Transcript CORPORATE GOVERNANCE - Midlands State University

CORPORATE GOVERNANCE
By
Mr. A. Matongo
18 July 2015
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rights reserved
1
WHAT IS CORPORATE
GOVERNANCE?
•DEFINITIONS & ISSUES
•CONCEPTS, ETHICS & ROLES
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2
DEFINITIONS & ISSUES IN
CORPORATE GOVERNANCE
• Governance is the exercise of powers and
actions to achieve goals of an organizational
entity.
• Organizational entities range from families,
companies, countries through to
multinational organizations such as the UN,
World Bank, IMF, etc
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DEFINITIONS & ISSUES IN
CORPORATE GOVERNANCE
• Corporate governance is the system by which
companies are directed and controlled in order to
achieve their goals.
• In the governance of a democratic country powers
are shared among and exercised by the
Legislature, the Executive and the Judiciary with
the goal of an improved quality of life for all
citizens.
• CG is concerned with how powers are shared and
exercised by different stakeholder groups to
ensure achievement of company goals.
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DEFINITIONS & ISSUES IN
CORPORATE GOVERNANCE
• Major stakeholder groups of a company
are:
 Shareholders
 Board of directors and
 Executive directors.
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DEFINITIONS & ISSUES IN
CORPORATE GOVERNANCE
• Day-to-day mgt is not cg
• Powers of executive managers to direct
business operations are one aspect of cg.
• Managerial skills are not cg.
• Formulation of business strategy is not cg.
• Taking strategic decisions by directors &
executive managers is cg.
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DEFINITIONS & ISSUES IN
CORPORATE GOVERNANCE
• To direct co. towards achievement of its
objectives.
• To satisfy the diverse interests of the
shareholders, directors and other interest
groups.
• To attract foreign investment.
• To support capital markets.
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CG & NON-CORPORATE
ORGANIZATIONS
• Key debates in cg have focused on public
companies whose shares are traded on a
major stock exchange.
• However many issues of cg also apply to
smaller companies and non-corporate
organizations such as state-owned
enterprises, govt. depts., bodies, institutes,
associations and charitable organizations.
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1.6 CG & NON-CORPORATE
ORGANIZATIONS
•
•
Such organizations face the central dilemma of
cg: how rights & responsibilities are shared and
exercised by different groups to ensure
achievement of common objectives.
Examples:
1. A co. should be run in the interests of its shareholders, its
Board and workers.
2. A govt. dept. should be run in the interests of the general
public and in pursuit of the aims of the govt. itself.
3. A charitable organization should be run in the interests of the
beneficiaries of the charitable activity and with regard to the
interest and concerns of the funders.
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1.6 CG & NON-CORPORATE
ORGANIZATIONS
• Each sector is increasingly developing guidelines
and codes of best practice in cg.
• Irrespective of type of ownership & structure, the
wider governance agenda advocates that all
organizations should act ethically & in a socially
responsible manner.
• Individuals controlling an organization should
work for the objectives of the organization & not
allow self-interest to dominate their decisions &
actions.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
• CG is a young discipline that has grown out of
•
•
concern raised by spectacular & well-publicised
corporate failures.
In the US many organizations in the savings &
thrift industry had to be rescued from financial
collapse in the 1980s & 1990s.
In the UK a number of companies collapsed
unexpectedly in the 1980s & 1990s.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
• Examples of collapsed companies from the UK:
1. Polly Peck International;
2. Bank of Credit and Commerce International;
3. British and Commonwealth;
4. The Mirror Group News International;
5. Barings Bank.
• In each case there appeared to be serious
accounting or financial reporting irregularities &
inadequate internal controls & risk management.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
• In some cases “creative accounting” &
inadequate financial regulations were seen
as cause of corporate failure.
• In other cases e.g. the collapse of the
Barings Bank due to losses of a trader,
inadequate controls were a key factor.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
• Analysis of corporate collapses of well
established companies without warning
revealed the following themes:
1.Investors were not kept informed about what
was really going on in the company.
2.Published financial statements were misleading.
3.External auditors were accused of failing to
spot the warning signs.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
4. Most of the blame fell on self-seeking chiefs,
their apparent lack of personal & business
ethics and the inability of their colleagues on
the board to restrain them from acting
improperly.
5. Financial collapse can be prevented by
adequate risk management.
6. In all cases of corporate failures financial
controls had been inadequate or ineffective.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
BRIEF HISTORY OF CG
THE UK (The Cadbury Report)
• Main impetus for better practices in cg
started in the late 1980s & early 1990s.
• The landmark report on the Financial
Aspects of Corporate Governance ( The
Cadbury Report) was published in 1992.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
• The Report included a Code of Best Practice.
• UK listed companies came under pressure from
city institutions to comply with the requirements
of the Code.
The Myners Report
• In 1995 a working group chaired by Paul Myners
produced the Myners Report on the relationship
between companies & institutional investors.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Myners Report (cont.)
• The main recommendation of the report was:
When a company is performing badly institutional
investors should do something to put things right
instead of selling their shares & washing their
hands off the company.
• Report argued for legislative compulsion of
institutional investors who did not exercise their
rights more forcibly in the governance of their
companies.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Greenbury Report
• On the recommendation of the Cadbury
Committee the Greenbury Committee was set up
to review progress on cg in UK listed companies.
• In 1995 the Greenbury Report was produced & it
focused mainly on directors’ remuneration.
• At that time the UK press had mounted an
onslaught on the “fat cat” directors especially
those in newly privatized companies.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Greenbury Report (cont)
• The Greenbury Report issued a Code of Best
Practice on the following:
1. establishing remuneration committees;
2. enhanced disclosures about the remuneration of
directors;
3. remuneration policy;
4. notice periods in directors’ service contracts &
5. compensation payments in the event of early
termination of contracts.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Hampel Report
• In 1995 Sir Ronald Hampel chaired
another Committee on Corporate
Governance to review the
recommendations of the Cadbury
&Greenbury Committees.
• The final Hampel Report was published in
1998.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Hampel Report (cont.)
• The Report covered the following cg issues:
1. Composition of the board & the role of directors ;
2. Directors’ remuneration;
3. The role of shareholders particularly institutional
shareholders;
4. Communication between company & its
shareholders;
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Hampel Report (cont.)
5. Financial reporting;
6. Auditing &
7. Financial control.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Combined Code
• The Hampel Report suggested the combining of
its report with those of the Cadbury & Greenbury
Committees prior to it.
• The suggestion led to the publication of the
Combined Code.
• The Combined Code on cg is a voluntary code
rather than a regulatory requirement.
• The UK Listing Rules, however, require listed
companies to disclose in their annual reports the
extent of their compliance with the Code.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Combined Code (cont.)
• Listing Rules also include an obligation to
disclose remuneration details for directors.
• The Combined Code was to be reviewed
from time to time.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The Higgs & Smith Reports
• In Jan. 2003 the Higgs Report made
recommendations on the role that nonexecutive directors should play in good cg.
• In Jan. 2003 again the Smith Report issued
guidelines for the role & responsibilities of
the audit committees.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
The UK Govt. Action
• The UK Govt. has also considered the following
measures to try to improve corporate
governance:
1.
2.
3.
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In 1998 a company law review was initiated.
A White Paper on proposed changes in the law was
published in 2002.
In same year, 2002, new regulations for greater
disclosures of directors’ remuneration by quoted
companies were introduced.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
UK Companies' Action
• Another development has been the growing
awareness on the part of large companies of
potential risks to their reputation and long-term
success posed by failures to comply with laws &
regulations or to act in an ethical way.
• Many companies claim to recognize the potential
long-term benefits of acting in a socially
responsible manner.
• The UK has, therefore, been in the forefront of the
move towards setting up a better cg framework.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
• There have been similar developments in other
countries.
• In developing countries good cg is seen as an
essential basic requirement for attracting vital
foreign investment capital.
IN SA (King Reports)
• In SA a code of cg has been developed by the
King Committee.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
IN ZIMBABWE (RBZ Guideline No. 012004/BSD)
• The Institute of Directors of Zimbabwe produced
“Principles for Corporate Governance in
Zimbabwe”in 1994 which was really an adaptation
of the King Report.
• Guidelines for good cg in the financial sector only
came into being in 2004 following a spate of
corporate failures of financial institutions
including ENG, Barbican, Time, Intermarket,
Rapid Discount Hse,Royal, Trust, etc.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
ON THE INTERNATIONAL SCENE
• The following international organizations have
published cg principles for the benefit of the
corporate sectors of member countries:
1. The Commonwealth Association for Corporate
Governance (CACG);
2. Organization of Economic Co-operation &
Development (OECD) and
3. Institute of Chartered Secretaries
&Administrators (ICSA)
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
IN GERMANY
• The Cromme Code has been developed as best
practice for German companies to attract foreign
investment.
IN THE USA
• Very little concern for better cg was shown
throughout the 1990s.
• Occasionally some activist institutional
shareholders such as Calpers raised noises during
this period mainly out of fear for their investment.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
IN THE USA (cont.)
• After the collapse of Enron, Arthur Anderson,
WorldCom, & others from the late 2001 the
situation changed dramatically & a series of
regulations & statutory provisions on cg were
introduced in 2002 through the Sarbanes-Oxley
Act
• Whereas the UK opted for voluntary code on cg,
the US preferred legislation & regulation
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
INTERNATIONAL ASPECTS OF CG
• Although cg has become a matter of some interest
in many countries the pace of change & nature of
cg vary substantially between countries.
• The OECD monitors developments in cg in
member countries (visit OECD website).
• Much of the pressure for change has come from
institutional investors, particularly in the USA
who have invested heavily in companies in other
countries.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
INTERNATIONAL ASPECTS OF CG (cont)
• At the centre of pressure for change is the right to
vote & equal treatment with other equity
shareholders.
• Developments of cg in developing countries have
been greatly influenced by foreign investors e.g.
the concept of protection of minority shareholder
rights.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
DORMINANT PERSONALITY &
LEADERSHIP ASPECTS OF CG.
• A no. of corporate failures have been
blamed on a dominant individual acting as
Chairman & CEO & running the co. as a
personal kingdom with complete disregard
to the interests of shareholders & other
stakeholders.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
• Robert Maxwell is a typical example
• When he died in 1991 it was discovered that
he had misappropriated about ₤900m from
the pension funds of his companies.
• Prior to his death nobody could question
such a flamboyant character.
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1.7 DEVELOPMENT OF
CORPORATE GOVERNANCE
•
In Zimbabwe the following dominant characters
existed in their respective companies:
1. Roger Boka in his United Merchant Bank;
2. Nicholas Vingirai & his Intermarket Holdings;
3. William Nyemba & Trust Holdings and many
others.
• The RBZ has moved in to remove these through
Guideline No. 01-2004/BSD.
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1.8 STAKEHOLDERS OF A
COMPANY
• A stakeholder in a co. is someone who has an
interest or “stake” in it & is affected by what the
co. does.
• Each stakeholder holds certain expectations with
regard to co. behavior.
• A stakeholder expects to have a say in some of the
decisions & actions a co. takes
• The balance of power between different
stakeholder groups & the way in which the power
is exercised are key issues in cg.
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1.8 STAKEHOLDERS OF A
COMPANY
•
The most important stakeholders in a public
company are:
1. Shareholders
2. Board of directors &
3. Executives
• The most powerful of these are the executive
directors.
• In a co. with a majority shareholder, that
shareholder can remove & vote in directors.
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1.8 STAKEHOLDERS OF A
COMPANY
• Where a majority shareholder exists
interests of minority shareholders may be
disregarded.
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1.8 STAKEHOLDERS OF A
COMPANY
• THE BOARD
• Board has responsibility to give direction
•
to the co.
