Transcript Strengthening Corporate Governance with the OECD Principles: An Outcome-oriented Approach Dr. William Witherell

Strengthening Corporate Governance
with the OECD Principles: An
Outcome-oriented Approach
Dr. William Witherell
Director for Financial and Enterprise Affairs
Organization for Economic Cooperation and Development (OECD)
Academy of European Law Seminar
Corporate Governance: Legal Implications for Europe and the
United States
Trier, Germany 7-8 March, 2005
1
BACKGROUND AND OVERVIEW




After Asian Crisis, corporate governance
reform seen as a priority for emerging markets.
OECD Principles agreed in 1999 and soon
became the international benchmark.
More recent wave of corporate scandals and
large failures in major OECD advanced market
economies undermined investor confidence
and has lead to wide-spread governance
reforms.
OECD in 2003-4 carried out a review and
updating of the Principles in light of recent
experience.
2
But why do national and international policymakers care about corporate governance??

The dominance of the joint-stock corporation

Institution building in less developed
countries

The growth of the private corporate sector

The growth of equity markets

The growth of international private capital
flows
3
Corporate Governance influences the
outcomes at all stages of the investment
process

The mobilization or raising of capital (in
both domestic and international markets)

The allocation of capital to its most effect
uses

The monitoring of how capital is employed
4
Why “core principles”?



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Enormous variation in ownership and control
structures in the world
No single model of good corporate
governance: but need for a global language
Detailed codes, best practices should be
established at national and regional levels
Objective: to identify common elements or
core principles underlying good corporate
governance across the different systems: a
multilateral policy framework
5
Implications of “core principles”:
outcome-oriented




The Principles cover the general features or
functions to be in place, e.g. high level of
accounting standards, diligent and capable
directors.
These are termed outcomes.
They involve functional equivalence: they can
be achieved in many different ways and with
different institutions.
Principles need, therefore, to be adapted to the
legal and institutional environment of each
6
country.
The OECD Principles are based on a
wide interpretation of corporate
governance, which emphasises
resource inputs :
“Corporate governance … involves a set of
relationships between a company’s management,
its board, its shareholders and other stakeholders.
Corporate governance also provides the structure
through which the objectives of the company are
set, and the means of attaining those objectives
and monitoring performance are determined.”
7
Moreover,

“Good corporate governance should
provide proper incentives for the board
and management to pursue objectives that
are in the interests of the company and
shareholders and should facilitate
effective monitoring, thereby encouraging
firms to use resources more efficiently”.
8
Two implications for the desirable
characteristics (outcomes) of a corporate
governance system

Checks and balances

A structure of incentives that is
compatible with the checks and balances
and with achieving the objectives of the
company
9
Intended uses of the Principles

Primarily aimed to provide a conceptual
framework for governments.

Guidance also for stock exchanges,
investors, corporations, commissions.

A benchmark that facilitates convergence.
10
The Principles are the international
benchmark




Endorsed by the Financial Stability Forum as one
of 12 Key Standards for Sound Financial Systems
Used as the basis of the corporate governance
component of the World Bank/IMF Reports on the
Observance of Standards and Codes (ROSC)
Recommended by the Emerging Markets
Committee of the International Organization of
Securities Commissions (IOSCO)
Provide a basis for numerous national or sectorspecific codes and listing requirements.
11
The objectives of international cooperation under OECD-World Bank
Corporate Governance Partnership



To build the rudiments of a global
normative framework
To build a corporate governance culture
among corporations and investors
To marshal human and financial resources
at a global level in order to help regional
and local, private and public efforts bear
their fruits.
12
OECD-World Bank
Regional Corporate Governance Roundtables

Public-Private regional dialogue.

Participants are senior policy- makers,
regulators, corporations, investor,
professional organizations, labor, and
others.

OECD Principles are a framework for the
dialogue.
13
Non-OECD Countries in the Roundtables

Asia:

Latin America:

Eurasia:

South

Russia
Bangladesh, China, HK (China), India, Indonesia,
Malaysia, Pakistan, Philippines, Singapore, Sri Lanka,
Chinese Taipei, Thailand, Viet Nam
Argentina, Bolivia, Brazil, Chile,
Columbia, El Salvador, Peru, Uruguay, Venezuela
Armenia, Azerbaijan, Georgia, Kazakhstan,
Kyrgyz Rep., Mongolia, Ukraine, Uzbekistan
Eastern
Europe:
Albania, BosniaHerzegovina, Bulgaria, Croatia, FYR of Macedonia, Serbia
and Montenegro, Romania
14
Objectives of the Roundtables

