Corporate Governance
Week 1
Have you heard about!
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NICL Scam (Pakistan)
Mehran Bank (Pakistan)
Enron
Satyam Computers
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Corporate Governance – An Introduction
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Corporate – related with corporations
Governance- derived from Latin
‘gubernare’- meaning to ‘steer’
The way in which companies are directed
and controlled (Cadbury Report 1992)
Recent examples of massive collapses
resulting from weak systems of CG have
highlighted the need to improve and
reform CG at international level.
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Corporate Governance – An Introduction
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Some recent reforms:
• USA issued Sarbane-Oxley Act (2002)
• Higgs and Smith Reports (2003) UK
• SECP guidelines in Pakistan
• OECD guidelines in European continent.
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Corporate Governance – An Introduction
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There are different perspectives of CG and
the same is evident from the definitions as
well.
One approach of CG adopts a narrow view,
where CG is restricted to the relationship
b/w a company and its shareholders.
In an other approach, CG has broader
spectrum beyond shareholders extending
that to stakeholders such as employees,
customers, suppliers, governments etc.
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Corporate Governance – An Introduction
Some Definitions of CG are:
“the process of supervision and control intended to
ensure that the company’s management acts in
accordance with the interests of shareholders
(Parkinson 1994)
“the governance of an enterprise is the sum of
those activities that makeup the internal
regulation of the business in compliance with the
obligations placed on the firm by legislation,
ownership and control. It incorporates the
trusteeship of assets, their management and their
deployment (Cannon 1994)
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Corporate Governance – An Introduction
Some Definitions of CG are (Contd):
According to Solomon & Solomon (2004: 14) CG is
“the system of checks and balances, both internal
and external to companies, which ensures that
companies discharge their accountability to all
their stakeholders and act in a socially responsible
way in all areas of their business activity.”
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This definition perceives that companies can
maximize value creation over the long term by
discharging their accountability to all of their
stakeholders and by optimizing their system of
CG
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Corporate Governance – An Introduction
The same outcome was identified by
different independent researches such as
the reports of UK Investment Institute of
the Higgs report found that:
Companies that demonstrate a commitment to a
broad range of stakeholders are likely to show
better management skills and increase in
accountability can maximise the sustainable
wealth creation.
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Body shop, Tesco, Patagonia
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Governance and
Management
How do these terms differ?
 Does Governance include
Management?
Or
 Does Management include
Governance?
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Governance & Management
Governance
Function
Management
Approval of Plans
Planning
Preparation of plans
Providing overall
leadership
Leading
Leading those who
implement plans
Arranging
resources
Organizing
Tasks division &
resource usage
Controlling
managers
Controlling
Controlling
employees
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What is a Corporate Body?
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Any Company is a corporate body. However, in a
broader sense only public limited companies are
taken to be the subject matter of CG.
So far the thrust of CG is only on listed
companies.
What about family businesses, private
companies?
In USA and Europe, companies are frequently
run by minority shareholders. Hence, they
require even greater degree of CG.
Please refer to Butt, S (2011), Pages: 16-18
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Corporate Governance – Theoretical Frameworks
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A number of different theoretical
frameworks have evolved to explain and
analyze CG such as:
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The Agency Theory (Finance and
Economics)
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Transaction Cost Theory (Economics and
Organizational Theory)
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Stakeholder Theory (Social-oriented
perspective)
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Corporate Governance – Theoretical Frameworks
The Agency Theory:
 Owners (shareholders) delegate the running of
the company to management
• Owners: Principals
• Management: Agents
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Their relationship is the agency theory.
The problem is that sometime the agents take
decisions which are not in the best interests of
the principals.
Due to managers ego-ism or personal objectives
leading to short term profits but ignoring the long
term sustainable profit maximisation or in other
words ignoring the long term consequences.
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Corporate Governance – Theoretical Frameworks
The Agency Theory (Cont’d):
 Same is in case of risk sharing
 Again the monitoring of agents by
principals is a difficult and expensive task.
• Usually contract (agreements) are performed
to solve this problem.
• As well as the voting power of the shareholders
and their power for “Take-over” vote is useful
for the balancing of powers.