Board delegates most executive powers to
the executive management.
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1.8 STAKEHOLDERS OF A
COMPANY
THE BOARD (cont.)
• Board usually reserves the following
powers to itself:
1. Decisions about raising finance
2.
^
^
paying dividends
3. Making major investments &
4. Hiring & firing executive management
personnel
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1.8 STAKEHOLDERS OF A
COMPANY
THE BOARD (cont.)
• Executive mgt. is accountable to the board for
their performance.
• A board has executive and non-executive
directors.
• Boards are generally dominated by the Chairman
& CEO or MD.
• Powers of shareholders in large, listed companies
are very limited & have to rely on directors to act
in their interests.
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1.8 STAKEHOLDERS OF A
COMPANY
THE BOARD (cont.)
• Main interest of individual executive
directors is likely to be power & authority,
high remuneration & a wealthy life-style.
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1.8 STAKEHOLDERS OF A
COMPANY
• In companies with a majority shareholder
(one with over 50% shareholding) the
shareholder can remove & vote in directors.
• Interests of minority shareholders may be
disregarded where a majority shareholder
exists.
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1.8 STAKEHOLDERS OF A
COMPANY
MANAGEMENT
• Mgt. is responsible for running business
operations & is accountable to the board through
the CEO.
• Interest of individual managers on co. mgt. are
power, status & high remuneration.
• As employees managers may see their stake in the
co. in terms of career development & wealthy lifestyle.
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1.8 STAKEHOLDERS OF A
COMPANY
EMPLOYEES
• Employees’ stake in a company is provision of
jobs & income.
• Their expectations are security of employment,
good pay & favourable working conditions.
• Some rights of employees are protected by
employment law but powers of employees are
generally limited.
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1.8 STAKEHOLDERS OF A
COMPANY
LENDERS & OTHER CREDITORS
• Their interest in a company is the
repayment of what they are owed.
• In situations of insolvency creditors take
greater control of the company.
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1.8 STAKEHOLDERS OF A
COMPANY
INVESTMENT INSTITUTIONS
• These are important stakeholders of public
companies.
• In the UK these include:
1. Association of British Insurers (ABI)
2. National Association of Pension Funds (NAPF)
3. International Corporate Governance Network.
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1.8 STAKEHOLDERS OF A
COMPANY
INVESTMENT INSTITUTIONS (cont.)
• These bodies influence activities of their
members by encouraging them to vote in a
particular way on resolutions at AGMs of
companies in which they hold shares.
• Investment institutions represent opinions
of the investment community generally.
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1.8 STAKEHOLDERS OF A
COMPANY
GENERAL PUBLIC
• General public are stakeholders of the corporate
and non-corporate sectors by virtue of them
being consumers of goods or services provided
by these.
• Examples:
1. Households expect the GMB to provide food
security at the national & household levels.
2. Households expect utility bodies to provide
uninterrupted supply of water, electricity, gas, &
reliable telephone connection.
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1.8 STAKEHOLDERS OF A
COMPANY
GENERAL PUBLIC (cont)
• Commuters expect transport service to &
from work at a affordable charge.
• Sometimes powerful pressure groups take
very unorthodox measures to influence
decisions of companies e.g. the Greens &
animal protection movements engaging in
violent street demonstrations .
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1.9 KEY OBJECTIVES OF
CORPORATE GOVERNANCE
• To balance demands & needs of stakeholders.
• To reconcile conflicting demands of stakeholders.
• To reduce temptation by more powerful
stakeholders to take decisions to further their
personal interests at the expense of other
stakeholders.
• To provide protection to the owners of the
company against loss due to actions of executive
personnel.
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1.9 KEY OBJECTIVES OF
CORPORATE GOVERNANCE
• To help develop measures to prevent financial
prejudice to owners (outsiders) due to action of
agents (insiders) or executives.
• To help develop measures for redress should the
executives cause financial prejudice to the owners.
• To reduce conflict between various pairs of
stakeholders e.g. shareholders & the board.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
1. Financial Reporting & Auditing
• Main issues are: “dressed up” or “window•
•
dressed” published accounts.
Who should be responsible for discovering fraud
or errors: external auditors or directors?
The extent of external auditors' independence &
freedom from influence of the company’s mgt.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
2. Directors’ Remuneration
• The main issue is the “fat cat” directors’
•
remuneration that is maintained at a high
level irrespective of the performance of
the company.
The other issue of controversy is the form
of remuneration.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
3. Decision-making Powers
• The key issue here is whose interests do
•
•
directors consider foremost in taking decisions
for the company.
Should the company law give more powers to
shareholders over the directors.
How far are shareholders using the power they
already have under the existing company law.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
4. Risk Management
• The rule that investors expect higher returns
•
•
•
when higher business risks are taken is not
observed by directors.
Directors take decisions on the basis of
prospects of profit without consideration of the
risks that are associated with such profits.
Directors’ remuneration is blind to risk aspects
of their activities.
Greatest risks are generally associated with
mergers & takeovers.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
5. Information & Communication
• The issues are that shareholders, both small &
•
•
big, never seem to get enough information from
the board.
The annual reports are sometimes not very easy
for the shareholders to understand.
Companies have not developed a culture of
promoting shareholder attendance &
participation at AGMs.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
5. Information & Communication (cont.)
• Many companies avoid governance issues such
•
as directors’ remuneration, internal control &
risk mgt. & policies on health, safety,
environment & social responsibility.
Companies are under pressure to use electronic
communications including use of website &
electronic voting.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
6. The extent of cg legislation
• Companies are constrained in what they can do
•
•
by laws.
Laws regulate what companies can do in their
dealings with other people such as creditors,
customers, employees & society at large.
Companies are also subject to various
regulations and codes of practice from external
bodies e.g listing authorities, local authorities,
standards control authorities, etc.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
6. The extent of cg legislation (cont)
• Issues in this area are:
 Extent to which cg practices should be forced on
companies by legislation.
 How much should be left to regulation by
external bodies?
 How much should be left to companies to decide
for themselves within a published framework of
best practice guidelines?
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
7. Ethical Issues
• Ethical issues are at the root of many problems
•
•
in cg.
Individuals are expected to behave in an ethical
way.
Companies may be aware of the need to
maintain a culture of corporate ethics by
providing a code of conduct for directors &
employees.
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1.10 KEY ISSUES IN
CORPORATE GOVERNANCE
7. Ethical Issues (cont)
• A company’s reputation may be affected by
•
perception of ethical issues by external pressure
groups e.g. companies involved in advanced
research in stem cells, cloning of humans,
research in aids cure and vaccines.
Such companies have sometimes been subjected
to public demonstrations against their activities
& operations.
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1.11 APPROACHES TO
CORPORATE GOVERNANCE
• Three approaches in the practice of cg do
exist:
1. Shareholder value approach;
2. Enlightened shareholder approach &
3. Stakeholder or pluralist approach.
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1.11 APPROACHES TO
CORPORATE GOVERNANCE
1. Shareholder value approach
• Well established view supported by company
•
•
•
law in advanced economies.
View: the board should govern in the best
interest of the shareholders.
Main objective should be to maximize wealth of
shareholder by share price & dividend growth.
Strength of the view lies in its widespread
support.
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1.11 APPROACHES TO
CORPORATE GOVENANCE
2. Stakeholder Approach
• View: directors should run companies in the
•
•
•
i.
interest of all stakeholders of the co.
Also called the pluralist approach.
Concern is to achieve a balance between
economic & social goals & between individual
& communal goals.
Sound cg should recognize the following:
economic imperatives faced by companies in
competitive markets;
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1.11 APPROACHES TO
CORPORATE GOVENANCE
ii. Encourage efficient use of resources through
sound investment;
iii. Ensure accountability from board of directors to
shareholders for the stewardship of company
resources.
• Aim of cg should be to recognize the interest of
other individuals, companies & society at large
in the decisions & activities of the company.
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1.11 APPROACHES TO
CORPORATE GOVENANCE
• One problem with the stakeholder approach
is that the company law does not reinforce
the approach.
• Supporters of stakeholder approach argue
that there would have to be company
legislation giving it support (changes in
company law) e.g. greenhouse gas
emissions.
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•
Some stakeholder interests are protected by
other laws other than company law such as
employment law, health & safety legislation &
environmental law.
3. The enlightened shareholder approach
• Directors of companies should pursue the
interests of their shareholders in an enlightened
& inclusive way.
• Directors should also look to the long-term in
addition to the short-term.
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• Managers should maintain productive
relationships with a range of stakeholders.
• Approach requires support of the law.
• Criticism of the approach is that most shareholders
do not fit the image of the enlightened investor.
• Most shares in public companies are owned by
institutional investors who are themselves
relatively unaccountable to their beneficiaries e.g.
pension funds, insurance companies, medical
societies.
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4. An Integrated Approach
• Advocated for by SA’s King Reports.
• Took the view that company has wide range of
stakeholders whose views should be considered.
• CG should be participative of these stakeholders.
• King Report made a distinction between
accountability & responsibility as follows:
i. Accountability is liability to render account to
someone else
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ii. The board of directors should be
accountable to none other than the
shareholders arguing that accountability to
everyone results in accountability to no
one.
iii. Responsibility is the liability of a person
to be called to account when that person is
responsible.
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iv. The King Committee suggested that the board of
directors should be accountable to shareholders
only but be responsible to all other stakeholder
groups as well as shareholders.
v. Accountability to all stakeholder groups would
restrict enterprise & flair.
vi. King Report identified 3 “corporate sins” of
sloth, greed & fear:
 Sloth is unwillingness to take risks & initiatives.
It results in loss of flair & enterprise & creation
of slow-moving bureaucracy to manage the co.
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 Greed is the desire of executive managers to get
the best for themselves out of the company.
 Generally leads to short-term decision-making
without proper regard to the long-term future.
 Decisions are often based on the desire to drive up
the share price & so the directors’ own share
options.
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Fear arises when executives worry about
what their shareholders/investment
community will say or do.
Decisions taken are those that will keep the
shareholders content.
Fear, like sloth, leads to an erosion of
enterprise & flair.
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vii.King Report arose from investor concerns
about excessive power in the hands of
greedy professional executive managers.
viii.Protecting investors against greed runs
the risk of sloth & fear.
ix. This calls for a careful balance in cg
between protection of shareholders & the
enterprise & flair of the directors.
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1.11 APPROACHES TO
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5. The generally accepted approach
• In practice shareholder value approach to
•
•
cg is the generally accepted view.
However questions about the merits of the
other approaches are increasingly being
raised by academics & practitioners alike.
The UK Company Law Review Steering
Group raised these questions in 1998.
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1.11 APPROACHES TO
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•
The committee made a case for the inclusion of
the enlightened shareholder & pluralist concepts
in the company law of the UK.
• The Law Society of England &Wales rejected
the recommendation for the following reasons;
i. Company law should not be used to implement
social & cultural changes
ii. There is enough scope & flexibility in the
existing law to apply pluralist & enlightened
shareholder concepts.
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iii. Most boards of directors took into consideration
the interests of stakeholders in the decisions they
made.
iv. Pluralist approach could damage share values
since actions to further interests of other
stakeholders might reduce returns to to
shareholders.
v. In view of current attitudes it is unlikely that the
pluralist approach will replace the shareholder
approach.
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6. Achieving best practice in corporate
•
•
governance
It is debatable whether a single set of rules
of best practice in cg could be drawn up to
apply to all public companies
Corporate circumstances differ & what is
best for one company may not necessarily
be best for another.
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• Even assuming consensus on what is best
practice in cg the next disagreement could
be whether the best practice should be
recommended as a voluntary code or
enforced through regulation e.g. by
company law.
