Corporate Governance

Introduction: Ask not only “Can I do this?” but “Should I do this?”

Early definition → (Indefinable term)
Corporate Governance is the system by which companies are directed (policies, management) and
controlled (boundaries, limits)
Its principles identify the distribution of rights and responsibilities among the Participants
Participant stakeholders are:
o board of directors (strategic, long-terms decisions, guardians of shareholder interest that chose them)
o managers
o shareholders (effective owners of the company. Today tendency to separate ownership and management)
o auditors (guarantors)
o employees
o creditors
o suppliers
o customers
o consumers
o regulators
o community
o and other stakeholders

Institutional investors lend in the company and receive a share of, it. They don’t have right to vote.
Board of directors represent the interests of shareholders and control and help management
Legislation can limit, regulate and facilitate corporations’ activity
Societal stakeholders: interests
growing because parts in play are increasing
Roles
Boards of directors are responsible for the governance of their companies.
The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy
themselves that an appropriate governance structure is in place
Other def.
Corporate governance describes the framework of rules, relationships, systems and processes within
and by which authority is exercised and controlled in corporations.
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.
The system of regulating and overseeing corporate conduct and of balancing the interests of all
internal stakeholders and other parties (external stakeholders, governments and local communities)
who can be affected by the corporation’s conduct, in order to ensure responsible behaviour by
corporations and to achieve the maximum level of efficiency and profitability for a corporation

A discipline in constant evolution:

Overall, corporate governance continues to evolve.
The metamorphosis () has yet to occur. Present practice is still rooted in the 19th century legal concept
of the corporation that is totally inadequate in the emerging global business environment
Why do we need C.G.?
To prevent and solve possible conflicts of interest between participant stakeholders
2 live debate:

Why do we need C.G? (To prevent)

• Corporate collapses, insolvency or bankruptcy of major business enterprises (e.g. Enron, MCI)
• Corporate scandals, unethical behaviours by people within an organization (e.g. Madoff and the Ponzi
scheme)
MANAGEMENT: They basically manage the company (CEO, Executives, Employees)

GOVERNANCE: Owner, Board and CEO have governance of the company

The CEO is in the middle. He takes care of governance and management.

Board of director, CEO and executives run the company.

Who actually initiate strategies? Strategies could be taken following a bottom-up or a top-down approach.
If the company is managed properly, targets are aligned.
Who chose the CEO? The board of directors, but also the executives indirectly, because if they do not support the
CEO and make troubles to him, he will be taken out.
Thus, the CEO should appeal with both Board of director and executives.

TIMELINE OF ALL CORPORATIONS IN THE WORLD

OWNERS
IPO
FINANCIAL ADVISORS
PE INSTITUTIONAL
↓ risk
VCs INVESTORS
MF ↓ returns
BAs FUND MANAGEMENT
FFF BOARD OF DIRECTORS
↑ risk

↑ returns
OWNER
CEO
↑ % interest
to lend money ↓ % interest to
borrow money:
cheap capital

At the beginning, owner and CEO are the same person. The owner can only think about his business, it’s in his
blood.
In the last stage, we find many actors:
- owners
- financial advisors
- institutional investors
- fund management
- board of director
- CEO

At this stage the owners don’t even know how the business is run. They face directly with financial advisors that
advise to which investors they should put money. At this stage who takes care? Institutional investors only care
about performances. Board take care in a professional manner, related with reputation. They do this role
additionally. The CEO takes care? Many only care about money. They sometimes take care at the beginning and
then their attention falls down.
All that people at the end are working on a fee or bonus/salary, that is not necessarily directly related to
company performance.

How does company raise capital?

FFF → Bas → Mentoring funding → VC
Then it keeps growing → Private Equity
That means more money and more complexity, but also less risk.
Then the company decide to go to the public → IPO → it needs a board of directors.

The cost of capital in stage 1 is higher than in 2, when the risk falls ↓. But also Returns ↓ (as dividends, ROI ecc)
What happens when performance ↓ ? → a % of the company is sold to private equity. They run revision to fix
problems and then margin returns profitable → PE sells, and investors will buy %.
It is therefore a dynamic cycle

Following the legislation, in USA members of boards cannot know about business, so they may not be suppliers,
lawyer, etc. The aim is to bring to board people less “contaminated”. This is best for US law, however, sounds
weird in Asia and UE.

We have 2 type of board:

- supervision boards
- operational boards

and their committee

Boards member chose the CEO. Who chose the members of the board?

