Company Law II

Module 1: Corporate Governance

INTRODUCTION

What Is Corporate Governance: Singapore Code of Corporate Governance the processes and structure by which the business and affairs of the company are directed and
managed..
..to enhance long term shareholder value through enhancing corporate performance and
accountability
..taking into account the interests of other stakeholders.
Good corporate governance therefore embodies both enterprise (performance) and accountability
CG Models and CG Practices: In the Report of the HIH Royal Commission in Australia, which
investigated the collapse in 2001 of Australias second largest insurance company (HIH), Owen J stated:
Corporate governance - as properly understood describes the framework of rules, relationships,
systems and processes within and by which authority is exercised and controlled in corporations.
Understood in this way, the expression corporate governance embraces not only the models or systems
themselves but also the practices by which that exercise and control of authority is in fact effected.
I am becoming less and less comfortable with the phrase corporate governance not because of its
content but because it has been so widely used that it may become meaningless. There is a danger it will be
recited as a mantra, without regard to its real import. If that happens, the tendency will be for those who
have to pay regard to it to develop a tick the box mentality. The attitude might be, Yes, we have a state-ofthe-art corporate governance model; yes, it is committed to writing; and, yes, the company secretary has
checked that each item is in place and has included a statement to that effect in the annual report. Therefore
there could be no problem in the corporation..HIH had a corporate governance model. The
directors said so in the annual reports. But there is little, if any, evidence that the board periodically
assessed the companys corporate governance practices to ensure that they were, and continued to be,
suited to the changing environment in which the company operated. For example, what might have been
adequate for a group that was primarily Australian-based, as it was in 1996, might not have been so as the
overseas operations burgeoned in subsequent years. The danger of this practice is that, among other things,
it can lead to the tick the box approach just mentioned. There is little point in having a corporate
governance model if the directors fail to examine periodically its practical effectiveness.

Systems and structures can provide an environment conducive to good corporate governance practices,
but at the end of the day it is the acts or omissions of the people charged with relevant responsibilities
that will determine whether governance objectives are in fact achieved. For example, the identification of
the background, skills and expertise of the people who walk into the board room is a good start, but it is
what they do when they get there that is critical.
CG Best Practices & Corporate Culture: In the HIH Report, Owen J commented:
There is a demand for more transparency by companies about their governance processes. This is
accompanied by a demand for a more prescriptive approach to so-called best practice. In general this trend
is healthy and is to be welcomed. It should not however be overdone.Nonetheless the effectiveness of
corporate best practice models in themselves is limited. Those companies with an ethical culture are likely
to adopt appropriate corporate governance practices, while those where this culture is lacking are more
likely to continue to adopt an idiosyncratic or expedient approach. Those in charge of a company should
turn their minds to the effectiveness of their governance model in practice, and not content themselves with
the mechanisms. It is yet another instance where substance is to be preferred to form.

Two Categories of CG problems: Adverse Selection incompetence, negligence, shirking

Moral Hazards dishonesty, disloyalty: self-dealing, fraud, stealing
Recent CG Problems:
Adverse selection: Daniels v Anderson (1992 & NSWCA 1995); Barings
Moral hazard cases: Enron, Worldcom, Hollinger, Parmalat, HIH, Satyam.
Factors Influencing CG:
- Ownership Structure: separation of management & ownership
dispersed ownership & managerial control
institutional investors (pension funds, mutual funds etc)
hedge funds
ownership concentration (Spore, Europe, Asia)
- The Corporate Decision Process:
4 Steps:- (1)
(2)
(3)
(4)