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2.0 CONCEPTS, ETHICS &
ROLES
Learning outcomes of unit
• Understanding & appreciation of
i. core concepts underlying best practice in cg.
ii. the importance of ethics & significance of
corporate social responsibility (CSR)
iii. role of whistleblower in uncovering malpractice
& unethical behaviour &
iv. role of company secretary & company lawyer.
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2.1 CORE CONCEPTS IN CG
1. Openness, Honesty & Transparency
1.1 Openness:
• Willingness to give all stakeholders information
except that which is commercially sensitive.
• Information about current developments in the
company’s affairs must be provided timeously
through newspapers, radio, tv, website, etc.
1.2 Honesty
• In this age of spin & manipulation of facts
honesty can no longer be taken for granted.
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1.2 Honesty (cont.)
• Honesty of a company can be judged by
reactions of the public to its announcements.
• When a company’s statements are generally
believed then the company is perceived as being
honest.
• When skepticism and disbelief greet a company’s
statements then the company’s honesty is
doubtful.
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1.3 Transparency:
• Ease with which an outsider can make a
meaningful analysis of a company & its actions.
• Transparency involves financial & non-financial
matters e.g. balance sheet matters, direction of
co., strategic objectives, etc.
• A transparent co is one that investors understand
• In a transparent co. there is trust among
stakeholders & clarity of decision-making
processes.
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2. Independence
• Freedom from influence of one or more
•
•
•
individuals.
Also freedom from conflict of interest.
Concept is particularly relevant to a company’s
NEDs.
NEDs are independent if they are able to
express their honest &/or professional opinion in
the best interest of the company.
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2. Independence(cont.)
• Independence can be threatened by:
i. Having some connection to the co. or
dependence on its goodwill or its mgt.
ii. Overwhelming personal interests in the co.
• A NED will not be independent if he/she:
i. Has recently occupied a senior executive
position in the co.
ii. He/she represents a major shareholder.
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2. Independence(cont.)
• An auditor may not be independent if he or his
•
audit firm relies on the company for a large
percentage of its annual income.
Familiarity undermines independence e.g. when
a NED or auditor has known a co. for a long
time during which time personal friendships that
blind them to mgt failings & shortcomings
develop.
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2.1 CORE CONCEPTS IN CG
3. Accountability
• The requirement for a person in a position
•
of responsibility to justify, explain or
account for the exercise of his/her
authority, performance or actions.
Accountability is from person/s from
whom authority is derived.
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3. Accountability (cont.)
• If objective of co. is maximizing
shareholder value then directors should be
held accountable to shareholders for:
i. Gross profit margin
ii. Net profit margin
iii. ROI
iv. ROE
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3. Accountability (cont.)
v. EPS growth
vi. DPS growth
vii. Share price movements/market
•
capitalization.
Period for measuring the above measures
ranges form short-term (up to 1 year) to
long-term (5 yrs to 10 yrs)
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3. Accountability (cont.)
• Overindulgence in short-term measures of
returns to shareholders may force directors to
concentrate on short-term measures that may not
yield much long-term benefits to the co.
• Examples of measures that may have initially
caused short-term inconveniencies to
shareholders are:
i. Unbundling of Delta Corporation
ii. Old Mutual and FML demutualisation.
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3.
Accountability (cont.)
• Rights Issue of CAPS, Kingdom,
iv. Private placement of shares by Ariston
v. Share buyback at NMBZ, CFI, etc.
vi. Scrip dividend in lieu of cash dividend at
BNC.
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2.1 CORE CONCEPTS IN CG
4. Responsibility
• Means being liable to be called to account.
• Reporting in accountability is mandatory but in
•
responsibility it is conditional.
Shareholders expect publication of annual
reports of their co. by a given date, but society at
large can only get reports on CSR if they call
upon the company to do so.
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5. Fairness
• Impartiality or lack of bias.
• Refers mainly to the way companies treat
vulnerable stakeholders such as minority
shareholders, employees, foreign investors, visa-vis their respective counterparts.
6. Reputation
• Character generally ascribed to a company or
organizational entity.
• It may be good or bad.
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6. Reputation (cont.)
• For a listed company a good reputation is a key
•
•
•
.
asset.
Companies with high reputations have high share
prices.
Strong share prices facilitate the raising of extra
capital from existing & new members.
Strong share price makes company shares
acceptable as payment for acquisitions,
remuneration of staff and payment of dividend.
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6. Reputation (cont.)
• Damage to the reputation of a co. is quickly
•
•
reflected by a drop in its share price
A good reputation for a co. built over several
years results in the company attaining ‘bluechip’ status.
A good reputation improves the way in which
the co. is perceived by markets & the wider
community.
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6. Reputation (cont.)
• It takes several years to build co. reputation but
•
•
this may be destroyed overnight by a badly
handled catastrophe or bad publicity.
Recovery of damaged reputation takes more
work than is required to acquire good reputation
in the 1st place.
Loss of reputation may, in some cases, destroy a
co. completely e.g. Arthur Andersen,
Zimbabwe’s banks, etc.
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2.2 ETHICS & CORPORATE
GOVERNANCE
2.2.1 Background
• Personal & business ethics form the foundation of
regulations & codification in cg.
• Laws & regulations, even with criminal & civil
punishment, alone can never guarantee fair
practice.
• Individuals in positions of influence & authority
must have the will to apply fair practice & abide
by the rules.
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2.2.1 Background (cont.)
• Some individuals will think more about
themselves than about the collective goals of their
organizations.
• In extreme cases an individual will think about
him or herself to the exclusion of any other
interests.
• To such people laws, stock market regulations &
cg codes are obstacles to overcome rather
guidelines for conduct.
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2.2.1 Background (cont.)
• Good practice in cg calls for ethical conduct & a
firm sense of what is right & wrong.
• Ethical conduct is behaviour that is in accordance
with a written or unwritten code of behaviour &
moral values.
• Code of ethics can be defined as:
i. a comprehensive set of rules or guidelines for
moral behaviour or
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2.2.1 Background (cont.)
ii. Rules of conduct recognized as appropriate;
• Can be written or unwritten;
• Each company must have one to sustain its
corporate culture.
• Conflicts of interest in organizations should be
resolved through negotiations & bargaining
arrangements that rely on trust between parties &
an implied assumption of fair dealing.
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2.2.1 Background (cont.)
• Without ethical conduct regulations & codes of
practice will not work.
2.2.2 A code of ethics
• In 2002 the NYSE recommended for changes in
cg by requiring every co. listed on it to publish its
code of ethics.
• Code was to be binding to directors, mangers &
employees.
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2.2.2 A code of ethics (cont.)
• NYSE argued that a code was necessary for the
Board & mgt to focus on areas of ethical risk.
• Issues that had to be dealt with in the code are:
i. Avoiding conflicts of interest;
ii. Employees getting opportunities for personal
gain using co. property & position.
iii. Confidentiality;
iv. Fair dealing with customers, suppliers,
employees & competitors;
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2.2.2 A code of ethics (cont.)
v. Protection & proper use of co. assets;
vi. Compliance with laws & regulations;
vii. Encouraging the reporting of illegal &
unethical behaviour.
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2.2.3 Securities & Exchange Commission (SEC)
• In 2002 the US SEC ordered CEOs & CFOs of
all US listed companies to take an oath of
honesty;
• A deadline for filing the oath that depended on
year-end of each co. was given;
• In the oath the CEO & CFO had to attest that, to
the best of their knowledge, the latest accounts
of their co. did not contain:
i. untrue statements of material fact
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2.2.3 Securities & Exchange Commission (SEC)
ii. did not omit a material fact;
iii. that they had reviewed the statements with the
audit committee or with the NEDs of the co.
• The oath of honest was seen as an investorconfidence boosting measure following a spurt
of corporate failures in the US.
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2.2.3 Corporate Social Responsibility (CSR)
• Responsibility shown by a company or other
organization for matters of general concern to
the society in which it operates e.g. protection of
environment, health & safety & social welfare.
• Major issues in CSR include:
i. minimization of environmental damage;
ii. promoting ‘sustainable’ business;
iii. having liberal employment policies;
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2.2.3 Corporate Social Responsibility (CSR)
iv. investing money in local communities;
v. helping in the fight against crime, disease,
poverty, human rights abuses or injustice, etc.
• Specific examples of CSR in Zimbabwe:
i. scholarship awards for environmental studies;
ii. Relief aid for victims of accident, earthquake,
torture, etc.;
iii. Building a strong civil society for protection of
individual & collective freedoms.
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2.2.3 Corporate Social Responsibility (CSR)
• Companies/organizations that have been in the
forefront of CSR are:
i. Old Mutual & its Mathematics Olympiad;
ii. Campfire Association with financial assistance
to communal lands bordering game parks.
iii. Rio Tinto with its schools & training
programmes.
iv. Zim. Lawyers for Human Rights’ help for
victims of political, social & economic injustice.
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2.2.3 Corporate Social Responsibility (CSR)
• In the UK institutional investors have
brought pressure to bear on public
companies to report on CSR.
2.2.3.1
The State as Shareholder
• Where a co. is partly owned by the govt.
other shareholders need to be aware of the
interest of the state.
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2.2.3.1 The State as Shareholder (cont.)
• A govt. may just act as a rational shareholder &
look for maximization of long-term returns.
• Govt. may only be interested in the interest of
other stakeholders such as the company’s
employees or the public as a whole.
• Knowing govt.’s interest helps other shareholders
to know how decision-making in the board is
likely to be affected.
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2.2.3.1
The State as Shareholder
• Boards of state-owned companies are generally
reckless in decision-making as they are almost
always bailed out by government when in
financial stress.
• Government can also retain a ‘golden share’ when
they privatize nationalized industries & use such
share to veto decisions of the Board.
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2.2.3.2 State-owned industries in emerging
economies
• CACG issued guidelines for state-owned
industries in emerging economies of The
Commonwealth.
• Key features of the guidelines are:
i. The largest and most significant industry is stateowned & private sector is often very small.
ii. Many directors are not independent & are often
political appointees.
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2.2.3.2 State-owned industries in emerging
economies (cont.)
3. There is a critical shortage of the necessary skills
for appointment to the boards.
• Bottom-line is that state-owned company
directors have a duty to taxpayers & the
community.
• To the taxpayer they owe the duty of proper use
of funds raised in taxes.
• To the community they owe a duty of efficient
delivery of services or goods they produce.
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2.2.3.2 State-owned industries in emerging
economies (cont.)
• CACG also emphasized the need for state-owned
companies to be exemplary in their cg as they are
taken as role models by all other sectors.
• If state companies govern themselves well it
becomes easy to persuade private sector
companies to do likewise.
• If state companies are badly governed it becomes
difficult to persuade private sector to do better.
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2.2.3.2 State-owned industries in emerging
economies (cont.)
• In emerging economies an aspect of cg
governance that is worryingly becoming of
great concern is the ethical behaviour of
companies.
• The King Report has a section dealing with
ethical guidelines for companies.
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2.2.4 Whistleblowing
• Reporting act/s of misconduct or misdemeanours
by someone in an organization without using
normal channels.
• A whistleblower goes to a senior individual or
someone outside the organization.
• A whistleblowing procedure is a system that
encourages or allows whistleblowers to report
genuine suspicions of misconduct.
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2.2.4 Whistleblowing (cont.)
• The procedure gives the whistleblower
protection against retaliation.
• An employee is driven into whistleblowing by
the following:
i. violation of law or regulation by the co.
ii. a miscarriage of justice.
iii. financial malpractice &
iv. A danger to public health & safety.
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2.2.4 Whistleblowing (cont.)
• In the public sector a whistleblower might
also provide evidence of gross waste of
public funds or gross mismanagement.
• Assumption: that the whistleblower has
failed to get favourable response from
normal channels.
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2.2.4 Whistleblowing (cont.)
