corporate governance(edited)

8/14/2019 Corporate Governance(Edited)

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Corporate Governance

Corporate governance is about minimizing the loss of value that results from the separation of ownership and control.

It deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment.

While corporate governance has been a hot issue in recent years (Enron, Worldcomm, HIH and ne.!el" it is a problem that has been

around for hundreds of years # $dam %mith (&''".

)ood corporate governance practices involve*

!he corporate governance framewor+ should protect shareholders rights.

!he corporate governance framewor+ should ensure the equitable treatment of all shareholders.

%ta+eholders should be involved in corporate governance.

Disclosure and transparencyis critical.

!he board of directors should be monitored and held accountablefor what guidance it gives.

Internal Mechanisms

oard of -irectors

oard %ize Independence

Chairman/CE 0ositions

oard Committees

E1ecutive Compensation

wnership %tructure

Concentrated versus -ispersed wnership

Identity of wners

ther loc+holders

External Mechanisms


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E1ternal $uditors

-ebt E2uity 3ar+ets

3onitoring by debt holders

$nalysts

3ergers $c2uisitions

4egal/5egulatory %ystem

Common versus Civil 4aw

E1tent of 4aw Enforcement

5ecent 5egulations #)ood Corporate )overnance 0rinciples

International Differences

Board of Directors

!he board of directors is responsible for overseeing management and representing shareholders6 interests.

7% and $ustralia have single8tiered boards, headed by a Chairman of the oard. !he CE and other e1ecutives usually also sit on the

board.

%ome other countries ()ermany, Indonesia" have two8tiered boards. !he roles and composition of the two boards can differ.

Board i!e

oards should be an appropriate size # not too big not too small.

-epending on the size of the company within the range of 98&9 is normal.

If the board is too small, there is a lac+ of monitoring.

If the board is too big, there are problems reaching a consensus for decision ma+ing.

Board Independence

oards should have a ma:ority/high proportion of outside/independent directors.

utside/independent directors should have no personal interest in the company and therefore are more effective monitors.


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ut, it is also a good idea to have some company insiders (CE, e1ecutives" on the board to provide the board with a better

understanding of the company6s operations.

Chairman"CE# $ositions

!he Chairman of the oard is responsible for overseeing the board of directors.

!he CE is responsible for the day8to8day running of the company.

In family8controlled companies it is common for the same person or relatives to hold both of these positions. ut, this concentrates

power and reduces monitoring.

!herefore, the positions of Chairman and CE should be separated.

Board Committees

!he board of directors can delegate certain duties to board committees # this can provide increased monitoring on specific issues.

$udit committee # responsible for internal audit function and appointment of e1ternal auditor.

5emuneration committee # responsible for setting appropriate compensation for directors and e1ecutives.

;omination committee # responsible for finding appropriate directors and e1ecutives.

Executive Compensation

Compensation of top e1ecutives can be used to tie the interests of the e1ecutives to those of shareholders.


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loc+holders can be governments, financial institutions, individuals or other companies.

External &uditors

toc' exchange listing requirements usually ma'e it mandatory for companies to employ an external auditor to audit their

financial statements (and internal controls).

External auditor should be independent of management* but +.

,enure of auditor

,enure of audit partner

Monitoring by Debt holders

Debt holders provide capital to the company usually %ith conditions-

Debt covenants

ecured on assets

,herefore debt holders actively monitor management to ensure that companies are meeting debt conditions and

that they %ont default.

&nalysts

%ecurities analysts are professionals employed by investment ban+s / bro+ers / asset managers to monitor companies and provide

stoc+ recommendations (buy/sell", earnings forecasts, long8term growth forecasts, target prices etc.

0rovides an e1tra level of monitoring for investors.

ut, analysts incentives/conflicts of interest mean that not all of their output is trustworthy.

,a'eover Mar'et

!he merger and ac2uisition (3$" mar+et stands as a ?court of last resort6 for assets that are not being utilized to their full potential.

If management are underperforming there is a good chance that this will be noticed by the mar+et and other players will want to ta+e

control of the company.

!here are active ta+eover mar+ets in $ustralia, 7%, 7@, ;ew Aealand, but few other countries.

Intervening /ariables

3easures put in place by companies that restrict shareholder rights and the effectiveness of ta+eover mar+ets*

%taggered boards

4imits to by8law/charter changes

%uperma:ority re2uirements for mergers

0oison pills

)olden parachutes

0egal ystems

Each country6s legal system has built in a certain degree of investor protection. However, there is a wide variation in protection and

enforcement of these rules around the world.


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Common law countries provide highest protection and =rench civil law countries provide the least protection.

4ow investor protection seems to result in concentrated ownership and underdeveloped e2uity mar+ets.

Measuring Corporate Governance

7nderstanding what good corporate governance is about is 2uite easy. However, it is difficult to measure whether companies are

really committed to good governance.

$ll we can do is measure if they have certain corporate governance mechanisms in place # we don6t +now if they are effective or notB

rganizations such as %tandard and 0oors and Credit 4yonnais %ecurities $sia have started providing corporate governance ratings in

recent years.

Benefits of Good Governance

5esearchers have shown that companies with good corporate governance practices are valued more highly and run more effectively.

%o the benefits of good governance include*

Higher share price

4ower cost of funds

)reater international following

1hat you need to remember+

When investing it is worthwhile +eeping in mind whether a company has committed to good corporate governance or not. ou can use

the mechanisms highlighted in this lecture or corporate governance ratings as a guide.

Corporate governance becomes most important during stoc+ mar+et crashes and bad economic times.

ut, it is not a perfect science. 3anagers will always find a way to circumvent monitoring to achieve their own goalsB

corporate governance(edited)

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