02. Historical evolution of corporations

Roots of CG: Early merchants and first monopolies
Word Origin: Ancient Greek - “Corporate governance” appears only in 1980s - However, Shakespeare
understood the problem in the 16th century (The Merchant of Venice, c.1596-1599)
1720: South sea bubble
first financial bubble
- influence
- chamber of Tor could change -> negligence and intentionality
Speculation -> pyramidal effect
Many nobles ruined, in bankrupt, prison or workhouses

Separation of ownership from operations

XIX century
• 1807 Société en commandité par actions à limited liability of external investors, unlimited liability of
executive directors
• 1855 & 1862 British Companies Acts à limited liability of all stakeholders

XX century
› Companies grow big and complex
› First stock exchanges
› Management ← → Investors

1970s – years of regulations

Examples of Corporate Governance regulators:
• SEC (Securities and Exchange Commission) – aims to protect US investors by requiring listed
companies to facilitate capital information (EDGAR database).
• Companies House – central registry for all companies registered in the UK.
• Colegio de Registradores (The Spanish Business Registrar) – collects information on over 800 000
firms, provides detailed statistical information and credit reporting on SMEs.
• Stock exchange listing rules – set of standards for the behaviour of public companies, including
disclosure of information, meetings, rules of composing the Board, internal audit, voting right of
stockholders etc.
• USA - SEC recommends public companies to create audit committees (1972)
• Europe – EEC proposed that two-tier boards are promoted (executive directors in management board
decided about company’s objective and implement necessary measures, and non-executive directors in
the supervisory board monitor decisions on behalf of other parties).
• UK – Accounting standards steering committee produced The Corporate Report (1975) – all economic
entities must report publicly and accept accountability to all those whose interests were affected by the
directors’ decisions.
1980s – years of deregulations
• State-run entities privatization
• Deregulation of financial market
• Drexel Burnham Lambert, Nomura Securities, Rothwells Ltd., Guinness collapses.
• Increasing pressure on Boards of Directors

1990s: corporate governance codes arrive (as consequence of 80s’ deregulation)

Cadbury Report (1992):
• Wider use of independent directors defined as being “independent of management and free from
any business or other relationship which could materially interfere with the exercise of independent
judgment, apart from their fees and shareholding”.
• Introduction of audit committee of the board with independent members
• Division of responsibilities between the CEO and the Chairman
• Use of remuneration committee of the board
• Reporting publicly that the CG code had been complied with or, if not, explaining why.

OECD (Organization for Economic Co-operation and Development) – global guidelines on corporate
governance (1998)
• Emphasis on contrast between the strong external investment and CG practices in the US and UK, and
those in Japan, Germany and France, with less demanding governance requirements
Early 21st century: reactions to more corporate collapses
• Sarbanes-Oxley Act (2002)
• Requires executives to certify accuracy of financial statement personally (20 years of jail)
• Requires hiring independent auditors to review accounting practices
• Prohibits external auditors from doing consulting work for their auditing clients.
• Protects employees that report fraud and testify in court against their employers
• Was a response on the lack of liability of corporate executives, which made it difficult to prosecute
them
Corporate governance theories

The agency dilemma

How to ensure that the executives (agents) act solely in the interests of investors/owners (principals)?
Agency theory
If both parties are utility maximizers there is good reason to believe that the agent will not always act in
the best interests of the principal. Therefore they cannot be trusted.
Agency Theory: top managers in large corporations as agents whose interests may diverge from those
of their principals, the shareholders, as both parties are utility maximizers.
More control = less losses for the principal
Stewardship theory
Directors’ legal duty is to their shareholders, not themselves, nor to other interest groups. They do not
inevitably act in a way that maximizes their own personal interests: they can and do act responsibly
with independence and integrity. Therefore they can be trusted.
Stewardship Theory: top managers are not motivated by individual goals, but rather are stewards
whose interests are aligned with the objectives of their principals.
Stakeholder perspective
Questioning of the role of major corporation in society. Directors must be accountable to a wide range
of stakeholders (not only shareholders), which would be the price that the society demands from
companies for the privilege of incorporation, and granting shareholders with limited liability for the
company’s debts.
… but … can a company be accountable to all stakeholders at a time?

Agency Theory
200 years of economic research: an economic model of man

 Based on rational behaviour

 Both agents and principals seek to receive maximal utilities with minimal expenditure
 Ownership and control increasingly diverge as modern corporations exceed individual capital
contribution
 Owners become principals when they contract with executives to manage firms for them. They
delegate control
 As an agent, an executive is morally responsible to maximize shareholder utility, but executives
may accept the agent role as an opportunity to maximize their own utility.
When agency costs appear…

 If both utilities coincide, there is no agency problem, both maximize their wealth
 Agency costs are incurred by the principals when both interests diverge, because given the
opportunity, agents will rationally maximize their own utility at the expense of their
principals
  Principals do not know ex-ante which agents will self-aggrandize so they have to set limits to
their potential losses
 The objective in agency theory is to reduce agency costs to the principals by imposing
controls
Internal and external control mechanisms