• Examples of situations & reasons:
i. In defence-equipment manufacturing co. a
worker may pass on information to the
press about illegal arms sales.
ii. An employee may feel his superiors are in
breach of company regulation.
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2.2.4 Whistleblowing (cont.)
• Prejudices that a company may suffer from
neglect of serious malpractices or
misdemeaners:
i. financial loss where fraud is suspected;
ii. severe penalties where employees break the law;
iii. damage to company’s reputation when
malpractice or misdemeaner is made public;
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2.2.4 Whistleblowing (cont.)
• Board & senior mgt have responsibility to
develop a culture that supports honest
whistleblowing whilst discouraging malicious
whistleblowing.
• Concerns for whistleblowing have intensified in
recent times because of the following:
i.
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Huge amount of information held in co. computer
files;
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2.2.4 Whistleblowing (cont.)
i.
Overemphasis on loyalty that has seen
whistleblowers labeled as ‘traitors’ &
victimized by co. mgt;
ii. Key role played by whistleblowers in
uncovering financial & accounting
mismanagement at Enron (2001) &
WorldCom (2002). Read Case 2.3 & 2.4
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2.2.4 Whistleblowing (cont.)
Assignment 1: (a) What type of culture exists in
state-owned companies with respect to
whistleblowers? Use real life examples to support
your answer. [30 marks].
(b) The RBZ recently benefited immensely from
whistleblowers in its effort to bring to book those
executives involved in the externalization of
scarce foreign currency resources. Give a detailed
account of the cases involved. [30 marks]
Due date: 24 March 2006.
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2.2.4 Whistleblowing (cont.)
2.2.4.1 Whistleblowing: best practice
• Whistleblowing can be honest as well as
malicious.
• Best practice requires that companies put in place
systems to encourage the former whilst
discouraging the latter.
• Companies need to develop effective systems for
listening to employees’ concerns.
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2.2.4.1 Whistleblowing: best practice (cont.)
• Diligent employees can act as an early
warning system of problems & if effectively
handled can become a reliable risk mgt tool.
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2.2.4.2 Internal procedures for dealing with
whistleblowers’ allegations
• Honest whistleblowers must not feel threatened
when making allegations.
• Procedures for whistleblowing must be known to
all employees.
• A formal internal channel for whistleblowing is a
better option than an ad hoc one.
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2.2.4.2 Internal procedures for dealing with
whistleblowers’ allegations (cont)
• Whistleblowing procedures could contain these
features:
i. Co. should provide workers with clear
procedures for whistleblowing.
ii. Rewards for honest whistleblowing & sanctions
for malicious whistleblowing should be made
clear.
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2.2.4.2 Internal procedures for dealing with
whistleblowers’ allegations (cont)
iii. Generally accepted channel is to direct
allegations to Co. Secretary for onward
transmission to a NED or a committee of NEDs
who decide on how to investigate the allegation.
iv. If criminality or huge civil liability are strong
possibilities then NEDs can enlist services of a
law firm.
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2.2.4.2 Internal procedures for dealing with
whistleblowers’ allegations (cont)
v. If option in iv above is chosen then the
independence of the law firm must be verified
by ensuring that the company is not a large
client of the law firm.
• Until workers feel a genuine & enlightened
approach to their allegations is in place many of
them will not trust internal procedures & will
opt for an external authority.
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2.2.4.2 Internal procedures for dealing with
whistleblowers’ allegations (cont)
• Going out to external authorities puts workers’
jobs at risk & a company’s reputation in serious
jeopardy.
• Whistleblowers need protection
2.2.4.3 Laws to protect whistleblowers
• Some countries have put in place laws to protect
whistleblowers.
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2.2.4.3 Laws to protect whistleblowers (cont.)
• In the UK a ‘Whistleblower’s Charter’ was
turned into Public Interest Disclosure Act 1998
which came into force in 1999.
• Under the act workers are given protection for
giving the following information:
i. Financial malpractice;
ii. Dangers to health & safety &
iii. Miscarriages of justice in their employer’s
organization.
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2.2.4.3 Laws to protect whistleblowers (cont.)
• Employees making such ‘qualifying
disclosure’ are not to suffer:
i. Demotion or
ii. Failure to receive promotion or
iii. Redundancy
• A whistleblower so penalized can take
case to an industrial tribunal.
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2.2 ETHICS & CORPORATE
GOVERNANCE
2.2.4.3 Laws to protect whistleblowers (cont.)
• Act makes ‘gagging’ clause in an
employee’s service contract void.
• Gagging clause forbids an employee from
voicing concerns about illegal activity &
gives right to employer to sack such
whistleblowers.
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2.2 ETHICS & CORPORATE
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2.2.4.3 Laws to protect whistleblowers (cont.)
• A “qualifying disclosure” protected by the
act must satisfy the following criteria:
i. Should be made in good faith;
ii. Should be made in the reasonable belief
that the information tends to reveal:
 a criminal offence;
 failure to comply with a legal obligation;
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2.2.4.3 Laws to protect whistleblowers (cont.)


a danger to the health or safety of one or more people
or
damage to the environment.
iii. It is made to employer under an internal
whistleblowing procedure ( or, in certain
circumstances, to another person)
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2.2.4.3 Laws to protect whistleblowers (cont.)
• Act also protects individuals making a disclosure
if the criteria below are met:
i. Disclosure has been made in good faith.
ii. Should not be made for personal gain.
iii. It is reasonable for disclosure to be made outside the
organization.
iv. Employee reasonably believes that he or she will be
victimized by making the disclosure to the employer.
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2.2 ETHICS & CORPORATE
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2.2.4.3 Laws to protect whistleblowers (cont.)
v.
The employee has already made the disclosure to the
employer with no effect.
vi. The employee believes making the disclosure to the
employer will result in the concealment or
destruction of evidence.
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2.2 ETHICS & CORPORATE
GOVERNANCE
2.2.4.4 Combining internal & external
procedures
• In the UK Financial Services Authority (FSA)
supervises firms in the financial services industry.
• FSA has seen the non-professional investor fall
victim to corruption & malpractice.
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2.2.4.4 Combining internal & external procedures
• FSA has suggested a plan to combine external &
internal procedures of dealing with
whistleblowing in the following steps that firms
can follow:
i.
Formal statement by co. to all employees that the firm
takes whistleblowing seriously.
ii. Firm should indicate the type of ‘failure’ that would
merit whistleblowing.
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2.2.4.4 Combining internal & external
procedures (cont.)
iii. Firm to guarantee respect for whistleblower.
iv. Firm to guarantee protection of whistleblowers
against victimization.
v. System to provide alternative lines of
communication.
vi. Whistleblowers could take their concerns to Co.
Secretary or internal auditor or audit committee of the
board.
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2.2.4.4 Combining internal & external
procedures (cont.)
vii. Employees making false claims should be
subjected to disciplinary measures by
employer.
viii.Firm should indicate procedures that
employees should follow when presenting
their concerns to outside bodies.
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2.2 ETHICS & CORPORATE
GOVERNANCE
2.2.4.5 ICSA Best Practice Guide on
Whistleblowing
• Issued in 1999 as response to Public Interest and
Disclosure Act.
• Key to effectiveness of whistleblowing procedure
is confidence of employees derived from
employer’s genuine commitment to procedure.
• Employees’ reps. should be involved in
developing procedure & in monitoring of
implementation.
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2.2.4.5 ICSA Best Practice Guide on
Whistleblowing (cont.)
• Internal wb procedures should be documented and
given to every worker.
• Procedure should indicate key aspects e.g. person
to receive report.
• Employer should indicate his/her seriousness and
commitment to the culture of openness and that
workers should report concerns without fear of
punishment.
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2.2.4.5 ICSA Best Practice Guide on
Whistleblowing (cont.)
• Should give examples of acts that are reportable.
• Make a statement that false or malicious
allegations will attract disciplinary action.
• Clear statement on external and internal
procedures.
• Statement of procedures to be used to investigate
allegations should be made.
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2.2 ETHICS & CORPORATE
GOVERNANCE
2.2.5 The co. lawyer & cg:
• The co. lawyer acts as an important adviser to the
board on matters of cg in the following ways:
 Establishing whether the co. is in breach of a law
or regulation;
 Establish nature of breach;
 Provide estimate of potential liability from breach.
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2.2.6 The co. secretary & cg:
• Co. secretary plays a key role in the application of
best practice in cg.
• He/she is close to the board & should have a
thorough knowledge of best practice in cg.
• Should be in a position to give suitable advice &
guidance to the board.
• ICSA has produced a specimen job description for
the cg role of the co. secretary. Read more about
this.
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ASSIGNMENT 1-2007-08
a)
i.
ii.
iii.
iv.
v.
b)
Transparency is one of the most fundamental principles of good
corporate governance for listed companies. Test the principle for the
following companies listed on the Zimbabwe Stock Exchange
(ZSE) by unraveling their ownership right down to the identities of
individuals and the sizes of their respective interests:
Apex Corporation of Zimbabwe Ltd.
CAFCA Limited
Innscor Africa Limited
Phoenix Consolidated Industries and
Willdale Limited
Explain the hurdles you faced in testing the principle and the
measures you took to overcome the hurdles.
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ASSIGNMENT I-2007-08 (cont.)
c)
Test the attitudes of key stakeholders of of the ZSE to the hurdles
you encountered.
d) What measures, if any, do key stakeholders of the ZSE propose for
the enhancement of transparency of ownership of listed companies
and how feasible are these measures?
Due date: 7 September 2007.
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3.0 DIRECTORS &
SHAREHOLDERS
3.1 Powers of directors.
• Contained in co.’s constitution or Articles of
Association.
• Standard form of Articles of Association, known
as Table A, found in Companies Act, Chapter
24.3.
• Most companies use it as model for own
Articles.
• Article 81 states that ‘directors may exercise all
the powers of the company’
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3.1 Powers of directors. (cont.)
• Powers are exercised subject to:
i. Provisions of the company law;
ii. Requirements of any other company’s
constitution;
iii. Directions given by a valid special
resolution of the shareholders voting in a
general meeting.
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3.1 Powers of directors. (cont.)
• Powers are given to the board of directors as a
whole but may, in terms of Article --- of Table A
be:
i. delegated to a committee of the board e.g.
remuneration committee, nomination committee,
audit committee, etc.
ii. delegated to any executive director such as the
CEO or MD.
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3.1 Powers of directors. (cont.)
• Managers have neither powers nor duties
spelt out in the Articles of Association.
• These are established in their contracts of
employment.
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3.1.1 Borrowing powers:
• There is no restriction in law as to how much
directors can borrow on behalf of the company.
• Borrowing powers of companies are only limited
by what lenders are prepared to give.
• Conceivably, the directors could therefore put the
investment of their shareholders at risk by
borrowing more than the company can safely
afford.
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3.1.1 Borrowing powers: (cont.)
• To reduce this risk many companies put a
limit to the amount that can be borrowed in
their constitutions.
• Companies also require the amount of
borrowing to be stated, vis-à-vis the limit, in
annual reports & accounts.
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3.2 Duties of directors to their company
• Duty is what one must do because of one’s job
or because one thinks it is right.
• A co. is a legal person but it is inanimate.
• Duties are generally owed to individuals or
groups.
• Directors, however, owe their duties to their
companies & not to the shareholders or
employees.
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3.2 Duties of directors to their company (cont.)
• Duties are different from accountability &
responsibility in the following manner:
 Directors have responsibility to to use their
powers in ways that seem best for the co. & its
shareholders.
 Directors should be accountable to the
shareholders for the exercise of their powers & or
the performance of the co.
 They have duties to the co.
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3.2 Duties of directors to their company (cont)
• A director in breach of duty is subjected to a
process that calls on him to account.