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Corporate Governance – Theoretical Frameworks
Transaction Cost Theory (Caose, R)
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Talks about cost of transactions for a company and its
relationship with the management’s opportunism
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Bounded rationality of managers
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Cost of transactions
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Managers try to organize the transactions in their best
interests.
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Transaction cost theory suggests that shareholders should
have control (influence) in the decision making and
managers should pursue the best interests of the
shareholders rather than their own personal interests and
there should be some institutions to mange this sort of
transactions
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Corporate Governance – Theoretical Frameworks
Stakeholders Theory
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Freeman (1984) proposed that corporate accountability to a
broader range of stakeholders.
• Today you can see availability of Co information, annual reports
on different medium such as newspapers, websites
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The role of companies in societies has received increasing
attention over time, with their impacts on employees, the
environment, local communities as well their own
shareholders.
A basic thing is that Cos are now so large and they have
impact on the society. Imagine even in KPK the role of PTC,
Lakson on Tobacco growers!!!
Some BS!!
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Corporate Governance – Theoretical Frameworks
Stakeholders Theory (Cont’d)
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linked to stakeholders theory is the concept of corporate
Social Responsibility (CSR) as well.
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While researches have found a positive relationship b/w
revenues and CSR.
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However, it is very difficult to balance the interests of
different stakeholders.
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However, it is expected of today’s enterprises that they will
have to cater to the needs and wants of the different
stakeholders rather than a single stakeholder in term of
shareholders.
Look at Apple’s initiative or Dell and HP initiatives, Tesco etc
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Corporate Governance – Theoretical Frameworks
To Conclude we can say that:
 Ignoring the stakeholders can result in
corporate failure while concern for
stakeholders attracts investors in the
current times.
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And to survive companies has to look
beyond share holders to a broader range
of stakeholders as well as companies
should have more accountability (not mere
financial but all encompassing) and more
control on its internal processes.
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The CG Framework
Regulators
Legislation
Management
Auditors
Internal
mechanisms
Board
Shareholders
CG
Stakeholders
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Essential Principles of CG
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Discipline
Transparency
Independence
Accountability
Responsibility
Fairness
Social responsibility
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Is there some global uniformity
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Converging
Diverging
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Stakeholders in a Company
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Management and Employees
Lenders
Suppliers and Clients
Shareholders
Society at large (this includes
government)
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Opportunity to protect
individual interests
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Managers and Employees have the
greatest opportunity to protect their
interest(s)
Suppliers and Clients essentially go
by each transaction or contract.
Lenders and Shareholders are most
vulnerable.
Society depends entirely on law
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Shareholders
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Controlling Groups (Internal Equity)
Outsider Shareholders (External
Equity)
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Outsider Shareholders
Institutional Investors
 Have some means of protecting their
interest but still require protection
Individual or General Public
 They require the greatest degree of
protection, as they have virtually no
means of protecting their interest.
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Lenders
Institutional Investors
 Have some means of protecting their
interest through legal documentation, are
relatively at lower risk but still require
protection
Individual or General Public
 They require the greatest degree of
protection, as they have virtually no
means of protecting their interest.
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Society at Large
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Government (Taxes, Law and Order)
Clients (Value for money)
Community (Social Rights)
How do we ensure that these
stakeholders get their dues?
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Corporate Hierarchy
1.
2.
3.
Shareholders
Board of Directors
Management
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4.
CEO
Executive Directors
Senior Managers
Employees
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Key Players
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Shareholders (Voting power)
Board of Directors (Represents
interests)
CEO (Delegated executive powers)
Senior Managers (Delegated executive
powers)
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Scope of Corporate Governance
Interests
Individual
Stakeholders
Objectives / interests
Shareholders
Sustainable growth in net worth
Lenders
Security / timely interest payments
Employees
Continued employment at good terms
Business
Associates
Continued business at good terms
Society
Good citizenship by the company
Tools / Techniques
General Management
Legal frame work
Professional Codes
Industrial practices
Continued profitable existence
Collective Interest of all
stakeholders
Strategic Management
Risk Management
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References
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Solomon, J. and Solomon, A. (2004).
Corporate Governance and
Accountability. Chichester: John
Wiley & Sons – Pages 1-30
Butt, S. (2011). Corporate
Governance (Second Edition). Azeem
Academy, Lahore – Pages 15-29
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