 If managers entrench themselves with the sole objective of ensuring their own power, the
organisation is likely to lose sight of its competitive position and will fail
 If the internal control mechanisms proposed by the agency theory fail, more expensive
external control mechanisms (acquisitions, divestitures, etc.) will emerge to control self
serving managers
 Internal mechanisms are preferred as they are less costly than external ones
Agency governance mechanisms
Two mechanisms:
1) Alternative executive compensation schemes: rewards and punishments to align principal-agent
interests. Particularly useful when the agent has informational advantage
2) Governance Structures: Boards of Directors keep potentially self-serving executives in check by
performing audits and performance evaluations. Also nonmanagement boards ensure that proper
management oversight occurs
…given the opportunity…

Assumptions for Stewardship Theory

Other types of human’s behaviour
Rooted in psychology and sociology; situations in which executives as stewards are motivated to act in
the best interests of their principals
Behaviours
(> = higher utility)
Pro-organizational, collectivistic > individualistic, self-serving
Co-operation > Defection
(game theory)
The organization over the individual

 The steward seeks to attain the objectives of the organization (profits, etc.)
 This behaviour in turn will benefit principals (owners and super-ordinates)
 A steward protects and maximizes shareholders’ wealth through firm performance, because by
doing so, the steward’s utility is maximized

The more you empower stewards, the more will be company's utilities
less control -> less money
 Why do not chose the cheapest? Because the risk. It's risky to a person if you don’t trust in it.
The steward’s motivation

 A steward behaviour is organizationally-centred

 Stewards are motivated to make decisions in the best interest of the group and improve
organizational performance
 Stewards believe their interests are aligned with that of the corporation and its owners
 If the executive’s motivations fit the stewardship theory, then empowering is appropriate
 A steward’s autonomy should be deliberately extended to maximize the benefits of a
steward because he/she can be trusted: CEO chairing the Board of Directors
 Less control is better and cheaper as the executive’s interests are aligned with those of the
principals

Stewardship Theory
Risk aversion from the owners
2 alternative approaches:
Facilitate and empower (st.) vs. monitor and control (ag.)
Why not the cheapest (st.) one? Because of the owners’ risk aversion
Or even better, why ever take risks (ag.)? Because, research shows mixed findings
Factors that differentiate both theories
- Psycological: motivation
Simon vs. Argyris (Maslow)
Extrinsic motivation (ag.) tangible commodities, self-serving…
vs.
intrinsic motivation (st.) growth, achievement, collective-serving…
- Psychological: Social comparison, Identification
- Economic or class-related separation between principal and agent. Fairness is compensation
- Identification with the corporate mission, vision and values. Membership and affiliation. He/she takes
comments about the organization personally.
- A manager who identifies with the organization will work to achieve its goals, overcome barriers and
solve its problems: they want it to succeed
- Psychological: Power
Agency: coercive, institutional/organizational power (derived from the position of the principal in the
organization). Reward and control
Stewardship: personal power, interpersonal relationship, not affected by position
Power type used depends on the personal characteristics and the organizational culture
- Situational Mechanisms: Management Philosophy, Time frame, Risk-orientation
Control-oriented vs. involvement-oriented
Control: short-term, cost control, productivity, not sustainable long term. Ok in hard situations because
of low turnover.
+ Risk-> + Control
Involvement: environment is changing and control-oriented approaches are less viable, performance
enhancement
+ Risk-> + Empowerment
- Situational Mechanisms: Cultural Differences, Individualism vs. Collectivism
Individualism vs. Collectivism: nations and regions differ in this approach:
- USA, Canada, W.EUR-> Individualism.
- ASIA, LA, S.EUR ->collectivism
In collectivist cultures, the self is part of the group. Memberships are an important part of identity.
Members are identified by family names, harmony, group success.
Long-term relationships…get to know, trust, handshake (STEWARDSHIP)
In individualist cultures, rational, short-term, non-personal, cost-benefit analysis, contract (AGENCY)
- Situational Mechanisms: Cultural Differences, Power Distance
High power distance culture accepts well the difference in power: obedience, discipline, dependency,
privileges and status symbols are popular
Low power distance culture is more egalitarian, independence is encouraged and class symbols
criticised
Conclusions
Agency theory to explain conflicts between agent and principal
However, managerial behaviour and motivation is often more complex
Hence, the stewardship theory, derived from psychological and sociological traditions

04. Shareholders’ rights, duties and responsibilities

Company’s incorporation
- Normally with an indicator (Inc./Corp./Co./ S.A.)
- Tend to be registered in the states/autonomies with a low corporate tax and/or court system
sympathetic to Boards.
- Societas Europaea (SE) –– (European company) a company registered in accordance with the
corporate law of the European Union (2004)
- Can be private or public:
• Public companies – offers shares to the general public. Not all public companies are listed in a stock
exchange, but all listed companies must be public and meet listing requirements.
• Private company – cannot offer its shares to general public. Requirements are not as demanding as
those for public companies.
Classes of Shares
- Ordinary shares (one vote per share) no special rights to vote. Ranked after preferred in getting dividends.
Some companies have categories of ordinary shares (A, B, C, etc.)