• This might call for a disciplinary procedure such
as a court or a judicial panel.
• Disciplinary procedures are difficult to apply
except in extreme cases of misbehaviour.
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3.2.1 Statutory duties of directors:
• Laws define duties of companies & not
those of its directors.
• But because a co. is inanimate the directors
are made personally liable for performance
of the duties
• Failure to submit CR14 returns or failure to
take minutes of meetings are examples.
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3.2.2 Other duties of directors:
• Directors have other duties that emanate
from common law.
• Yet other duties may be imposed on
directors by regulatory authorities e.g. the
Listing Requirements of the ZSE.
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3.3 Fiduciary duties of directors:
• Duties given in trust & a director becomes a
trustee of his/her co.
• Fiduciary duties require a director to exercise his
powers bona fide or in good faith towards his co.
• A director in fiduciary relationship with his co.
acts for the benefit of the co. & avoids conflict
between his/her interests & those of the co.
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3.3 Fiduciary duties of directors(cont):
• Breach of fiduciary duties may result in
legal action by the company as
represented by:
i. majority of board of directors.
ii. majority of shareholders or
iii. a single controlling shareholder.
• Source of fiduciary duties is common law.
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3. Fiduciary duties of directors(cont):
• Fiduciary duties include:
i. entering into contracts on behalf of the
company;
ii. controlling the company’s assets, etc.
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3.3.1 Tests of breach of fiduciary duty:
Three key tests used are:
i. director is in breach of fiduciary duties if he/she
engages in transactions that are incidental to the
co.
ii. He/she is in breach if transaction was not bona
fide.
iii. He/she is in breach if he/she makes personal
benefit or secret profit at the expense of the
co.(Robinson v Randfontein Estates Gold
Mining Co Ltd)
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3.4 Director’s duty of skill & care
• Basic std. is the skill & care exercised by a
rational being in looking after his/her affairs.
• Duty involves avoidance of recklessness in
decision making
• Duty entails acquisition and maintenance of
sufficient knowledge about one’s company to
discharge one’s duties properly.
• Non-performing loan portfolios may be
indicative of negligence of duty of skill & care.
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4.
•


•
Director’s duty of skill & care (cont.)
Duty does not entail:
spending more time at the co. premises or
Watching closely activities of the
company’s management.
Duty of skill & care also means directors
must question reliability of information
given to them.
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3.4 Director’s duty of skill & care (cont.)
3.4.1 Wrongful trading & std of duty & care
• In the UK directors may be liable for wrongful
trading when they allowed a co. to trade when
they knew or should have known that it would
be unable to avoid insolvency & liquidation.
• In such situation liquidator may apply to the
court for director/s to be personally liable for
negligence under the Insolvency Act.
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3.5 Fair dealing by directors:
• Fair dealing means unbiased & equitable
dealing in accordance with established
rules or guidelines.
• The Companies Acts of various countries
contain clauses for enforcement of fair
dealing by the directors;
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3.5 Fair dealing by directors (cont.)
• Such clauses cover the following matters:
i. Prohibition of loans to directors & connected
people;
ii. Prohibition of taking unfair financial advantage
especially in situations involving contracts with
the company. Generally such clauses require full
disclosure & or shareholder approval;
iii. Prohibition of tax-free payments to directors
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3.5 Fair dealing by directors (cont.)
iv. Material interests & contracts with the company.
This generally involves a director’s direct or
indirect interest through spouses, relations or
organizations;
v. Substantial property transactions e.g. transfers
of non-cash assets ( land & buildings) to prevent
overpricing;
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3.5 Fair dealing by directors (cont.)
vi. Related party transactions & listing rules
(i.e. transactions involving major
shareholder, director, member of
director’s family or a company in which a
director or family member holds a
substantial stake)
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3.5 Fair dealing by directors (cont.)
For most related party transactions listed
companies are required to:
 Make announcements of details of
transaction to the stock market;
 Send circular to shareholders and
 Obtain prior approval of the shareholders
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6. Directors’ legal responsibilities to employees &
other stakeholders
6.1 Directors’ legal responsibilities to employees
• In the UK directors’ fiduciary duties include a
requirement to have regard to the company’s
employees.
• But because fiduciary duties are owed to the
company, employees do not have a right to
enforce the requirement.
• This issue is at the centre of proposals for co.
law reform – duties of directors to employees
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should be made more
specific & more onerous.
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Directors’ responsibilities to company
outsiders
• Contracts made by directors with outsiders are
binding if made in terms of its Articles of
Association.
• When directors enter into contracts with outsiders
without proper authority (e.g. shareholder
approval) such contracts are called ‘irregular
contracts’
• Irregular contracts may be binding if they are in
accordance with the co’s Articles of Association.
6.2
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Directors’ responsibilities to company
outsiders (cont.)
• A contract may be irregular & void if it is made
outside the terms of the co’s Articles of
Association.
• The general provision of company law is that an
irregular contract with an outsider is binding on a
company when approved by the board.
• Therefore irregular contracts do not affect third
parties or outsiders.
6.2
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Shareholders’ rights:
Shareholders’ powers are limited
Shareholders do have rights that include:
The right to receive a copy of co’s annual report
& accounts;
ii. Right to attend & vote at general meetings of
the co.
• Co. law requires some proposals to to be
approved by shareholders voting in a general
meeting with specified majorities needed for
adoption of theCopyright
resolution.
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7.
•
•
i.
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Shareholders’ rights:
Shareholders’ powers are limited
Shareholders do have rights that include:
The right to receive a copy of co’s annual
report & accounts;
ii. Right to attend & vote at general meetings
of the co.
7.
•
•
i.
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7. Shareholders’ rights: (cont.)
• Co. law requires some proposals to to be
approved by shareholders voting in a general
meeting with specified majorities needed for
adoption of the resolution.
 Ordinary resolution is one arrived at by simple
majority.
 Special resolution is arrived at by at least 75%
majority.
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7. Shareholders’ rights: (cont.)
 A proxy vote is one delivered by an individual
(proxy) on behalf of a shareholder in his/her
absence.
 An electronic vote is exercised via e-mail or the
company web-site.
7.1 New share issues:
• Authority of directors to issue new shares &
rights of shareholders is an important
determinant of balance of power in a company.
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7.1 New share issues (cont.)
• Authorized share capital is the maximum no. of
shares a co. can issue & is contained in the co’s
Memorandum of Association.
• To issue more than the authorized share capital the
co. has to vote on a change to its constitution.
• Issued or allotted share capital is the actual
amount of shares has issued so far.
• Directors cannot increase the issued share capital
without prior approval from shareholders.
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7.1 New share issues (cont.)
• Such approval is generally given by shareholders
for a full year on clearly stated terms.
• In some countries shareholders enjoy ‘pre-emption
rights’ or rights to buy new shares in the co. ahead
of shares being offered to anyone else.
7.2 Rights to remove director from office:
• Co. Articles of Association & co. law give rights
& procedures to shareholders to remove a director
from office by ordinary resolution should they be
dissatisfied with his conduct.
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7.2 Rights to remove director from office (cont)
• Once a proposal to remove a director is received
from a group of shareholders the board must call a
general meeting to vote on the matter.
7.3 Election & re-election of directors
• Co’s constitutions provide for retirement of
directors by rotation & their submission for reelection should they wish to.
• In the UK moves are under way to change co. law
to force every director retire every year to give
shareholders an opportunity to vote in new people.
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7.4 Other voting rights of shareholders
• Shareholders have the following rights given by
co. law & listing rules:
i. Election & re-election of external auditors
ii. Vote for approval or reduction of final dividend
of the previous year.
iii. Vote for adoption of annual report & accounts of
the co.
iv. Vote for approval of significant transactions e.g.
acquisition or mergers.
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8. Other restraining measures against
•
•
directors
Shareholders’ rights need protection
against abuse of price-sensitive
information by directors.
Directors may also be restrained by
disqualification from office.
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8.1 Share dealing restrictions for directors
• Shares in companies can be acquired by
directors through:
i. exercise of share options &/or
ii. Share purchase through the stock market
• Because directors get to know about pricesensitive information before other investors
there is need to restrict their share dealings.
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8.1 Share dealing restrictions for directors (cont.)
• Restrictions are effected by the following
measures:
i. Maintenance of register of directors interests;
ii. Outlawing of insider dealing/trading;
iii. Putting in place measures to deal with market
abuse.
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8.2 Listing rules on directors share dealings
• Listing requirements of the ZSE require that
directors be banned from dealing in shares of
their companies during ‘close periods’.
• Close periods are:
i. Period leading to announcement of results
ii. Period leading to profit warning
iii. Period leading to announcement a major
transaction e.g. merger, takeover, an acquisition,
a divestment, a joint venture, corporate
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8.2 Listing rules on directors share dealings
(cont.)
• In some countries e.g. the UK a director of a
listed co. needs clearance from the Chairman of
the Board to deal in shares of his co.
• The restrictions in dealing in shares are
contained in what is known in the UK as the
Model Code .
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8.3 Disqualification of directors
• A director may be disqualified from holding
office
i. If he becomes bankrupt;
ii. Suffers from mental disorder;
iii. Has absented himself/herself for a certain period
without permission of his/her colleagues.
iv. Has indulged in insider trading or market abuse.
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9. Shadow & alternate directors
9.1 Shadow directors
• A person not on the board of directors but
who gives instructions & directions which
are followed by the majority of directors.
• Not common but in countries where they
exist shareholders need to be informed.
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9.2 Alternate directors
• Appointed when a director is going to be
absent for long periods.
• Once appointed an alternate director
becomes director in his/her right.
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DIRECTORS
&
SHAREHOLDERS
BALANCE OF POWER
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BALANCE OF POWER ON
THE BOARD
•
•
•
i.
Balance of power on the board is a central issue
in cg.
Balance of power is needed to avoid autocratic
leadership by an all-powerful individual which
can be harmful to the interests of all the
stakeholders.
Measures of achieving balance of power are
Suitability of character of directors, possession
of useful skills that can contribute to sound
decision-making by the board & a high level of
personal honesty & integrity.
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BALANCE OF POWER ON
THE BOARD
ii. Board should have clear set of decision-making
responsibilities including review of performance
of executive management.
iii. Separation of persons working as Chairperson
of Board & CEO.
iv. Prevent dominance of board by executive
directors by appointing a majority of NEDs with
a senior independent director.
v. Delegate task of recommending new appointees
to a nominations committee the majority of
whose members should be NEDs.
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BALANCE OF POWER ON
THE BOARD
vi. A succession plan to senior positions of the
board such as the Chairperson & CEO should be
in place.
vii. There should be suitable training for new
directors.
viii.Audit committee that is truly independent with
proven expertise.
ix. Some countries such as Germany, France & the
Netherlands have two-tier boards which consists
of a supervisory boards of NEDs & a
management board led by the CEO.
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FINANCIAL REPORTING,
REWARDS & RISK
FINANCIAL REPORTING AND
AUDITING
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Financial reporting & auditing
1. Financial reporting & cg
• Reports & accounts are used by shareholders &
•
•
other investors to assess the stewardship of
directors & the financial health of the co.
Financial statements are instruments of
accountability of directors to shareholders.
They are also instruments of communication
between directors & shareholders.
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Financial reporting & auditing
1. Financial reporting & cg (cont.)
• For them to effectively achieve the two
roles they should be:
i. Clear & understandable to a reader of
reasonable financial awareness;
ii. Reliable & ‘believable’
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Financial reporting & auditing
1. Financial reporting & cg (cont.)
• The reliability & honesty of annual report &
accounts could be undermined by:
i. fraud & error in their preparation
ii. ‘window dressing’ of financial performance or
position of the co.