Improve understanding
discussion and exchange
through
peer

Identify areas for improvement and
formulate reform agenda: the White
Papers

Facilitate regional participation in global
dialogue on corporate governance

Identify needs and facilitate provision of
technical assistance.
15
Core Elements of the OECD Principles
1.
2.
3.
4.
5.
6.
Assuring an effective framework(1)
The rights of shareholders
The equitable treatment of
shareholders
The role of stakeholders
Disclosure and transparency
The responsibility of the boards
(1) This chapter added in 2004
16
Setting the new Chapter 1 aside until
later, let us look briefly at chapters II
to VI in reverse order to better
understand the overall logic of the
original Principles.
17
VI. The responsibilities of the board
“The corporate governance framework
should ensure the strategic guidance of the
company, the effective monitoring of
management by the board, and the board’s
accountability to the company and the
shareholders.”
Thus the board serves as the fulcrum,
balancing the ownership rights enjoyed by
shareholders with the discretion granted to
managers to run the business.
18
V. Disclosure and transparency
“The corporate governance framework should
ensure that timely and accurate disclosure is made
on all material matters regarding the corporation,
including the financial situation, performance,
ownership, and governance of the company.”


The process of disclosure and the integrity of
the accounting and financial reporting systems
should be overseen by the board.
Disclosure should include information about
the control structures and ownership of the
firm which should make potential conflicts of
interest (i.e. the incentive structure)
19
transparent.
Principles II, III and IV concern shareholders and
stakeholders, who have an important role in
effecting checks and balances
II. The rights of shareholders
“The corporate governance framework should
protect shareholders’ rights.”
III. The equitable treatment of shareholders
“The corporate governance framework should
ensure the equitable treatment of all
shareholders, including minority and foreign
shareholders. All shareholders should have the
opportunity to obtain effective redress for
violation of their rights.”
20

IV. The role of stakeholders in corporate
governance
“The corporate governance framework
should recognize the rights of
stakeholders as established by law and
encourage active co-operation between
corporations and stakeholders in creating
wealth, jobs, and the sustainability of
financially sound enterprises.”
“Stakeholders” include employees,
creditors, depositors, pensioners
21
In sum,

The Principles thus comprise checks and
balances: the board oversees management and is
in turn overseen by shareholders, creditors and
stakeholders who must be sufficiently informed to
do this.

Information should also make it possible to
understand the incentive structure facing the
board and management and thus make the checks
and balances effective.
22
The 2002 call by OECD Ministers
for an assessment/review of the
Principles
23
Policy concerns and driving forces

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Corporate scandals and large failures….
New awareness of links between corporate
governance arrangements and growth
Revealed need for improving:
»Implementation and enforcement
»Transparency and disclosure
»Alignment of incentives
»Monitoring by boards
»Shareholder rights
24
Recent Legal or Regulatory Changes in G-7
Comply or
Explain with
Principles or
codes
United
States
Comply
only
Germany
Defining
audit
functions
and limits
on auditors
X
X
France
United
Kingdom
1/2
Italy
Canada
Japan
X
Defining
and
controlling
conflicts of
interest
Improving
or easing
voting;
greater role
for AGM
X
Role for
independent
directors
X
X
X
X
X
X
X
X
Improving
transparency
X
X
X
X
X
X
X
X
25
OECD Ministers at their 2002 Annual
Meeting

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Observed that the integrity of corporations,
financial institutions and markets is essential to
maintain confidence and economic activity and to
protect the interests of stockholders.
Agreed to implement best practices in corporate
and financial governance which entails an
appropriate mix of incentives, balanced between
government regulations and self regulation,
backed by effective enforcement.
Agreed to survey recent experience and assess
the Principles of Corporate Governance.
26
The Review Process