- Non-voting shares (no right to vote and, sometimes, to attend meetings)

- Preferred shares (have a preferential right to a fixed amount of dividends expressed as a % of nominal
value of the share) preferred shares give a preference in paying dividends. Normally they do not have
voting rights
- Deferred ordinary shares (no dividend will be paid until other classes of shares have received a
minimum dividend) subtype of ordinary NOT paying dividend after other have received. Even in case of
liquidation.
- Management shares (extra voting rights so as to retain control of the company in particular hands,
e.g. through multiple votes per each share) – often issued by original owners
Shareholders’ rights
- Are determined by a company’s law, and depend on terms of issues of the shares, and their types
- Right to attend general meetings and vote (depending on shares’ class)
- Once they have voted, they can’t influence the company’s day-to-day management
- Share of the company’s profits (dividends)
- Copy of the company’s annual accounts
- Right to sue the company
Holding a chare entitle you to:
1. part of the corporation (no debt)
2. dividends if ...profit (based on agreement)
There's gonna be an agreement. It depends of shat shares you own
3. to sell it (may be could be some conditions)
4. information. Annual report. Financial information
6. voting rights (through voting you can governate the company)
7. Appoint outside
8. Actual generl meetings and shareholder meetings
9. you are entitled to know management salaries and benefits
10. sue the company

Shareholders’ right to information

- Financial and operating results of the company
- Company objectives and non-financial information
- Major share ownership, beneficial owners and voting rights
- Remuneration of Board members
- Board members’ information
- Foreseeable risk factors
- Issues regarding employees and other stakeholders

Shareholders’ dilemma

- Shareholders’ activism: Shall we allow shareholders a greater control? …or

not?
Should ownership and management be separated?
What can be done?
- Differentiation between shareholders with a short-term profit orientated interests and genuine long-
term investors
- Loyalty bonuses
- Relate share voting rights to the time of shares possession
- Shareholders: long-term owners or short-term speculators?
“International discussion about shareholder rights and responsibilities needs to be taken forward on a
balanced ticket.” Anne Simpson, head of corporate governance at CalPers

Types of boards
Basics
Board of Directors
Can include: executive (part of the company) and non-executive
directors (coming from outside)
- Non-executive directors can be:
- CNED – connected non-executive directors
- INED – independent non-executive directors

Types of boards
a. Unitary boards:
1. All-executive board
- Usually in small and/or start-up businesses
- Normally LLC (that require personal guarantee), not corporation
- Can be found in subsidiary companies of corporations

2. Majority-executive director board

- Some non-executive directors are invited to the Board
- Backing up expertise of executives in a growing successful company
- As representatives of lenders of significant investments
- In family business, when family members are not involved in business
activities directly but remain its shareholders

3. Majority-non-executive director board

- Often called ‘professional boards’
- Typically with only 3 executives (CEO/chairman, CFO, COO), and 3-4 times
more non-executives
- Chairman/CEO has considerable power and formulates strategy
- The role of non-executives is mostly supervision, not performance
4. Board composed entirely of non-executives
- Seldom in listed public companies, frequently in not-for-profit entities
- Sometimes called ‘stakeholder boards’

b. Two-tier boards
- In Germany all large and public companies are required to have a two-
tier structure
- Consists of supervisory and management boards
- Supervisory board consists entirely of outside directors, and
management board consists entirely of executives
- Half of supervisory board are appointed by worker unions and
represent employees’ interests; another half are appoint by
shareholders (e.g., financial institutions) and represent their interests
- Supervisory board have a right to appoint and remove members of
executive board
- Management board proposes strategies, plans and budget,
supervisory board comments, approves, rejects (sends to further
consideration), and assesses.
- In the Dutch model, supervisory board consists of: 1/3 – capital; 1/3 – employees; 1/3 – society)

c. Advisory board
- Suitable for companies with extended international activities or smaller young companies
- Business leaders, important politicians and professional consultants are invited
- Short-term – only while advice is needed
- Have no executive power

Do Boards Need Independent Directors?