• ‘Window dressing’ can be through aggressive
accounting policies (i.e. policies that make co.
performance & position look better than they
should actually be)
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Financial reporting & auditing
1. Financial reporting & cg (cont.)
• ‘Window dressing’ can also be through
•
conservative accounting policies (i.e.
policies that tend to underplay financial
performance & position of the co.)
The former hides information from
shareholders in the short term but sooner
or later the chickens come home to roost.
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Financial reporting & auditing
1.1 Financial reporting & investor confidence
• When investors have doubts about the honesty &
transparency of financial reporting they will hold
back from investing & share prices will fall.
• Problem also extends to the corporate bond
markets where due to lower bond credit ratings of
companies by top rating agencies (in the USA
Moody’s, Standard & Poor’s & Fitch) prices of
bonds will fall as demand for these wanes.
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Financial reporting & auditing
1.2
Key issues in financial reporting &
auditing.
These include the following:
• Why mgt of a co. do not want their financial
statements to give a true & fair view of co’s
performance & position?
• What are the consequences of financial statements
lacking credibility?
• What should be the role of the company’s external
auditors in ensuring that financial statements give
a true & and fair view?
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Financial reporting & auditing
1.2 Key issues in financial reporting & auditing
(cont.)
• In what ways might the independence of external
auditors be compromised?
• What measures should be taken to ensure that
published financial statements are reliable?
• How can investors obtain reassurance from
published statements that the co. is not going to go
into liquidation suddenly & unexpectedly?
– Financial reporting and auditing
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Financial reporting and auditing
2. Misleading financial statements(cont.)
• Many companies choose not to go for openness
•
•
•
& transparency in their reporting
This they do in order to report strong growth in
revenue & profits & even the balance sheet.
Generally done by ‘hiding’ debts & other
liabilities.
A co. can succeed in presenting a favourable
picture of its performance for a number of years
especially when the economy is strong &
business is growing.
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Financial reporting and auditing
2. Misleading financial statements(cont.)
• Eventually, however, it will become impossible
•
•
to ‘massage’ the figures any further.
Sooner or later a co. that uses ‘creative
accounting’ methods will have to report
declining profits.
Reports that show improving financial position
& performance, at least in the short term, show
the board of directors in favourable light & helps
to boost the co. share price.
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Financial reporting and auditing
2. Misleading financial statements(cont.)
• Individual directors benefit from this in
two ways:
i. Higher annual bonuses &
ii. More valuable share options.
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Financial reporting and auditing
2. Misleading financial statements(cont.)
• The worldwide fall in stock markets, particularly
in 2002 was because of loss of investor
confidence partly because of :
i. collapse of Enron & WorldCom without
warning &
ii. the widespread reports of major US companies
facing serious financial problems without any
slightest hint of this in earlier financial reports.
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Financial reporting and auditing
2.1 Ways of improving financial reports
• Spread income equitably over the period that it is
to be earned
• If a co. secures a contract that will earn $3 trillion
over 3 years then $1 trillion must be recognized as
income for each of the 3 yrs not $3 trillion in 1st
yr.
• Check the existence of ‘special purpose
vehicles’(i.e. companies set up to take debts off
the balance sheet)
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•
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Financial reporting and auditing
2.1 Ways of improving financial reports
(cont.)
• Check for disguisement of loans money in
operating income to increase cash flow
from operating activities.
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Financial reporting and auditing
Group Discussion:
Read the cases 7.1 to 7.5 and discuss the
following questions:
• Case Example 7.1:
i. Are there any cases in Zimbabwe’s
corporate sector history where similar
offences have been committed?
ii. Detail these cases in a written report.
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Financial reporting and auditing
•
Case Example 7.2
Do you feel curatorship as currently exercised in
Zimbabwe’s financial sector has long-term
benefits to the financial health of the sector?
Present a written report.
• Case Example7.3:
i. Are you aware of a case or cases of use of
‘special purpose vehicles’ in Zimbabwe’s
corporate sector?
ii. Detail this case or cases in a written report/s
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Financial reporting and auditing
Case Example 7.4:
How widespread are the practices of declaring
unearned income and ‘swap transactions’ in
Zimbabwe’s corporate sector?
Case Example 7.5
i. Explain clearly the events that led to the
collapse of WorldCom.
ii. Describe the debate revived in the accountancy
profession by financial reporting ‘scandals’ by
some US companies in 2001 &2002.
iii. Why are scandals
like these still very likely to 215
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happen in Zimbabwe?
Financial reporting and auditing
2.2 Blame for poor corporate financial
reporting
• When allegations of misleading financial
reporting are made the blame game starts:
i. Co. blames its auditors if they did not challenge
their accounting practices.
ii. Auditors blame the co. arguing that the choice
of accounting methods is a matter for the co.
itself.
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Financial reporting and auditing
•
i.
The blame game at WorldCom:
When WorldCom announced its $3.8 billion
accounting fraud its auditors, Arthur Andersen,
tried to lay the blame squarely on the CFO for
withholding important information from them.
ii. The fraud had been discovered by an internal
auditor in a routine check & not by one of the
external audit team.
iii. The Financial Times in an editorial of 27 June
2002 asked “ What is the purpose of an audit if
it is not to ask about hefty transfers in the
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Financial reporting and auditing
•
i.
The blame game at Enron
The US Senate investigating committee got
evidence that loans from some banks had been
disguised as energy trades or revenue to the co.
ii. When banks were asked why they did not
question this when they saw it in the reports &
accounts they blamed the solicitors and
accountants for having approved the accounting
treatment of the loans.
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Financial reporting and auditing
•
The concerns about financial reporting,
especially in the US, has drawn attention to:
i. The role of the external auditors & their
responsibilities;
ii. The responsibilities of the directors for financial
reporting;
iii. the relationship between the auditors & the
directors of their client companies.
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Financial reporting and auditing
3. Role of external auditors: the audit report
• Three issues relating to the auditors need
consideration:
i. What is the purpose of an annual audit? To what
extent can an auditor detect fraud or error in the
client company’s preparation of financial
statements?
ii. Independence from management & how it can
be protected.
iii. Controls over the audit profession.
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Financial reporting and auditing
3.1 Purpose of an external audit
• Purpose of audit report is to give users of co.
financial statements some reassurance that the
information in the statements is believable, free
of fraud & free of error.
• Fraud is intentional
• Error is unintentional & results in
i. Incorrect use of accounting policies;
ii. Omissions of fact or
iii. Misrepresentation of facts.
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Financial reporting and auditing
3.2 Responsibility for detecting fraud & error
• Auditors are not responsible for detecting fraud or
error.
• Mgt of a co is responsible for preventing &
detecting fraud & error through implementing an
adequate system of accounting & internal audit.
• Auditor should use audit procedures that provide
reasonable reassurance that material fraud or error
have not occurred.
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Financial reporting and auditing
3.3 The audit report
• Report for shareholders issued by external auditors
on completion of the annual audit.
• Forms part of the published annual report &
accounts.
3.3.1 Unqualified opinion
i. Given when auditor believes that the accounts
give a true & fair view of the company’s financial
position & performance
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Financial reporting and auditing
3.3.2 Qualified opinion
i. Given when the auditor is of the opinion
that the statements give a true & fair view
except for a particular matter.
ii. Example: acceptance of inventory figures
without physically counting them.
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Financial reporting and auditing
3.3.3 Disclaimer of opinion
i. Refusal by the auditor to give an opinion
on a particular item in the financial
statements.
ii. Auditor not provided with sufficient audit
evidence on a particular item & the
amount involved could be material.
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Financial reporting and auditing
3.3.4 Adverse opinion
i. Most negative type of modified audit report
ii. Issued when auditor believes that statements are
misleading or incomplete in a material or
pervasive way
iii. Adverse opinions are the least common form of
modified opinion.
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Financial reporting and auditing
4. Auditor independence
• Auditor independence exists when the
external auditors are able to:
i. exercise their professional judgement
without fear or favour;
ii. pass judgement without being influenced
by close relationship with client company
or matters of self interest.
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Financial reporting and auditing
4.1 Ethics & the accounting profession
• Auditors are accountants by profession
• The accountancy profession demands that
accountants in whatever sector they are
working in act with integrity & honesty.
• Accountants have to follow the code of
ethics prepared by their professional body.
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Financial reporting and auditing
4.1 Ethics & the accounting profession (cont)
• Often accountants face severe conflict
between demands of their profession and
those of their work places
• Example: a co. may force its accounting
staff to window-dress financial statements
in contravention of the code of ethics of the
the accounting profession.
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Financial reporting and auditing
4.2 Threats to auditor independence
• The following factors pose the most significant
threats to auditor independence:
i. Reliance of audit firm on co. mgt for
appointment & reappointment.
ii. Reliance of auditors on the information &
explanations of co. mgt.
iii. Undue dependence on a single client for a large
proportion of total income.
iv. Close relationship between a member of the
audit firm & an
employee of the client company
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Financial reporting and auditing
4.2 Threats to auditor independence (cont.)
v. Senior partner holding a significant
number of shares in the client firm.
vi. Performance of non-audit work by audit
company especially management function
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Financial reporting and auditing
5. The audit committee
• Codes of cg throughout the world call for
•
•
listed companies to have an audit
committee.
This is a committee of the board of
directors.
Generally codes give the minimum no. of
directors in the committee (3NEDs)
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Financial reporting and auditing
5. The audit committee (cont)
• The broad purpose of having an audit committee
is to:
i. assist board fulfill its obligations in respect of
financial reporting;
ii. strengthen independence of the external auditors
by providing another channel of communication
with the board other that the chairman, CEO or
finance director.
iii. Increase public confidence in the credibility of
the company’s financial statements.
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Financial reporting and auditing
5. The audit committee (cont)
• Functions of audit committee may vary from
company to company but could include the
following:
i. recommending the nomination & remuneration
of external auditors;
ii. reviewing the external audit;
iii. discussing problems that may arise in the
external audit with the external auditors;
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Financial reporting and auditing
5. The audit committee (cont)
iv. reviewing the company’s accounting policies
and need to make changes e.g. when new
accounting standard is issued;
v. reviewing company’s internal control
procedures;
vi. reviewing reports from the internal audit
department & in the process provide
independent reporting channel instead of
through the finance director;
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Financial reporting and auditing
5. The audit committee (cont)
vii. reviewing of financial statements prior to
approval by full board;
viii.review of independence & objectivity of
company auditors;
ix. assist board in the appointment of chief
financial officer,
x. assist in reviewing of the performance of the
CFO;
xi. ensuring adequacy of internal control
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FINANCIAL REPORTING,
REWARDS &RISK
RISK MANAGEMENT &
CORPORATE GOVERNANCE
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1. Nature of risk
• Risk refers to the possibility that something
•
•
•
unexpected or not planned for will happen.
Generally risk is taken as the possibility that
something bad will happen.
The risk or possibility that events will turn out
worse than expected is known as ‘downside risk
The risk or possibility that actual events will
turn out better than expected is known as ‘upside
risk’.
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1. Nature of risk (cont)
• Both types of risk require management which
•
i.
means making decisions about them.
Measures generally used as tools of risk
management are:
Accepting, avoiding or mitigating risk through
insurance, employment of risk managers &
assignment of responsibility for risk
management to the co. secretary.
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1. Nature of risk (cont)
ii. Internal control measures in the Accounts
Department to mitigate losses due to risk
of error, fraud & dishonesty.
iii. Institute measures to control risks from
investment activities.
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1.1 Connection between risk management &
corporate governance
• Risk mgt is relevant to cg in the following two
ways:
i. It is board’s responsibility to look after co.
assets & protect the value of shareholders
investment.
Responsibility involves duty to take measures to
prevent losses through error, omission, fraud &
dishonesty.
Control measures for such risks are provided
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through a system of
internal
control.