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OECD’s Steering Group on Corporate Governance
carried out the Review (30 OECD Governments, World
Bank, IMF, IOSCO, BIS, Basel Banking Committee, BIAC,
and TUAC)
Consultations held with a wider group of interested
parties, with non-OECD countries, and with several highlevel roundtables chaired by the Secretary-General
A survey of corporate governance developments in
OECD countries since 1999, and a summary of
experiences in non-OECD countries were produced.
Draft revisions placed on web for comment.
2004 Revision of the Principles endorsed by OECD
Ministers in May 2004
27
The key reference
OECD PRINCIPLES OF
CORPORATE GOVERNANCE 2004
Available for free download at
www.oecd.org/corporate
And for developments in the OECD
and non-OECD countries:
• CORPORATE
GOVERNANCE – A
SURVEY OF OECD
COUNTRIES – 2004
• EXPERIENCE FROM THE
REGIONAL CORPORATE
GOVERNANCE
ROUNDTABLES – 2003
Five sets of issues at the forefront of
discussions
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Ensuring an adequate regulatory framework
for corporate governance, taking account of
costs;
The effective exercise of share ownership
and the increasing role of institutional
investors;
The changing nature and role of the board;
Dealing with conflicts of interest
Stakeholder concerns
30
Issue 1: Ensuring an adequate
regulatory framework for corporate
governance, taking account of costs
31
Implementation and enforcement of
laws, regulations and codes

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Enacting laws, regulations and codes that meet
international standards is the easy step; effective
implementation and enforcement is much more difficult.
Scope and content of self regulation is under scrutiny;
incentives facing the professions may conflict with their
integrity and credibility to uphold and enforce expected
standards.
Capacity and independence of regulatory and enforcement
authorities are a serious concern, especially in emerging
market and transition countries.
Legal and regulatory framework should provide
shareholders opportunity for effective legal redress.
32
Key elements of disclosure and
transparency
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Major share ownership and voting rights
Material foreseeable risk factors
Full financial disclosure
Governance structure and policies
Information should be prepared audited
and disclosed in accordance with high
standards of accounting, audit and nonfinancial disclosure
Regular disclosure
33
The integrity of the disclosure process
and of transparency have been called
into question
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Rules-based accounting leads to “show
me I cant do it mentality”.
Holes such as derivative, pension and
options accounting are too wide.
Audit independence called into question.
They think they are employed by
management.
Standards of the big 4 not what they were
expected. Peer review failed.
34
Reactions
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Auditor independence strengthened both
structurally and by rules.
Move effective responsibility to another
organ than management
Convergence of accounting standards -but implementation an issue.
Greater consideration of disclosure of
material information
More calls for non-financial disclosure
35
Auditors in G-7
Auditors:
Independent
of consulting?
Auditors:
rotation?
Britain
France
Germany
Japan
USA
Italy
Canada
Recommended
(comply or
explain)
Voluntary
NO
YES
YES
YES
YES
5/7 years
(voluntary)
NO (two
auditor
system)
NO
YES (7
years)
YES (5
years)
YES (9
years)
YES (7
years)
36
IOSCO released (Oct. 2002) principles for national
standards covering auditor independence and auditor
oversight….
 Reflect a growing international consensus.

Many in OECD consider these principles to be minimum
requirements.

Importance of audit firms establishing internal
monitoring and control systems.

Auditors should be subject to an independent auditor
oversight body, or if a professional body plays that role,
it should be overseen by an independent body.
37
The Financial Stability Forum has “…underscored
the importance of progress towards a single set of
high quality principles-based accounting standards,
with due regard to financial stability concerns.”
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US moving closer to a principles-based system.
Process in place to work towards convergence of
IAS and US GAP.
EU (including its candidate states), Australia, NZ,
Hong Kong, Russia, Singapore to adopt IAS.
Indeed, GAAP Convergence 2002 survey of 59
countries indicated that all but three ( Japan,
Saudi Arabia and Iceland) intend to converge
with IAS.
38
A number of countries have moved to require better
disclosure of board and executive compensation…

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Nomination and appointment of the board is a key
corporate governance decision; transparent and evenhanded nomination and recruitment process is needed.
Remuneration including information on the structure of
compensation schemes and termination conditions
relevant not only for financial implications but also for
assessing incentives and performance.
Some countries call for disclosure of individual
remuneration; others ask for only aggregate board
compensation.
NYSE and NASDAQ have proposed independent
compensation committees; codes and principles in
39
other countries go in same direction.
Ensuring that corporate service providers
work in the interests of shareholders…
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In exercising ownership rights, shareholders have to
rely on agents (brokers, investment advisors,
analysts, rating agencies) for information.
Recently a number of cases of serious conflicts of
interest and inappropriate incentives have come to
light.
Responses include changes in stock exchange rules
and professional codes of conduct, structural
changes such as firewalls, and increased disclosure,
e.g., of material conflicts of interest.
40
The Principles: Ensuring an adequate regulatory
framework for corporate governance, taking
account of costs ( A new Chapter 1)