Board committees
Board committee are typically of 4 types. 2 more important: audit committee and compensation
committee (at top level)
Committee are groups of people devoted, formed by independent directors.
Audit
Audit committee
Need of more mechanism control. A company have the financial bookkeeping department + internal
auditors who are employees. they evaluate effectiveness of the control system.
- Entirely (sometimes predominantly) independent directors
- Normally 3-5 members
- Should have financial expertise
- Its aim is to avoid any domination of the board by executives
- 3-4 meetings per year
- Recommend on appointment, removal and remuneration of external auditors and ensuring their
independence
- Supervising internal auditors, and reviewing the appointment, performance, remuneration, and
replacement of the head of the internal audit function, and ensuring continuing independence of the
internal auditors from undue managerial influence
- Reviewing the exposure of the company to risk
- Reviewing disclosed financial and other information to shareholders
- In some organizations, internal auditors report directly to audit committee rather than CFO
Internal Audit
Who are they?
- Employees of a company
- Evaluation of the extent and effectiveness of control systems
- Reviewing operational and financial performance
- Assessing the achievement of corporate mission, policies and objectives
- Checking possible irregularities and frauds
- Reviewing organizational values and code of conduct or ethics
- Evaluating risks at all organizational levels
Who should they report to?

External Audit
- Report to Audit committee/BD as representatives of shareholders
- Have access to all the books and records of a company
- Mainly focus on financial information
- In EU public companies are required to rotate external auditors every 10 years, with an option to
extend this period to 20 years.

Executive Compensation
Compensation committee:
- Consists of INEDs
- Appointed by a responsible to the Board
- Acts as a link between the CEO and the Board on all compensation and HR issues
- Their main duty is to determine and approve the Executive Compensation Package
- Is not involved in any “micromanaging” compensation processes, but rather oversees compensation
matters
Compensation package components:
Short-term incentives:
- Base salary
- Annual bonus
- Perquisites
Long-term incentives:
- Stock options
- Restricted stock units
Guarantees:
- Severance agreement
- Change in control provision
- Pension
Compensation trends explained
- In 1992 SEC requires public companies to disclose the executive compensation
- In 2001 Sarbanes-Oxley Act increased independence of Board Committees and restricted the
compensation explosion of the executives
- According to EPI, average CEO compensation for the largest (taken by sales) 350 US firms was $16.3
million in 2014. (up 3.9% since 2013).
- From 1978 to 2014 it increased 997% (inflation-adjusted) versus 10.9% growth of a typical worker
- CEO-to-worker ratio was 20:1 in 1965, peaked at 376:1 in 2000, was 303:1 in 2014
Why are executive compensations so high?
Greed?
“I think people on the top should voluntarily take less. Do you really think that a man who craves power and
significance, and likes the decision making and running a big US corporation, do you really think he would work
more effectively if you increase his salary?” Charlie Munger, Vice Chairman Berkshire Hathaway
“I do not think, executive compensation is out of control, it’s just high.” Don Delves, president of Delves Group
Incentive?
- Competition against executive fellows rather than money itself
- Being paid more is about outperforming
- Risky decisions and responsibility, feeling entitled
- Executives see big bonuses in crises situations differently
Is “pay-for-performance” the right manner to measure executive?
Compensation CEO-to-worker ratio
- Compensation as a signal of what is important for a company
- Corporate culture and employees’ morale
- Employees’ disconnection from the company, CEOs’ disconnection from the real world
- Intrinsic aspect of work is less important
- CEOs’ addiction to stock options
- Overall economic effect on societal inequality
Economic effect of CEO-to-worker ratio
- Squeezing out middle class
- Limited purchasing power
- Lower demand
- Decreased amount of jobs
- Even lower purchasing power
Principles to improve compensation policies:
1. Utilitarianism:
- Doing best for a company is not always doing best for the society
- CEOs can create value for a company, which will not necessarily create value for the community.
2. Virtue ethics principle:
- Virtuous CEO wouldn’t accept a job with such a high rate of pay, since it will disrupt the corporate
culture.
3. Deontology:
- Carrot and stick approach – you do good, you are compensated, you do bad – you are punished.
Fair executive compensation
- There are minimum wages, there should be maximum wages (or maximum disparity level within a
company)
- Relative performance of a company compared to competitors, and market in general
- Providing exceptional shareholder return over an extended period time
- Good corporate practices (compensation committee, independent advisor, longterm orientation)
- Incentivize CEOs by giving them autonomy, flexibility, and the possibility to master what they do
- Great corporate cultures are more attractive than big compensations
Nomination Committee
- Consists of a minimum of 3 and a maximum of 5 Board Directors
- Identify candidates to be nominated
- Accept nomination of of candidates
- Propose candidates for election