Initiation of activity
Ratification
Implementation
Monitoring

Decision Management: initiation + implementation

Decision Control: ratification + monitoring

Decision Management + Decision Control = key components of corporate decision process.
Decision management process controlled by professional managers whose interests not necessarily
similar to those of residual claimants (shareholders), giving rise to 2 problems:
(1) moral hazard (loyalty) problem, and
(2) adverse selection (managerial incompetence) problem.
These agency problems give rise to agency costs, which include costs of structuring, monitoring,
and bonding.
An effective system of decision control implies Control (ratification + monitoring) decisions
separate from Management (initiation + implementation) decisions.
Agency problems may be controlled by decision systems that separate Decision Management and
Decision Control of important corporate decisions at all levels of the organization: Devices for
separating decision management and decision control include (1) decision hierarchies in which the
decision initiatives of lower level agents are passed on to higher level agents, first for ratification
and then for monitoring, (2) boards of directors that ratify and monitor the organizations most
important decisions and hire, fire, and compensate top-level decision managers, and (3) incentive
structures that encourage mutual monitoring among decision agents.
(Fama & Jensen, Agency Problems and Residual Claims, SSRN 1983)
Modern public company: internal control delegated by shareholders to board of directors (as apex
of decision control system), but retain approval rights on various matters (board membership,
appointment of auditors, share issues, mergers and acquisitions, etc); other management and control
functions are left to the board who then delegates limited management and control decisions to
other managers down the line as it retains control (ratification + monitoring).
Where the decision processes are dominated by an individual CEO, this signals absence of
separation of decision management and decision control.
Role Of CG & Corporate Law
Management (Adverse Selection and Moral Hazard) Issues: How should CG and Corporate Law
intervene in such issues?
Enterprise and Ownership Issues:
Enterprise Issues: eg. Should the company manufacture TVs rather than cell phones or computers? Should
a trading company move into property development as a business? Should a company move its
manufacturing plant from Singapore to Shanghai?
Ownership Issues: eg. Should a property/hotel company merge with an airline or an electronic company?
Should a company change its ownership or capital structure in order to fend off a takeover bid by another
company?

How, if at all, should CG and Corporate Law intervene in such issues?

Pre-emptive Measures
Management & Oversight Structures, Independent Directors, Board Committees, Internal Controls
Shareholders Participatory Rights
Shareholders voting rights as check on managerial abuse and influence on corporate direction, removal
of directors, advisory vote on executive remuneration
- dispersed ownership: problem of collective action, shareholder apathy, free-riders
- substantial or concentrated ownership: influence of controlling shareholder; institutional
investors; minorities & hedge funds
Shareholder Protection
Markets - Capital Market: gatekeepers, analysts, stock brokers, institutional investors, takeovers
Debt Market: debt covenants, banks. other creditors
CCG, Stock Exchange - eg Singapore CG Code and 2012,
UK Combined Code of CG, as revised June 2010 (Cadbury, Higgs, etc)
OECD CG Principles
Stock Exchange Listing Requirements (In India, this is enshrined in
Clause 49 of the Listing Agreement).
Legal & Regulatory- Statutory Disclosures: Conflicted Transactions
- Statutory provisions affecting board composition: AC & INDs; election and
removal of directors
- Statutory control rights of shareholders: eg share issues, stock options, M & A
- Other Statutory Prohibitions: Director Loans & certain compensations
- Common Law duties of care, oversight & fiduciary obligations;
- Statutory duties under SCA: diligence, honesty, etc
Access to Legal Remedies: Public Enforcement/Prosecutions
Private Litigation derivative actions; statutory minority actions
Some Special Issues:
US - INDs, Litigation, Disclosures, Takeover Market
Australia/UK - INDs, Shareholder Control, Disclosures

Shareholder v Director Primacy Debate in the US

Enforcement Issues: CG & SX comply or explain
Civil actions and remedies
Criminal sanction
Cultural & Globalization Factors:
Western historical origins of CG current best practices of CG based on developed Western
economies;
- Western CG driven by capital markets; pressure on
companies to adopt governance regime conducive to
investment by investors, esp. fund managers, pension
funds, etc.
Asia Many Western style CG measures introduced:
(a) in wake of recent Asian financial crisis, notably 1997;
(b) globalization of trade, business and investment, eg. cross-border listings,
cross-border investments, M & A activities;
(c) diversion of capital away from countries perceived by the West to be high
risk due to weak CG structures, processes and practices (eg. no independent
directors, no audit committees, no transparency, no risk management and
internal control mechanisms).
One Size Fits All CG:
(a) Even in the West, it is increasingly recognized that a prescriptive one size fits
all approach to CG is a mistake; need to pay attention to company-specific
characteristics, esp. ownership structures;
(b) Need to focus on country-specific attributes of CG systems specific country
historical experience, political, cultural, social norms;
(c) Western legal cultures individualism, rationalism, transparency;
(d) Asian Confucian culture collectivist, hierarchical, national order, personal
relationships, long-term orientation, informality, as opposed to structural and
process based governance.