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

Clear objectives for policy in establishing a system leading
to transparent and efficient markets.
Legal and regulatory instruments to be transparent and
enforceable.
Clear division of responsibilities between domestic
authorities
Supervisory, regulatory and enforcement authorities
should have authority, integrity and resources to fulfil
duties.
Greater role for shareholders and improved transparency
Improved financial market integrity (see next slide)
41
Also assuring financial market integrity



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
Better disclosure by the company including related
party transactions
Boards to focus on overseeing internal controls and
major accounting assumptions through independent
audit committee.
More emphasis on auditor independence and
reference to IOSCO standards.
Accountability of external auditors to shareholders
and duty of professional care to the company
Those providing analysis and advice to be free of
conflicts of interest
42
Issue 2: The effective exercise of share
ownership and the increasing role of
institutional investors
43
The corporate governance framework
should protect shareholders rights

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

Right to have shares registered and
secure
Should be able to take part in shareholder
meetings and in major decisions
concerning the firm
Equitable treatment of all shareholders,
foreign and minority especially
Should not be abused by insiders
44
But in practice the rights are often
weak and redress is difficult




Need for greater voice through
strengthened voting rights and
information
More active institutional investors and
disclosure of their conflicts of interest
In presence of major shareholders
improve protection of minority
shareholders
Takeovers often blocked
45
Improving Shareholder voice…



The ability of shareholders to elect board
members of their choice, to table
proposals and ask questions of directors
is, in reality, very limited in a number of
countries.
Should shareholders be given more
decision rights with respect to board and
executive compensation?
Need to avoid shareholders second
guessing management
46
Ownership and shareholding
structures
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The transparency of ownership and
shareholding structures, including pyramids
that result in control rights being greater than
cash flow rights, is limited in many cases.
The Regional Roundtables have called for
improvements in the disclosure of beneficial
ownership to assist in efforts to curb abusive
related party transactions.
Beneficial ownership information also is
important for the battle against international
financial crime
47
Regional Roundtables on shareholder
rights and equitable treatment…




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Typically high degree of concentrated ownership, with
control through pyramids and cross-holdings, combined
with weak shareholder protection and insufficient
disclosure: equitable treatment of shareholders is a
pivotal issue.
Need to facilitate the exercise of shareholder rights.
Minority shareholder rights in relation to changes in
capital structure, in corporate control and delisting a
concern (lack of pre-emptive or tag-along rights, etc.)
Voting of depository receipts.
Frequent abuse of related party transactions; improved
disclosure needed.
48
Improving and facilitating the exercise of
voting rights…

Exercise of voting rights varies widely
VOTES CAST BY INVESTORS AS A % OF TOTAL
U.S.
Japan
U.K.
83%
71-80%
50%

Greater use of electronic communications?
Institutional investors that act as fiduciaries being
pressed to be more active.
Legal and practical problems to cross-border voting
widespread among the OECD countries.


49
Over The Past Two Decades Institutional Investors
Have Grown Significantly In Size and Importance
Financial Assets of Institutional Investors in OECD as a Proportion of GDP
148.82
140.74
160
140
120
81.09
100
Per Cent
80
60
38
40
20
0
1981
1991
1999
2001
Source: OECD Institutional Investors Statistical Yearbook 2003
50
Financial assets of institutional investors as a
per cent of GDP – Some individual countries
1991
2001
United States
124.2
191
United Kingdom
116.3
190.8
Sweden
82.8
153.5
France
56.4
131.8
Japan
73.3
94.7
Korea
49.5
77.2
Australia
56.2
129.7
Source: OECD Institutional Investor Yearbook 2003
51
The rights and responsibilities of
institutional investors.

While institutional ownership is growing in size and
importance, institutional investors typically play a
limited role in corporate governance.

The issue is not always to add to their already
established rights as shareholders. The problem is
that they do not make use of them.