Struggling Boards. The Case for Design

Struggling Boards
Boards are struggling to accomplish their mission.
Directors don’t understand the business. Board meetings are a waste of time
Establish Boards best practices:
Boards must be empowered and to be so, they need to have independent directors with incentives
aligned to those of shareholders
Shareholder protection and high levels of financial disclosure
Enhance Board
Enhance Board power and defend shareholders’ interests:
• Majority of independent members
• Leader of the Board is not the CEO but an independent Chairman or other Director
• Selection of Board members by independent directors
• 3 Committees formed by independent directors: audit, compensation and governance or nomination
• Independent directors should meet periodically alone w/o the CEO
• Boards should be as small as feasible: better communication and easier for consensus
• Board Activities to signal their governance:
• Strategy approval, management control
• CEO appraisal and compensation
• Oversight of management development and succession plans (seniors)
• Evaluation of Board’s diligence, procedures and achievements
• Directors should receive a motivating compensation aligned with shareholder value objectives

Poor implementation of best practices

But there seems to be a disconnection between best practice theory and implementation, Why?
• Balance of power and relationships between Board and CEO still problematic and tensioned
• Gap between expectations on the board and time/knowledge available to directors
• Historical practices vs. increasing complexity and compliance requirements
• Lack of time and focus to implementation details of best practices. Poor design
Board design is the cause
Board design explains why best practices are not always followed, working against directors:
• They have their own careers with busy agendas. Board director is only a side activity for them
• They don’t spend much time together <100 hours 7 meetings/year incl. 2 x 2/3 days strategy retreat
which is clearly insufficient given the growing complexity of large businesses
• Most executives feel their independent directors lack knowledge and ability, understanding and
business intelligence to take appropriate strategic decisions
• Board members don’t spend enough time with senior management according to executives
• Not merely ask good questions, be sufficiently informed to make good judgement and question
management’s views
• Directors cannot recall what happened at previous meetings, are insufficiently prepared or agendas
are too crammed, poorly planned Board meetings and lack of meeting leadership
• Not much time left for meaningful discussion and too many members difficult interaction
• Too much information, too focused on past financial performance and not on competitive
performance, product performance, customer reactions, morale, team or strategy
• Finally, stockholders complain that their interests are not duly preserved or defended, with boards
reacting too slowly when problems arise or not even noticing until it is too late. “The devil is in the
details
An even more challenging future
• The effects of company globalization on board composition: global business is no longer an appendix
of domestic business.
• Companies increasingly need board members from other regions of the world to bring valuable
understanding of those markets
• The impact of technology on approving business strategy: hard to understand and everchanging and
increasingly crucial to the company’s success or demise

The growing importance of intellectual capital as the driver of value creation:

• the preeminence of shareholder value over stakeholder (a.o. employees) value is questioned by the
fact that increasingly value creation is more based on intellectual capital than physical assets.
• However, boards tend to concentrate in financial assets and their return rather than in human assets
and the return on human assets. They need a value framework to calculate this
The Board’s Dilemma
Increasing pressure on the Board’s scrutiny function:
• aggressive accounting, excessive CEO compensation, but these external factors are only the tip of the
iceberg in good corporate governance.
• Much of what matters happens inside the boardroom and is only visible to those attending board
meetings:
• advice and oversight of management,
• succession planning,
• senior management appraisal,
 • decision on strategic directions

Governance body
› Shareholders rights and activism
› Directors’ types, rights and responsibilities

Shareholders’ rights and activism

Shareholders’ rights:
- Determined by a company’s law, and depend on terms of issues of the shares, and their types
- Right to attend general meetings and vote (choose directors)
- Once they have voted, they can’t influence the company’s day-to-day management
- Share of the company’s profits (dividends)
- Copy of the company’s annual accounts
- Right to sue the company
Entitled to vote but not involved in day-to-day business

Classes of shares:
- Ordinary shares (one vote per share)
- Non-voting shares (no right to vote and, sometimes to attend meetings)
- Preference shares (have a preferential right to a fixed amount of dividends expressed as a % of
nominal value of the share)
- Deferred ordinary shares (no dividend will be paid until other classes of shares have received a
minimum dividend)
- Management shares (extra voting rights so as to retain control of the company in particular hands, e.g.
through multiple votes per each share) – often issued by original owners

Shareholder democracy vs corporation dictatorship:

Shall we allow shareholders a greater control?
- Shareholders are watchdogs over corporate activities
- Shareholders as controllers of executives remunerations, challengers of risky schemes, and protectors
from predators
… or not?
- Shareholders opportunism
- Divestments and cuts in underperforming companies
- Short-term vs. long-term firm’s survival
- Differentiation between shareholders with a short-term profit orientated interests and genuine long-
term investors
- Loyalty bonuses
- Relate share voting rights to the time of shares possession
- Shareholders: long-term owners or short-term speculators?