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RISK MANAGEMENT &
CORPORATE GOVERNANCE
1.1 Connection between risk management
& corporate governance (cont.)
ii. Board is also responsible for protecting the
company against losses from serious downside
risks such as:
- Fire damage;
- Theft;
- Flood damage’
- Accident claims by employees; etc.
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2. Internal control system
• Consists of control environment & control
•
procedures
control environment is the awareness of &
attitude to internal controls in the organization
shown by:
- directors;
- management &
- employees, generally.
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2. Internal control system (cont.)
• control procedures & policies are what is
generally called the the internal controls.
• These are devised & enforced to ensure orderly
& efficient conduct of business.
• They include the following measures to :
i. safeguard the assets of the co;
ii. prevent & detect fraud & error;
iii. ensure accuracy & completeness of accounting
records;
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iv.
Ensure timelyCopyright
preparation
of
reliable
financial
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information.
RISK MANAGEMENT &
CORPORATE GOVERNANCE
2. Internal control system (cont.)
• Several types of internal controls exist.
–
A useful method of categorizing internal controls is
remembered by the mnemonic/acronym SPAMSOAP
standing for:
• Segregation of duties;
• Physical controls;
• Authorization and approval;
• Management controls;
• Supervision;
• Organization;
• Arithmetical and accounting controls &
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SPAMSOAP
S
P
A
M
S
O
A
P
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Segregation of duties: 2 or more
people to act as counterchecks.
Physical controls: cash,computers, ..
Authorization & approval of all
financial transactions.
Mgt controls: budgetary, reviews,…
Supervision to reduce errors/fraud
Organisation for responsibilities
Arithmetic & acc. controls
Personnel
quality: skills, integrity,..
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2. Internal control system (cont.)
• Factors that influence nature & extent of
internal controls in an organization are:
i. size of organization;
ii. affordability &
iii. quantum of benefits envisaged.
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4. Role of internal audit:
• Internal audit is a control function that examines
•
& evaluates the adequacy & effectiveness of
internal controls.
Should act independently of executive managers
& report to any one of these:
i.
ii.
iii.
iv.
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board itself;
the audit committee;
the CEO or
the finance director.
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4. Role of internal audit:(cont)
• Internal audit work is not prescribed by
•
i.
regulation but is decided by mgt or the board or
the audit committee.
Possible tasks of internal audit include:
Reviewing internal control systems:
•
•
•
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checks for existence of suitable financial controls;
checks for proper application of the controls &
checks for effectiveness of the controls.
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4. Role of internal audit:(cont)
ii. Conducting special investigations into particular
aspects of organisation’s operations e.g.
outsourcing of inputs, etc.
iii. Examination of financial & operating
information for timeliness & accuracy of
reporting.
iv. Conducting value for money audits (VFM audit)
v. Reviewing compliance by organisation with
particular laws or regulations e.g. aids levy,
NSSA levy, income tax, etc.
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4. Role of internal audit:(cont)
vi. Risk assessment of adequacy of
mechanisms for:
•
•
•
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identifying,
assessing &
controlling significant risks to the organisation
from both internal & external sources.
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4.1 Investigation of internal controls
• Internal auditors are often called upon to check
the soundness of internal financial controls.
• The process entails the following factors:
i.
Whether manual or automated:
(automated controls are more reliable than
manual controls but not error-proof or fraudproof.)
ii.
Whether discretionary or non-discretionary:
(non-discretionary are mandatory;
discretionary
are voluntary)
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4.1 Investigation of internal controls (cont.)
• Whether effective in achieving purpose:
(i.e. are they extensive or frequent or
rigorous enough)
• Internal auditors can provide reassurance
that controls are effective or recommend
improvements.
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4.2
•
•
•
•
Objectivity & independence of internal
auditors
This depends on the reporting structure.
If internal auditor reports to the Finance Director
he/she will find it difficult to be critical of the
same.
The same can be said if he/she reports to the CEO.
The independence of the internal auditors could be
compromised by the reporting structure.
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5. Risk management
• Organizations face numerous risks of
•
•
varying nature & severity
Risks also change in nature & severity
over time
Some risks become less significant while
new risks emerge.
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5.1
Categories of risk
• For companies risks can be broadly divided into
business risks &financial risks.
5.1.1 Business risks
• Risks that business performance could be much worse or better
than expected.
• Examples:
i. Demand for a new product or service could be
lower or higher than had been expected e.g.
Internet services or 3G telecommunications
services.
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5.1.1 Business risks (cont.)
•
Examples:(cont.)
ii. Risk of obsolescence:
•
•
For typewriter manufacturers the risk was realised with the
arrival of the PC & word processing software.
For analogue TV manufacturers there has been the risk of
replacement by digital TV.
iii. Risk of competition:
•
•
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From new entrants to the industry.
From mergers or takeovers.
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5.1.1 Business risks (cont.)
• Examples:(cont.)
iv. Risk of liabilities or losses due to:
•
•
•
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damage to property;
actions of employees;
injuries to employees.
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5.1.2 Financial risks:
• Arises from possibility that financial situation
may turn out to be different from what had been
expected.
• Sub-categories of financial risks are:
i. Credit risks:
•
•
•
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faced by companies that lend money;
is the risk that losses from bad debts will much higher or
lower than expected;
in economic downturn many borrowers default on debt
repayments & lenders suffer severe losses.
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5.1.2 Financial risks (cont.)
ii. Foreign exchange risk:
•
•
•
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faced by companies that import or export;
arises from the possibility that a volatile exchange
rate may change for the worse or the better;
generally a weakening of the local currency
benefits exporters but disadvantages importers
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5.1.2 Financial risks (cont.)
iii. Interest rate risks:
•
•
•
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arises from possibilities that interest rates may rise
or fall & cause gains or losses there from;
companies exposed to this are those that borrow,
lend or invest on both the money & equity
markets;
such companies include banks, heavily geared
companies, investment companies & cash-rich
companies.
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5.1.2 Financial risks (cont.)
• Financial risks in the banking sector
•
•
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in the banking sector sophisticated risk mgt
techniques using internationally accepted rules
called the Basel Accord 1 & 2 are in use.
the rules are to protect depositor's funds against
losses from default on debts by borrowing
governments or multinational corporations.
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5.1.2 Financial risks (cont.)
• Financial risks in the banking sector (cont)
• rules are also to cover market risk i.e. the risk
of losses from trading on the capital and money
markets i.e. equities,bonds, foreign exchange &
money markets.
• banks are also required to keep minimum
amounts of capital to cover operational risks.
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RISK MANAGEMENT &
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•
i.
Other risks:
Regulatory & compliance risk
•
•
Risk of loss from breaking law or failure to comply with
regulation.
Risk found in such areas as:









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Health & safety.
Environment
Product safety
Competition law
Bribery & corruption
Financial services regulation
data protection
Taxation &
Company law in general.
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i.
Regulatory & compliance risks (cont)
•
•
Breaches of regulations may be punished with fines;
The hidden risks of damaged reputation & depressed morale
of employees are generally overlooked.
ii. Reputational risk:
•
•
•
•
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Risk to a company’s reputation;
Linked to CSR & regulatory risk;
Mainly suffered with customers and the public in reaction to
company’s products & activities;
In open societies reputation risks is heightened by activities
of pressure groups e.g. the Greens in Europe, the antinuclear activists groups, the SPCAs, all over the world,
labour unions, human rights groups, etc
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CORPORATE GOVERNANCE
5.2 Principles for effective risk management
• Four basic elements of effective risk mgt.
i.
ii.
iii.
iv.
•
Risk identification;
Risk evaluation;
Risk mgt measures &
Risk control & review.
Risk Identification
•
•
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Entails establishment of policies & procedures for reviewing
risks faced by the organization
Risks change over time & risk reviews should be regular
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RISK MANAGEMENT &
CORPORATE GOVERNANCE
5.2 Principles for effective risk mgt. (cont)
• Risk evaluation:
– Involves procedures to assess the potential size
of risk;
– Expected losses depend on probability that an
adverse outcome will occur & the size of the
loss should the adverse outcome materialize.
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RISK MANAGEMENT &
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5.2 Principles for effective risk mgt. (cont.)
• Risk mgt measures:
– Decided by mgt & mgt is accountable to the board.
– Measures include:
• Insurance;
• Divesting;
• Hedging using forward contracts; financial derivatives
instruments;
• Diversification product range (to avoid reliance on one
product);
• Joint ventures (to share new venture risk) &
• Cost reduction (to reduce risks from competition).
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• Risk control & review:
– Involves system that includes:
• Monitoring component;
• Internal control;
• Review mechanism.
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DIRECTORS’
REMUNERATION
1. Background
• Until the 1990s in the UK, 2002 in the US &
2005 in Zimbabwe directors’ remuneration was
not viewed as a major problem in corporate
governance.
• A sense that something might be wrong was
triggered by 3 developments:
i.
Public hostility, generated by media information, at what
they perceived to be excessive pay.
ii. Criticism by investment institutions of the ever-rising pay of
directors even when their companies performed badly &
iii. Hyperinflation in Zimbabwe
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1. Background (cont)
• Directors’ remuneration has tended to rise
•
rapidly regardless of company performance.
Yet one important principle of good governance
is that remuneration should be linked, to some
extent, to co. performance. (i.e. a director should
earn more when the co. does well & less when it
does badly)
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• Background (cont)
• In the UK the situation was exacerbated by
the fact that in many listed companies the
CEO & the executive chairman were
involved in deciding their packages.
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DIRECTORS’
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2. Public attitudes
• General perception: directors pay themselves
excessively.
• Negative sentiment has a damaging effect on
companies’ performance on the stock market.
• Private investors may become reluctant to invest
in companies that pay their directors excessively.
• If public anger is stirred to high levels this can
cause serious problems for the capital markets.
• Problem started in the UK in the 1990s with the
privatization of state-owned
enterprises.
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DIRECTORS’
REMUNERATION
2. Public attitudes (cont.)
• Same individuals got improved remunerations
when appointed directors of newly established
listed companies.
• For doing exactly the same jobs as before, they
were paid more money.
• The notorious British press led a campaign against
what they termed the “fat cat” directors such as
leaders of British Gas & United Utilities.
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DIRECTORS’
REMUNERATION
2. Public attitudes (cont.)
• In 2000 shareholders anger at allegations of
excessive use of company “perks” including use
private planes & company-owned apartments by
CEO of Tomkins, an industrial group, led to his
dismissal.
• In July 2002 Allan Greenspan attributed the
collapse of the stock markets to the “infectious
greed” of senior executives during the stock
market boom of the late 1990s which created “an
outsized increase in opportunities for avarice”
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DIRECTORS’
REMUNERATION
2. Public attitudes (cont.)
• In Sept. 2002, the President of the Federal
Reserve, Bill McDonough, attacked high levels of
remuneration for chief executives as “morally
dubious”
• He commented that the average CEO, at the time,
earned more than 400 times the average
employee’s income compared to 42 times 20 years
before.
• Yet, the President reckoned, the CEOs were not 10
times
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DIRECTORS’
REMUNERATION
2. Public attitudes (cont.)
• Public anger also aroused by revelations of
perks of former chairman of General Electric in
a divorce case:
i. use of company’s Boeing 737
ii. use of apartment in Central Park &
iii. free wine, food, toiletries, flowers, limousine
service, tickets to Wimbledon & baseball
games & country club membership;
iv. all in addition to $9m per year pension.
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DIRECTORS’
REMUNERATION
2. Public attitudes (cont.)
• Chairman gave up most of his perks fearing that
he would be seen as someone out of touch with
today’s post-Enron world.
• In Zimbabwe the current divorce case of Nomutsa
Chideya is quite revealing of the remuneration that
top executives are getting.