This is partly due to a lack of proper incentives and
sometimes due to restrictions on their ability to set
aside sufficient resources to carry out key ownership
functions in an informed way.
52
Should those who act as fiduciaries
disclose their voting policies? If they do,
it would also be natural to ask that they
disclose how they, in practice, will
implement these policies; for example
what resources will they set aside to
carry out their ownership functions
53
The Principles: The effective exercise
of share ownership and the increasing
role of institutional investors




Call for effective shareholder participation in key
decisions such as the nomination and election of board
members, proposing resolutions and making views
known on compensation policy
Improved possibilities for shareholders to consult with
each other on key governance issues.
Eliminating impediments to cross border voting
Call for institutional investors acting in a fiduciary
capacity to declare voting policies and how they are
handling conflict of interests
54
Also control abuse between related
companies





Clear statement on fiduciary duties of board
members to the company and not to the company
group.
Explicit statement that boards to review related
party transactions using independent directors
Stronger annotations on disclosure of related
party transactions
Stronger principle on board and executive
disclosure of material interests
Stronger call for protection of minority
shareholders
55
Issue 3: The changing nature and role
of the board
56
He’s becoming insufferably ‘More transparent than
thou!’
57
Towards independent and more effective
boards…


Moves towards increasing not only the number of nonexecutive directors but also ensuring they are
“independent”:
1. UK - Higgs Report
2. Japan – new company law
3. US –
Commission on Public Trust and Private Enterprise
NYSE
Sarbanes-Oxley
Independence of judgement and independence from
management.
58
Board Integrity Issues
Responsibility to Whom? Is it Clear?
 Duty of Loyalty / Duty of Care
 Status of Independent Directors
 Legal Status of Committees
 Alternate / Supplementary Directors

59
Legal requirements for boards in the
G-7
Britain
Independent No (comply or
directors
explain if a half
not
in a majority
independent)
on board?
Separate
chairman
and CEO?
France
Germany
Japan
USA
Italy
Canada
NO
YES
(supervi
sory
board)
NO
YES (NYSE
and NASDAQ
listing
requierment)
NO
No.
Comply or
explain
No.
Voluntary
No. Voluntary
No. comply or Voluntary
YES
explain
(supervi
sory
board)
No.
No.
Voluntary Comply or
explain
60
The Principles: The changing nature
and role of the board




More general statement of board independence to
cover “those in a position to influence the
company and not just management”
Greater possibilities for shareholders to question
boards and to participate
Tightening of fiduciary responsibility of boards
Strengthened principle calling for boards to
establish ethical guidelines and effective
compliance procedures
61
The board (continued)



Boards to oversee internal controls and provide
confidential access to whistleblowers
Disclosure of mandate, working procedures and
composition of board committees
Boards to align key executive and board
remuneration with the longer terms interests of
company and shareholders and establish a
remuneration policy
62
Issue 4:Dealing with conflicts of
interest
63
The Principles: Dealing with conflicts
of interest




Institutional investors called on to disclose
conflicts of interest and how they manage them.
Providers of advice to investors, such as
analysts and brokers, should provide advice free
from conflicts of interest
Tighter conditions specified to ensure no
material conflict of interest by auditors and
thereby guard auditor independence
Tightened disclosure standards to the board and
64
to the market
Issue 5: Stakeholder Concerns
65
The role of stakeholders in corporate
governance





Stakeholders include creditors, depositors
and employees
Encourage active co-operation between
between company and stakeholders
Performance enhancing mechanisms
should be available
Redress for violation of legal rights
Access to relevant information
66
Stakeholders Issues are complex and difficult.
Best to consider two major groups- creditors and
employees – separately
Creditor rights are important for the terms and conditions
of finance…
 These rights arise from bankruptcy and other laws, but
in some countries these rights are deficient and/or the
courts are poorly structured to enforce them.
 Recent reforms in Germany, Japan and Italy.
 Reorganization procedures and the rights of creditors to
remove management vary widely.
 World Bank and UNCITRAL developing principles.
67
Regional Roundtables have stressed their
concerns about corporate practices that impede
the opportunities for employees
 to seek redress for violation of their rights.
 To communicate their concerns about illegal or
unethical transactions they have observed or
asked to undertake.
Such complaints can provide important
information to shareholders.
68
The Principles: The role of stakeholders





Recognise the role of stakeholders to creating value
and therefore corporate governance framework
should recognise their interests.
Whistleblower protection is now a principle
covering individuals and their organisations
Better disclosure to stakeholders and of company
policy towards them.
Improved powers for shareholders and greater
pressure for institutions to disclose voting policies
important for pensions.
Principle that board should set company ethics and
establish a compliance policy will benefit
employees
69
Summary of steps toward implementing
more robust corporate governance regimes




Review regulatory costs of any proposed
measure and whether there are any more
effective instruments at hand.
Strengthen market disciplines as they are the
most effective continuing discipline on
management. Give emphasis to getting
incentives aligned properly.
Strengthen the ownership function of
shareholders.
Monitor the governance system – particularly the
effects of new measures.
70