Shareholder information
OECD Principles of corporate Governance
- Financial and operating results of the company
- Company objectives and non-financial information
- Major share ownership, beneficial owners and voting rights
- Remuneration of Board members
- Board members information
- Foreseeable risk factors
- Issues regarding employees and other stakeholders
- Annual audit should be conducted by an independent auditor

rif. Orcel case: reputation of Santander

Shareholder information
How reliable are Sustainability and CSR reports?
“In 1992, Terry Smith published the first edition of his best-selling exposé Accounting for Growth, of the
methods by which some UK companies in the 1980s and 1990s had used accounting techniques to turn
losses into profits, expenditure into assets and debt into somebody else’s liability […]. A review of the
published annual report and accounts of the banks […] shows that the accounting trickery of 1980s were
replaced by a thick, glossy catalogue of useless puffery, where mindless box-ticking compliance and
endless committees stupefy the reader with page after page of irrelevant disclosure, such as CO2
output of bank branches and details of the water-saving toilet flushing system installed in the head
office…”

Directors’ types and rights

Types of directors
All directors of a company have similar roles and responsibilities.
Executive directors – members of BD, and also executive managers.
Non-executive directors – members of BD, who do not hold any executive management position in the
company.
- Independent non-executive directors (INED) – directors with NO affiliation or other relationship with
the company. Definition of Independence is clarified by the code of good practices (see list of the
International Financial Corporation’s requirements on the next slide).

Requirements to INED, by IFC, World Bank group:

- Is not, and has not been employed by the Company or its affiliates in the past five years
- Does not and has not had a business relationship with the company or its affiliates in the past five years
- Is not affiliated with any NGO that receives significant funding from the company or its affiliates
- Does not receive and has not received any additional remuneration from the Company or its Affiliates other
than director’s fee, and this fee does not constitutes a significant portion of their annual income
- Does not hold any material interest in the company and its affiliates
- Etc.

- Connected non-executive directors (CNED) – directors who, although not members of the
management team, do have some relationship with the company (retired executives, close relatives of
the executives, nominated by a large shareholder, linked with an important supplier, distributor, or
customer, representative of a major financial partner).

Shadow directors – people, who although formally a member of a board, are able to exert pressure on
the decisions of that board.
Alternate directors – people who can take the place of directors if those cannot attend meetings.
Nominee directors - directors nominated to the board by a major shareholder or other contractual
stakeholder (such as an important lender), to represent their interests (find themselves in a dual
loyalties situation).
Governing directors (mainly in Australia) –those directors who have a dominant power in a private
company.
Corporate directors (in some jurisdictions) – when a director is a company, not a human being (having
the same role and responsibilities as any other single director in BD).
Worker/employee directors (mainly in Europe) – chosen from and by workers’ union of a company
Associate director – title given to an executive who is legally not a member of BD at all (as a matter of
prestige, rewards and/or status).
Cross-directorship – when a director of Company A is made a director of Company B and vice versa,
creating, thus a network of directors.
Pros: economic benefits, sharing of rare talents and experiences of members of BD.
Cons: concentration of power, lack of transparency and accountability.
Duties and rights of directors
- Duty of trust (soft factor: the person is supposed to be that)– duty to act with integrity, behaving
honestly and fairly for the benefit of the shareholders, recognizing the interests of any minority
shareholders
- Duty of care – duty to exercise judgments with care, skills an diligence (standards of professionalism
expected from directors are much higher than a few years ago).
- Directors can be accused of power abuse and repression of minority stakeholder interests
- Liability exposure of directors can be unlimited, if they are found guilty of theft, fraud and negligence
Chairman of the Board
- Appointment practices, duties and other aspects of chairman role depend on a company’s constitution

- Recently, Chairman’s responsibility has grown wider: plan and run shareholders’ and directors’
meetings, ensure proper inauguration of new directors, their training and development,
appropriateness of structure and membership of the Board, viability of the company’s strategic
direction.
- Normally, chairman is an INED, should never be a member of Management (nowadays dilemma)
- In practice… read here and here
- Though the roles are separated, their relationships are crucial
Dilemma: should be separated or not? You have to pay x2 but more transparency

Board diversity
Contents
1. Cultural aspect
2. US model
3. UK model
4. German model
5. Japanese model
6. Chinese model
7. Indian model
8. Women on the Board of Directors
Cultural aspect
“Culture is the collective programming of the mind which distinguishes the members of one group or
society from those of another.”
Cultural aspects define and scales attitudes, behaviour and values

Cultural aspects (Hofstede’s framework)

