Chapter 5 Corporate Governance Instructor: Dr. Tôn Nữ Ngọc Hân Center for Public Administration International University Vietnam National University HCMC Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Outcomes • Explain the term corporate governance. • Understand the responsibilities of the board of directors and the major governance committees. • Explain the significance of the “King One” and “King Two” reports. • Explain the differences between the following two governance methodologies: “comply or explain” and “comply or else.” • Identify an appropriate corporate governance model for an organization. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Corporate Governance System by which business corporations are directed and controlled. • Good corporate governance: Plays a vital role in underpinning the integrity and efficiency of financial markets. • Poor corporate governance: Weakens a company’s potential and can lead to financial difficulties and fraud. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. What Does Corporate Governance Look Like? Owners: Supply equity or risk capital to the company by purchasing shares in the corporation. Board of directors: Group of individuals who oversee governance of an organization. • Elected by vote of the shareholders at the annual general meeting (AGM). Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Audit and Compensation Committees Operating committees staffed by members of the board of directors plus independent or outside directors. • Audit committees are responsible for monitoring the financial policies and procedures of the organization. • Compensation committees are responsible for setting the compensation for the chief executive officer (CEO) and other senior executives. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Corporate Governance Committee • Monitors the ethical performance of the corporation. • Oversees compliance with the company’s internal code of ethics as well as any federal and state regulations on corporate conduct. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Figure 5.1: Governance of the Modern Corporation Source: Adapted from Fred R. Kaen, A Blueprint for Corporate Governance (New York: AMACOM, 2003). Access the text alternative for slide images. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. In Pursuit of Corporate Governance King One report was recognized as advocating the highest standards for corporate governance. • Took a more integrated approach to the topic of corporate governance. • By recognizing the involvement of all the corporation’s stakeholders in the efficient and appropriate operation of the organization. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. King Two Report 1 Formally recognized the need to: • Move the stakeholder model forward. • Consider a triple bottom line as opposed to the traditional single bottom line of profitability. • Triple bottom line recognizes the economic, environmental, and social aspects of a company’s activities. Successful governance in the world in the 21st century requires companies to adopt an inclusive and not exclusive approach. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. King Two Report 2 • Company must be open to institutional activism and should emphasize the sustainable or nonfinancial aspects of its performance. • Boards must apply the tests of fairness, accountability, responsibility, and transparency to all acts and be accountable to the company and its stakeholders. • Correct balance between conformance with governance principles and performance in an entrepreneurial market economy must be found. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Two Governance Methodologies Comply or explain. • Guidelines that require companies to abide by a set of operating standards or explain why they choose not to. Comply or else. • Guidelines that require companies to abide by a set of operating standards or face stiff financial penalties. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. The Chairman and the CEO 1 Disregarding the corporate governance model involves merging the roles of CEO and chairman of the board into one individual. • Oversight provided by the board of directors is lost. • Operational focus changes from long term to short term. • Merging the two roles may lead to higher efficiency. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. The Chairman and the CEO 2 Advantages of merging. • Potential for conflict is minimized. • Board is given the benefit of leadership from someone who is in touch with the inner workings of the organization rather than an outsider. Disadvantages of merging. • Governance of the corporation is with one person, which eliminates the checks and balances process that the board was created for in the first place. • Independence of the board is compromised, and the power of the stockholders is minimized. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Effective Corporate Governance 1 INSEAD, the European business school, emphasizes corporate governance as an organizational culture issue through CRAFTED principles. • Consistency, responsibility, accountability, fairness, transparency, and effectiveness that is deployed throughout the organization. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Effective Corporate Governance 2 To serve the purpose in setting the operational tone for the organization, the board should be: • Comprised of members who represent professional conduct. • Granted proper authority to fulfill their responsibilities of oversight, guidance, and approval. • Willing to work with the executive leadership to provide feedback and guidance in a detailed and timely manner. Electing to take strategic projects under advisement for extended periods of time may serve to reinforce the power of the board of directors. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Dangers of a Corporate Governance Checklist Effective corporate governance is more than just maintaining a checklist of items to be monitored on a regular basis. • Having mechanisms in place will not guarantee good governance. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. A Fiduciary Responsibility Corporate governance is about managers fulfilling a fiduciary responsibility to the owners of their companies. Based on trust, which is a difficult trait to test when hiring a manager or enforcing it later. • Enforcement only becomes an option when that trust has been broken. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Key Safeguards for Corporate Governance • Properly constituted boards. • Separation of the functions of chairperson and CEO. • Audit committees. • Vigilant shareholders. • Financial reporting and auditing systems that provide full and timely disclosure. Copyright © 2021 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
