P1

Chapter 1

Corporate Governance
Definition & two views

The system by which companies are directed & controlled in the interest of shareholders & other
stakeholders

Narrow View agency theory (if no indication, always use narrow view*)
- Agency Director(agent), Shareholders(principal) (1) separation of ownership & control (2) agency
cost incurred (3) monitoring

Broad view stakeholder theory

Purpose and objectives of corporate governance

Maximise shareholders returns

Safeguard their investments

Aligning boards interest with that of shareholders

Ease of raising finance
Enable a country to attract foreign direct investment

Suitable balance of power on the board

EDs remunerated fairly

Managing & monitoring the risk

External auditors & NEDss independence
Address certain issues (business ethics, CSR, protection of whitleblower)

Concepts in sound corporate governance

Openness
maintain an honest & open relationship with the stakeholders

Probity/honesty
integrity, honour, virtue & fair-dealing

Transparency
timely reporting, voluntary provide more infor to remove information asymmetry , over and above

Independence
decision made or conclusion reach based solely on the facts & information gathered without being
influenced by personal opinion or pressure from others CG monitoring role NED & external
auditors

Accountability
Fairness
Responsibility

Fairness

Reputation
reputation risk, general deterioration of public perception form of business risk

Innovation

Skepticism

Judgement
director make decision on behalf of shareholders, separation of ownership & control, make sound
judgment

Narrow View
Requires all categories of shareholders to be treated equally
Institutional vs private
Majority vs minority
Foreign vs local

Broad view
Requires both shareholders and other stakeholders to be treated the same

Reputation Risk
General deterioration of a public perception of the company or land goods & services that it supplies
This is a form of business risk if not addressed by the company and have the effect of reducing the
returns to shareholders i.e. bad CG

Professional scepticism
Requires parties involving in playing the monitoring to maintain a questioning mindset so that no
malpractices will be overlooked

Internal parties of an organisation

BoD
Company Secretaries
Sub-board management
Employees & the workforce

External parties of an organisation

Shareholders
Auditors
Institutional investors

Chapter 2
As a result of directors duty, two things that the board must observe:
Fiduciary Duty
A given in trust the agent is entrusted by the owner of the company i.e. run the company on behalf
which is why director must observe duty of care and duty of royalty to the shareholders
To avoid opportunistic behaviour/self-interest

Duty of care
Duty of loyalty

Short-termism
Short-termism can encourage the board to pursue investment that is high risk which promises high
return
This would inevitably increase the riskiness of the company from the financiers perspective resulting in
highest cost of capital to cooperate for the exposure

Shor-termism practice
Decision that benefit the company in the short term but do not necessarily do good to the company in
the long run
E.g. Failure to undertake research & development in order to boost short term reported profit

Shareholders monitoring

Voting at AGMS
Establishing a nexus of optimal contracts
Voting in favour of a takeover
Passing of shareholder resolutions
Dialogue

Accountability

Discharge of responsibilities in accordance to the position one holds in an organisation. For instance, ED
should oversee the companys operation and attend the board meetings whereas NEDs should be
involved in their monitoring role
Be held responsible for the outcome & decisions made

How would the separation of chairman & CEO lead to greater accountability to the shareholders?
1. Define accountability
Discharging of ones responsibilities in accordance to the position he/she holds in an organisation
When chairman & CEO are separated, the former would be more ready to reprimand the latter for any
malpractice that occur or less than satisfactory performance which is the responsibility of a chairman
NEDs are also likely to discharge their monitoring role better when chairman & CEO roles are separated
because there is an avenue for him & her to resolve any difference that may arise with the CEO
The separation of the roles mean that both chairman & CEO would have more time to discharge their
respective responsibilities i.e. run the board & run the business well which is not possible if they are
combined
Be held responsible for the outcome of the decision made
When chairman is different from the CEO, he/she is more likely to make CEO responsible for the poor
performance reported due to the avoidance of self-review threat

Classification of stakeholders

Internal and external stakeholders inside & outside

Narrow and wide stakeholders most affected & less-affected
Primary and secondary stakeholders going concern
Active and passive stakeholders (Mahoney) seek to participate or not
Voluntary and involuntary stakeholders engage with organisation voluntarily
Legitimate and illegitimate stakeholders depends on viewpoint
Recognised and unrecognised (by the organisation) stakeholders
Known about and unknown stakeholders