3. Elements of remuneration for executive directors
• Directors’ remuneration should be commensurate
with the work they do & the responsibilities they
shoulder.
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DIRECTORS’
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3.Elements of remuneration for executive directors
•
A co. that does not offer an attractive package will not
attract individuals of the required calibre.
•
Directors’ remuneration should be linked to satisfactory
performance.
•
Factors that work against effective linkage are:
i. Unsuitable measures of performance.
ii. Short term performance targets may be achieved by at
the expense of long-term development targets.
iii. because rewards are given after performance as opposed
to during performance payment might actually be done
when company’s fortunes are on the decline.
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DIRECTORS’
REMUNERATION
3. Elements of remuneration for executive directors (cont)
iv. Severance payments for poorly performing executives
have sometimes been very high giving the impression to
the investment community that one is being paid for
failure.
•
In the US when when many companies went down in
the 2001-2 stock market crash, top executives of some
corporations got away with over $3.3 billion due to
packages agreed during the boom years of the late 1990s
•
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DIRECTORS’
REMUNERATION
3.1 Issues surrounding executive remuneration
• Balance between incentive-related & basic.
• Biggest problem with this is to get incentives that ensure
that shareholders benefit irretrievably before executive is
paid.
• Involvement of executives in decisions on their
remuneration.
3.2 Component elements of the executive directors
• Consists of 2 main sets of elements:
i. Annual compensation (short-term) &
ii. Long-term compensation
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DIRECTORS’
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3.2.1 Short-term compensation set
• Basic salary;
• Pension scheme;
• Bonus that may be tied to annual financial
performance;
• Perks: medical insurance; company
car/aircraft/boat/workers/house, etc.
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3.2.1 Long-term compensation set
• Share/stock options;
• Restricted share/stock &
• Additional options dependent on long-term
performance indicators.
• Severance payment.
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REMUNERATION
3.3 Overall size of remuneration package
• Should be adequate to attract people with requisite skills,
knowledge & integrity;
• If perception is that there are not enough such people, it is
a sellers’ market;
• If perception is there is a glut of such people it becomes a
buyers’ market;
• Companies often use remuneration consultants;
• Consultants use competitive pay data;
• Use of competitive pay data can lead to sharp upward
spiral in executive remuneration;
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REMUNERATION
3.3 Overall size of remuneration package (cont.)
• General arguments used to support competitive pay is
that if you do not pay competitive pay your executives
will be poached especially for global corporates.
• The International Corporate Governance Network
(ICGN) dispels this argument.
• ICGN has been calling for measures to prevent a senior
executive remuneration spiral getting out of hand.
3.4 Performance-based incentives:
• These may be bonuses based on attainment of specific
performance targets:
i. annual profit after taxation;
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REMUNERATION
3.4 Performance-based incentives (cont.):
•
annual profit before interest & taxation (PBIT)
•
annual earnings before interest, taxation,
depreciation & amortization (EBITDA);
iv. annual increase in profit, PBIT or EBITDA
compared to previous year.
• Problems associated with using profit measures
as basis for a reward system are:
i. measures can be manipulated within the
accounting rules;
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3.4 Performance-based incentives (cont.):
ii. attainment of profit targets does not necessarily mean
shareholders benefit
iii. example: higher annual profits do not automatically
guarantee higher dividends & higher share prices;
iv. a better measure for basis of bonus payment is total
shareholder return (TSR);
v. TSR = dividends + △market value of shares;
vi. The drawback to TSR is the volatility of share prices.
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DIRECTORS’
REMUNERATION
3.4 Performance-based incentives (cont.):
• Other types of performance-based remuneration
schemes are:
i. Use of different performance targets: short-term
financial targets & long-term strategic targets;
ii. Under the the system a CEO might have 2 or
more bonus schemes: one or more based on
short-term targets & one or more based on
longer term strategic achievements.
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DIRECTORS’
REMUNERATION
3.4 Performance-based incentives (cont.):
• Problems of rewarding executives for long-term
performance are:
i. An incoming executive inherits the long-term
results of efforts of his or her predecessor;
ii. The CEO might move to another position before
full impact of his or her efforts is fully appreciated
3.5 Compensation for loss of office
• Paid to a snr executive is dismissed from office
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3.5 Compensation for loss of office (cont)
• An executive may leave a co due to
i. Failure to do the job.
ii. Disagreement or falling out with other directors
• Generally service contract of director has a
clause for payment of compensation or the co
has to give a min period of notice
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DIRECTORS’
REMUNERATION
4. Share/stock options
• A share option is a contract that gives the right but not the
obligation to purchase shares in the co at a fixed price
(exercise/strike price) anytime between 2 future dates.
• Typically the strike price is the current market price of the
share at the time the share is granted.
• Hypothetical Example: a new CEO of Innscor is granted
1m share options on 11/09/2006 at a strike price of $295
(the stock market price of an Innscor share on the day of
issue of the options)
• Options may be exercisable any time e.g. from 3 years
after issue to 10 years
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REMUNERATION
4. Share/stock options (cont.)
• If after 3 years the share price of an Innscor share has risen
to $38940 the CEO can exercise his options by buying all
or part of his 1m options at $295 and sale them at $38940
to make a profit.
• In the US starting 2007 listed companies are required to
disclose, in tables attached to their annual financial
statements, the dating of options
• This is to fight a new problem of backdating options to
coincide with low market prices of the share so as to
maximize profits.
• Backdating options is illegal in the US if it is not disclosed
to shareholders prior to issue of options.
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REMUNERATION
4.1 Share/stock options &corporate governance
• Share options can align interests of snr executives with
their shareholders i.e. when share price rises both parties
stand to benefit.
• However existing shareholders suffer the dilution of
earnings per share when large amounts of options are
exercised.
• The new Innscor CEO puts $295m into the company to get
$38940m out.
• The CEO’s gain of $38645m is at the expense of the value
of shares of all other shareholders.
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REMUNERATION
4.1 Share options &corporate governance (cont)
•
Some authorities argue that options, once exercised, are
a cost to the company because they reduce earnings per
share and market price per share.
•
Options, when issued in large blocks, can be a
contentious issue in directors’ remuneration for the
following reasons:
i. They generate temptation for directors to focus on
measures to maximize share price at the exclusion of
other measures with longer term benefits.
ii. May generate temptation to manipulate profits to boost
share price.
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4.1 Share options &corporate governance (cont)
iii. May encourage “earnings management” (The Observer:
30 June 2002 on sacking of CFO of WorldCom in June
2002)
iv. In “earnings management” the executive starts with the
profit figure expected by the shareholders and securities
analysts and then adjust sales and expenses figures so
that they give that profit thus:
S – E = $5 billion
v. When profit equals or surpasses market expectation the
share price of the company goes up and the executive
makes high profits by exercising his/her options.
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REMUNERATION
4.1 Share options &corporate governance (cont)
• Measures suggested to curb abuse of options:
i. Control sale of shares after exercise of options
e.g. executive might be required to hold on to
shares so acquired for a minimum period after
exercising the options to prevent instant cash
gain.
ii. Permitting the immediate sale of shares only to
cover the cost of buying them.
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4.2 Size of option awards
• A share option scheme will set a limit on the
number of shares for which options may be issued.
• In the UK limit might be up to 5% of issued share
capital.
• Companies are generally advised to avoid large
blocks of options as they can be used for share
price manipulation by their holders.
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4.3
Drawbacks to rewarding executives with options
• May encourage a tendency of not paying out
dividends.
• During bull runs option holders may make money
without improving their companies.
• Share options cease to be an incentive when
market price falls below the exercise price.
• Cost of share options are not included in the
annual financial statements of the company.
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REMUNERATION
4.4
•
•
•
•
Alternatives to share option awards in large
blocks
Phased grant of options in small amounts
over several years.
Award of options with a strike price above the
current market price of share.
Use of retention ratios (i.e. holding a min prop of
shares acquired by exercise of share options.)
Restricted stock, i. e. free shares given out on
condition that they are held for a min.period
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DIRECTORS’
REMUNERATION
5. Remuneration of non-executive directors
• In the UK a NED receives fixed annual fee
•
•
usually between £10k & £20k p.a.
For their perceived independence there is a
growing demand for NEDs in the main board &
board committees.
There is also a growing expectation for higher
rewards for NEDs especially those in the audit
committee.
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DIRECTORS’
REMUNERATION
5.1 Additional fees
• Some companies especially in the US have paid
additional fees to NEDs calling these
“consultancy” fees.
• Any additional payment to NED is likely to
compromise the very attribute they are hired for,
independence.
• When Enron collapsed it was revealed that a
number of NEDs had obtained additional benefits.
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DIRECTORS’
REMUNERATION
6. The remuneration committee
• In the past the CEO & Board Chairman decided
•
•
i.
the elements & magnitude of remuneration of
the snr executives including theirs.
System was open to abuse as shown below
Example: After fall of Enron a Senate subcommittee reported in 2002:
In one financial year cash bonuses of almost
US$750m were paid to snr executives when total
reported net income was only US$975m.
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REMUNERATION
6. The remuneration committee (cont)
ii. Executives were allowed to run off-balance
sheet partnerships with co. that earned millions
of dollars at Enron’s expense.
iii. NEDs had other financial ties with the co. the
saw them paid consultancy fees.
• Due to increased concerns over directors’
remuneration in the UK the Greenbury
Committee Report reached the following
conclusions:
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DIRECTORS’
REMUNERATION
6. The remuneration committee (cont)
i.
Formulation of remuneration packages for snr
executive directors was a fundamental issue for
good corporate governance
ii. The system was open to abuse if executives
could decide their own remuneration.
iii. Shareholders could not decide directors’
remuneration but had every right to extensive
information about it.
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REMUNERATION
6. The remuneration committee (cont)
iv. Remuneration of executive directors should be
decided by a remuneration committee of the
board made up entirely of independent NEDs.
• In the US in 2002 the NYSE committee
suggested that the compensation committee
should:
i. Produce annual report on executive
remuneration;
ii. Review & approve the corporate goals relevant
for the remuneration package of the CEO;
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REMUNERATION
6. The remuneration committee (cont)
iii. Evaluate performance of the CEO in the light of
the goals;
iv. Set remuneration level of CEO on basis of
evaluation.
v. Make recommendation to the main board with
regard to incentive-based & equity-based
remuneration plans.
• In Zimbabwe the composition & duties of the
remuneration committee vary from co. to co.:
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REMUNERATION
i.
Dawn Properties (Yr ending March 2006):
Comp.: • 2 NEDs + CEO
Duties: • formulation of market
related remuneration policies
• review & approve remuneration
of snr executives.
ii. Interfresh (Yr ending Dec. 2005)
Comp.: • 3 NEDs only
Duties: • setting remuneration of directors,
executive management & the granting
of share
options
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DISCUSSION QUESTIONS
FAMILY BUSINESSES: HANDING OVER THE CROWN
1. For the past 6 or so years Zimbabwe has
witnessed a shrinkage of the formal sector and a
growth of the informal sector dominated by
family businesses. Use the special report:
i. Family businesses: Passing on the crown.
Nov 4th 2004: The Economist print ed. &
ii. Your own knowledge of Zimbabwe’s socioeconomic conditions
to analyze the main corporate governance issues
that surround informal family businesses.
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DISCUSSION QUESTIONS
CEMENTO ARGOS OF COLOMBIA
1. Describe the main features of the Corporate
Governance Code developed by Cemento Argos
of Colombia
2. The The Good Governance Code of Cemento
Argos published in 2004 complies with
recommendations of foreign bodies like NYSE,
OECD, World Bank, the Brazilian Institute for
Corporate Governance (IBGC) & those of local
institutions. Explain why this is so.
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