the corporate governance framework should include an

effective approach to ensure the integrity of those professions that serve as conduits of

analysis and advice to the market, such as brokers, analysts, and rating agencies.93

Unlike the foregoing chapters, Chapter 5 did not go unnoticed in relation to flaws

from some commentators and prominent business societies. FIDH94was not

90 OECD, Comments Received from Web consultations, International Federation for Human Rights(FIDH) (2003).91 See for instance OECD Principles 2004, Chapter 5, Principle A and C relating to Disclosurerequirements for board members and key executives; and the requirement for an annual external auditrespectively92 OECD Principles 2004, Chapter 5, Principle D.93 OECD Principles 2004, Chapter 5, Principle F.94 OECD, Comments Received from Web consultations, International Federation for Human Rights(FIDH) (2003).


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happy with the chapters limited scope on material to be disclosed by a company

and called for disclosure obligations of a company to include the companys

policies regarding human rights, social and environmental responsibilities, as well

as the actual impact on such activities.95

VI. Responsibility of the Board

Chapter 6 of the 2004 principles is an equivalent to chapter 5 of the 1999 principles.

Many of the provisions of the chapter were modified and some new ones added. The

duties and responsibilities of the board have been clarified as fiduciary in nature,

particularly important where company groups are concerned. The principle covering

board independence and objectivity has been extended to avoid conflicts of interest and

to cover situations characterised by block and controlling shareholders, as well as the

board's responsibility for oversight of internal control systems covering financial

reporting.

Board members are required to act on a fully informed basis, in good faith, with due

diligence and care, and in the best interest of the company and the shareholders.96The

chapter also calls for fairness on the part of the board and to apply high ethical

standards.97This is a new modification from the 1999 principles when looking at the

interest of shareholders.

Other changes were made to the key functions to be performed by the board paramount

of which was monitoring the effectiveness of the companys governance practices and

making changes as needed. This was to involve continuous review of the internal

structure of the company to ensure that there are clear lines of accountability for

management throughout the organisation.98Moreover the provision on board

remuneration was modified which called for boards to develop and disclose a

95 OECD, Comments Received from Web consultations, International Federation for Human Rights(FIDH) (2003).96 OECD Principles 2004, Chapter 6, Principle A.97 OECD Principles 2004, Chapter 6, Principle C.98 OECD Principles 2004, Chapter 6, Principle D.2


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remuneration policy statement covering board members and key executives and for such

policy statements to specify the relationship between remuneration and performance, and

include measurable standards that emphasise the longer run interests of the company over

short-term considerations.99

Further modifications were made in relation to exercise of judgements by the board.100

Objective judgement is very necessary for the exercise of the boards duties of

monitoring managerial performance, preventing conflicts of interest and balancing

competing demands on the corporation101. In order to prevent conflicts of interest an

independent board is most desirable. Independent board members can contribute

significantly to the decision-making of the board and for them to do this; it is desirable

that boards declare who they consider to be independent and the criterion for this

judgement. One of such criteria is when committees of the board are established; their

mandate, composition and working procedures should be well defined and disclosed by

the board.102Another criterion is for board members to be able to commit themselves

effectively to their responsibilities103.

In order to fulfil their responsibilities, board members should have access to accurate,

relevant and timely information.104

Chapter 6 also came under scrutiny from various divisions. The FIDH105for instance

finds it particularly regrettable principle C does not call for the duties of directors to

respect explicitly Human Rights Declaration and other human rights instruments, which

form the only possible foundation of such ethical standards (interest of stakeholders was

not taken into account). It further holds that the principle is not an internationally

accepted norm.

99 OECD Principles 2004, Chapter 6, Principle D.4100 OECD Principles 2004, Chapter 6, Principle D101 Ibid102 OECD Principles 2004, Chapter 6, Principle E.2103 OECD Principles 2004, Chapter 6, Principle E.2104 OECD Principles 2004, Chapter 6

Documents

Using the OECD Principles of Corporate G