Stakeholder claim
Refer to the situation where stakeholders interests are being affected by a companys activity or
decisions made
They made claim in order for their interest to be observed & respected
Understanding the influence of each stakeholder

Power is the stakeholders ability to influence objectives (how much they can)
Interest is the stakeholders willingness (how much they care)

stakeholder management is a continual process, as stakeholders may take up different positions in the
grid as they organize themselves or as the project progresses

Chapter 3
CG Code***
Directors
Directors Remuneration
Relations with shareholders
Accountability
Financial reporting
Internal control

Argue for two-tier board when the environment is turbulent

Turbulent characterised by fast changes in the environment
Necessitate fast decision making to address the changes

Why 2 tier board?

Decision can be made faster. Easier to achieve consensus on a particular course of action
Easier to agree on a common date for meeting as it involves lesser number of directors

Unitary board
All directors sitting in a same board
Sharing responsibilities
No disruption in the flow of information
EDs play the role of running business, NEDs monitoring

Two-tier board
2 boards mgt board (similar with unitary board) supervisory board (similar to NED)
Hold meetings separately
Disruption in the flow of information
Supervisory bank representatives founder of family members employee representative not
independent financial interest or family relationships

Directors
EDs
Full time directors
Involves in both operation and directorship
Earn both salary (for involvement in operation) & fee (for acting as director of the company)

NEDs
Part-time directors
Only assume directorship by attending board meetings & sub-board committee meetings
1. audit committee
2. remuneration
3. nomination
4. risk management
3. Only paid directors fee

Monitoring expenditure
NEDS & Auditor

Both NEDs & auditors are paid directors fee & audit fee respectively for playing the monitoring role in a
company. The payment of such fee, would have the effect of reducing the returns to shareholders

Shareholders
Shareholders would have to incur time & cost to attend AGMs & possibly dialogue with the investee
companys management

Roles of NED

Strategy
NED is tasked this role by attending board meetings. To challenge and contribute to the development
of strategy. Its made possible because NED comes from diversified background as its knowledge and
experience that allowed deliberations of issues being discussed

(b) Performance
this role is discussed when NED sits on the main board. To scrutinise (monitor) goals & objectives. This
would involve NED benchmarking the actual performance arguing the target and hold the ED & NED
accountable for the poor performance

(c) Risk
 to play this role would require NED to sit on the audit and risk management committee

(d) People
to discuss this role NED ought to sit on the remuneration & nomination committee

Limitations of NEDs

NEDs who come from a diversified background may not be familiar with the companys nature of biz &
the industry it operates. This would inevitably affect their ability to participate in strategic decision
making & the overseeing of risks & controls. This is especially the case of the NEDs come from public
sector background
NEDs may not spend adequate time in the company that they represent because they are part-time
directors and may sit on the board of several companies

Short tenure
In CG, a short tenure is preferred as it avoid severance payment

Roles of chairman

Oversee the running of the board including the sub-board committee

Chair the meeting i.e. board & annual general meetings
Set the agendas for meetings
Resolve differences, if any, between the EDs & NEDs
Ensure that decisions made by the board are fair to the shareholders especially the minority
shareholders

Chapter 4

Importance/benefits of having sub-board committees

Relieve the main board of having responsibilities. Attention could then be focussed only on strategic
decision making
Introduction of independence into decision making process on membership as many of the committees
(audit & remuneration) is independent NED
Promote specialization on directors with the needed knowledge & experience will be assigned to
committee that match their expertise. This would ensure that decisions made are sound & reflect the
current practices
Confidence of investors may be boosted due to avoidance of abuse in the area of directors
remuneration, recruitment of new directors, internal controls and financial reporting due to the
presence of NEDs in the decision making process

Roles of the remuneration committee (ICSA guidance notes)

Setting the remuneration policy

Individual remuneration package for each ED
Share incentive plans
Other board committees
monitor
Nomination committees duties

Succession planning
Identifying and nominating - recruitment existing board structure balanced board
Suspension of termination
Review regularly evaluation
Training up-to-date to changes of directors narrow the gap btw ED & NED

Roles of risk committees

Create risk awareness culture

Risk register take risk knowingly
Threshold exceeded limit avoid too risky projects
Holistic manner evaluate, assess, manage
Liaise with EDs & CEOs