- Power distance
- Individualism
- Masculinity
- Uncertainty avoidance
- Long-term orientation
- Indulgence

Cultural aspect
Cultural impact on Corporate governance
The higher the power distance, the lower the achievement of good corporate practices.
The higher the individualism, the lower the possibility of board members to be influenced by traditional
authorities, roles and social duties.
Low level of uncertainty avoidance shows openness to change and less desire to follow the existing
corporate set up.
Low masculinity cultures are more concerned about social welfare and therefore good corporate
practices are more likely to be developed

Models based on traditions

Anglo-saxon model – shareholder-centric model of governance
German (European) model – stakeholder-centric model of governance
Japanese model – business relationship-centric model of governance
Chinese model – affected by communism – capitalism transition
Indian model – influenced by a history of powerful family ownership
US model
- Each state has its own laws and regulations, oversighted by SEC on the federal level
- Shareholders’ interests are at core
- CEO is typically not a founder but rather a professional manager
- NYSE requirements:
• NED’s meetings outside the presence of EDs on a scheduled basis
• INEDs should be a majority
- Founder or a founder’s family member often retains vast influence on the company, and is a board
member
- Prominent role of external auditors (PwC, Deloitte, Ernst & Young, KMPG, Accenture)- that ensure that
a corporation employs sound practices of accounting and complies with GAAP (Generally Accepted
Accounting Principles), their services became significantly more expansive after Sarbanes-Oxley Act
UK model
- ‘Comply or explain’ approach – companies might not comply principles of good practices, but need to
explain why they don’t
- Not compliance should be openly announced and can have a consequence of being excluded from the
list of stock exchanges.
- Codes of good practices call for INEDs, audit, remuneration and nomination committees, and
separation of Chairman and CEO
- Shareholder minorities have greater rights, unlike the US model
- Companies should have programs for training and development of individuals for future director roles
- Changing ownership structure (the ownership of institutional investors is growing)
German model
- Rules-based company law
- Judges not juries play prominent role
- Stakeholder-centric model, with a vast participation of employees and communities (at risk of
changing)
- Relatively less developed stock markets
- Prominent power of banks (unlike Anglo-Saxon model, where institutional investments prevail)
Japanese model
- Keiretsu (系列) models (networks of companies connected through crossholding and interlocking
directorships)
- Keiretsu reflects social cohesion within society, unity throughout the organization, non-adversarial
relationships, lifetime employment, personnel policies encouraging commitment, and promotion based
on loyalty and social compatibility
- Board is seen as the top of the management pyramid (everyone can be ‘promoted’ to the board)
- Boards are big and distinction between management and labour, executives and employees is narrow
- INEDs are unusual, but their proportion is increasing (“How can an outsider possibly know enough
about the company to make a contribution?”)
- Ringi communication encourages dialogue up and down management hierarchy

Chinese model
influenced by passage from communism to capitalism
- High (inadequate?) protection of minority shareholders
- 2-R Government policy: retain control over large state-owned enterprises, and retreat from SMEs that
operate in highly competitive markets
- Two-tier board is adopted (Chinese version – no right of dismissal and appointment of BDs, and no
sufficient resources and meaningful mechanisms to ensure monitoring of BD)
- China Securities Regulatory Commission rules:
- Ban for all listed companies to provide loan guarantees for any related parties, including parent
company and subsidiaries
- Separation of a listed company from its controlling shareholder with regard to its employees, assets,
accounting, business operations and organizations
- INEDs should be one-third of BD
- Secretary of BD is responsible for the disclosure of all relevant information (not auditors)
- A company with 3 consecutive years of losses will be de-listed
Indian model
- Influenced by the UK model
- Vast majority of corporations are privately owned
- Recommended: One-third INEDs if the chairman is non-executive, and 50% INEDs if the chairman is
CEO.
- INEDs should have an understanding of balance sheets, profit and loss accounts, cash-flow statements
and financial ratios, and have some knowledge of various company laws.
- Corporate governance principles are young, but the vast majority of OECD principles is observed in
India’s desired corporate practices codes, with a solid shareholders protection and respect if takeholder
rights.
Women on the Board of Directors
- About 20% of all directors of Fortune’s 500 companies
- SEC requires to disclose board diversity policies
- Norway – 40% of directors must be women
- Difficulty to find the right candidate
- Female issues are different (no golf, weekends with children, surrounded by men, who do not see you
as a professional who can run the business)
- Arguable statement that Corporations with WBD perform better
- Diversity of angles of view increases board effectiveness
- Diversity as a contribution to discussions
- Women ask different questions and ask questions differently
- Women are better dealmakers, less likely to take unnecessary risks, less aggressive and don’t suffer
empire-building syndrome