Arguments for NEDs to sit on risk committee

Introduce independence in the overseeing of risks in the company. EDs will not have the opportunity to
cover risks that arose because of bad decisions made by them in the operational areas
NEDs with their diversified background and knowledge may be able to bring a fresh pair of eyes to the
managing of risks by sharing with the committee the situations found in other companies & how they
were addressed

Arguments against NEDs sitting on risk committee

EDs may feel de-activated as they oversee the operations & yet are not given the opportunity to manage
the risks that arose from their area of responsibility
NEDs are not full-time directors & so may not be able to respond quickly to new risks that arise in the
operations

audit committees duties

Oversee financial statement reporting

Review scope & outcome (external)
Useful bridge between internal & external professional relationship
(if too close, rotate)
whistleblowing

Chapter 5

Purposes of reward package

Reward packages are generally considered to have three purposes: to attract, retain and motivate.
To attract means that they must be set at a level adequate to ensure that people with suitable skills will
find the post attractive. If the salary is too high, a number of people with the wrong skill levels will be
attracted and if it is too low, too few suitable applicants will be attracted.
Retention means ensuring that the level is adequate to prevent a good chief executive from seeking
employment elsewhere in order to find a level of reward more suited to his or her skills and experience.
Finally, rewards serve to motivate. This means that there must be enough reward to provide loyalty and
a desire to achieve in the role. This is often done by providing a part of the reward in the form of a
variable payment linked to corporate performance.

Annual(short-term) compensation includes:

Basic salary
not performance related, instead they exist after consideration of a ED:
(1) Qualification (2) experience (3) job responsibility (4) mkt rate paid by competing company (5) Sercity
of a director (6) negotiation power

Personal pension scheme, perhaps

Bonus
Performance related, but the period used to evaluate director for the purpose of determining the bonus
should be long enough to avoid short termism practice

Perquisites
Membership of health insurance, private use of companys aircraft or boats
Excessive perquisite given to the ED can lead to residual loss situation

Long-term compensation includes

Share options
Right to purchase shares at a specified time period, the period should be of efficient manner in order to
avoid short termism practices as the outcome of directors strategic decision can only be seen in the
longer term

Company shares
Limits on their transferability for a set time
Various performance conditions should be met
Since the shares are given to the director free of any unit, such condition can be included as part of the
reward

Severance payment arrangement

Share and share options

ED treat share options as compensation not in family owned biz

ED to manage companies in such a way that the share prices will increase, as what the shareholders
want. Therefore, share options are believed to align managers goals with shareholders goal. Helps to
overcome some of the problems of separation of ownership & control
Arguments:
Shareholder returns (stock price appreciation & dividends), affected by price appreciation. ED might
forgo increasing dividends in favour of using the cash to increase stock price.
Tendency to pick a higher risk business strategy. This is because high risk projects promises high returns
which will boost up the share price & thus the capital gain when the director sells. Should the risky
project fail, the director will just abandon their right with no loss or damage, but leaving existing stock
with a low share price
In view of this, some argued that there should be controls over the sale of shares by EDs after they have
exercised options.

Performance related incentives

Targets:
shareholder return, share price etc
Profit-based measures, ROCE, EPS (the basis being used can be subject to manipulation by adopting a
more aggressive accounting policy)

Problems:
Expected results in short period, mismatched investor time horizon
Mgt remuneration is not correlated to corporate performance
EBT & EBITA not reflecting interest charge for that debt
- Would encourage ED to expand the company via borrowing, as interest element is excluded. However,
risk profile would increase inevitably because risk exposure would have implication on future borrowing

Linking remuneration to performances issues

Unsuitable measures of performance
- Unsuitable measures of performance (such as when profitability is being used as performance target),
although EDs succeeds in achieving high reward targets, shareholders do not obtain comparable
benefit.(this is because a companys ability is dependent on the CF & not profitability)

Short termism

Payment for failure

- Payment for last years well results when this years results are poor

Measures to avoid payment for failure

Notice period
Directors contract
Phased payments
Compensation for loss of office
Fixed as a number of shares, hence value of compensation would be linked to share price performance
Phased payments & limited severance pay

Solutions to overcome the problems in determining executive remuneration

Longer term tenures
More truly INEDs
Cessation of stock options & generous basic salary & 5-year restricted shares
TSR, 3year performance measure, share incentives not being available to NEDs

Balanced reward package

Short (standard of living) vs long (aligned interest)
Performance related (accountability, motivation) vs non-performance related (i.e. oil & gas industry)