Corporate
governance
Corporate Law: Law principles and practice
Defining corporate governance
In the UK, the Cadbury Report of 1992 referred to
corporate governance as ‘the system by which companies
are directed and controlled’.
Corporate governance is also said to be ‘concerned with
the way in which corporations are governed and in
particular in the United Kingdom the relationship between
the management of a company and its shareholders’.
Corporate Law: Law principles and practice
The parameters of corporate governance
Corporate governance, to a certain extent, is determined
by international standards or benchmarks.
Good governance is assessed based on the performance of
Australian companies, and within individual companies .
Corporate Law: Law principles and practice
Corporate governance cont …
Corporate governance involves the relationship between
three groups:
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the chief executive officer (CEO) and senior
employees
the board of directors
the shareholders as owners.
Corporate Law: Law principles and practice
Corporate governance cont …
Therefore, the focus of corporate governance is on:
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controlling the actions of the ‘insiders’, such as the CEO,
senior managers and directors, and ensuring they are
acting in the company’s, and by extension the
shareholders’, best interests.
instituting a check and balance system.
Corporate Law: Law principles and practice
Elements of corporate governance
Legal regulation
Corporations Act 2001 (Cth)
Codes of conduct, guidelines and statements of best
practice
These are voluntary guides adopted by the company itself.
Corporate Law: Law principles and practice
Elements of corporate governance cont …
Business ethics
Business ethics requires a super requirement of doing the
‘right thing’, as well as meeting all of the legal
requirements.
Triple bottom line reporting and corporate social
responsibility: triple bottom line reporting
provides a model for companies to consider three
measures of performance—financial, social and
environmental—rather than just the narrow traditional
financial measure.
Corporate Law: Law principles and practice
Stakeholders—a critical concept
Stakeholders are those groups within and outside a
company who have an interest, stake or entitlement in
how the firm is managed and controlled. Stakeholders of a
company would include:
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within the company, the employees and shareholders
external to the company, the suppliers and customers
in terms of the business environment, any competitors
more generally, regulators and other government
agencies
more nebulous is the social and environmental impact
of the company and the company’s attitude, as an
organisation, to ‘the future’ itself.
Corporate Law: Law principles and practice
Stakeholders—a critical concept cont …
In the business context, the regulators and relevant
government agencies include:
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the Australian Securities and Investments
Commission (ASIC)
the Australian Competition and Consumer
Commission (ACCC)
the Australian Prudential Regulation Authority
(APRA)
the Australian Tax Office (ATO).
Corporate Law: Law principles and practice
Matters concerning corporate governance
Competition issues:
• compliance with regulation
Internal stakeholders:
• members/shareholders
• employees
Examples of key issues:
• accountability
• transparency
• due process in decision-making
• regard for minority shareholders by the majority
Corporate Law: Law principles and practice
Matters concerning corporate governance cont …
External stakeholders:
• customers
• regulators
• competitors
• corporate social responsibility: sustainability,
environment and ‘the future’
Examples of key issues:
• rules of the market
• compliance with regulation
• a fair market
• profitable
• well managed
• satisfied shareholders
Corporate Law: Law principles and practice
Current and future trends in corporate
governance
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the adoption by the ASX of the Principles of Good
Corporate Governance and Best Practice
Recommendations (a form of self-regulation)
the introduction of the Corporate Law Economic
Reform Program (CLERP), adding to legal regulation
potential regulation about aligning a director’s pay
with company performance and giving greater voice to
shareholders in general meetings.
Corporate Law: Law principles and practice
Remuneration of directors
See Executive Remuneration in Australia, released in January
2010. The Productivity Commission considered:
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trends in director and executive remuneration in Australia
and internationally
the effectiveness of the existing framework for the
oversight, accountability and transparency of director and
executive remuneration practices
the role of institutional and retail shareholders in the
development, setting, reporting and consideration of
remuneration practices
any mechanisms that would better align the interests of
boards and executives with those of shareholders and the
wider community
the effectiveness of the international responses to
remuneration issues arising from the global financial crisis.
Corporate Law: Law principles and practice
Corporate governance for ASX companies
ASX principles of best practice
The Principles of Good Corporate Governance and Best
Practice Recommendations, published by the ASX, are a
form of self-regulation.
The report observed that corporate governance is ‘the
framework of rules, relationships, systems and processes
within and by which authority is exercised and controlled
in corporations’.
It encompasses the mechanisms by which companies, and
those in control, are held to account.
Corporate Law: Law principles and practice
The evolving nature of corporate governance
In Australia and overseas, corporate governance evolves
within a company and is tailored to suit its needs. There is
no one model of corporate governance.
Corporate Law: Law principles and practice
The fundamentals of corporate governance
Principle 1: a company’s corporate governance requires
that the board of directors and senior executives are clear
on their roles, which take into account the following
principles
Principle 2: that they demonstrate a balance of skills,
experience and independence on the board appropriate to
the nature and extent of company operations
Principle 3: that those who determine the company’s
strategy and financial performance must make responsible
and ethical decisions that comply with the law and are in
the interests of all stakeholders
Corporate Law: Law principles and practice
The fundamentals of corporate governance cont …
Principle 4: that they meet the information needs of the
investment community to ensure the integrity of company
reporting
Principle 5: that these processes provide a timely and
balanced picture of all material matters
Principle 6: that the rights of shareholders need to be
recognised and upheld
Corporate Law: Law principles and practice
The fundamentals of corporate governance cont …
Principle 7: that every business carries some uncertainty
and this must be managed through effective oversight and
internal control
Principle 8: that appropriate rewards are required to
attract the skills necessary for the performance expected
by members.
Corporate Law: Law principles and practice
Corporate governance in the prospectus
Listed companies get on to the stock market by the initial
public offering (IPO) or prospectus route. They need to
comply with ASX listing rules, which are part of the
corporate governance matrix with which listed firms have
to comply.
Corporate Law: Law principles and practice
Corporate governance for small and medium-sized
enterprises
The corporate governance regime for SMEs is provided
for under the Corporations Act 2001 (Cth) and, in
particular, the key directors’ duties.
Corporate governance guidance is provided by the 10page Small Business Guide in Part 1.5 of the
Corporations Act 2001 (Cth), commencing at s 111J.
Corporate Law: Law principles and practice
Competing models of the company
The Australian corporate form, whatever its size and
complexity, is arranged around the interests of the
shareholder.
A basic dichotomy is at play in terms of corporate models.
In very broad terms, the company may be viewed as either
a shareholder-focused entity or an entity that has to meet a
wider array of stakeholder interests.
Corporate Law: Law principles and practice
Different models
Berle’s model: shareholder-centred model of fiduciary
duties
Dodd’s model: company directors are ‘guardians of all
the interests which the corporation affects and not merely
servants of its absentee owners’.
Corporate Law: Law principles and practice
British and American influences
US corporate governance
• based on advanced capitalist democracy
• developed financial share market
• shareholders are pre-eminent
UK corporate governance
• based on advanced capitalist democracy
• influenced by several key reports (from Cadbury 1992
to the 2010 Code)
Corporate Law: Law principles and practice
The German–Japanese model
The company:
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focuses on the rights and interests of employees
employees are first among stakeholders
Other stakeholders include:
• customers
• shareholders
Corporate Law: Law principles and practice
Relevant economic concepts
Agency costs
The term ‘agency costs’ refers to the inevitable costs
incurred by a company in using an agent (who may use
company resources to their own benefit) to act on behalf
of the principal. This creates costs when applying
strategies to mitigate any associated problems.
Typically, agency costs arise because of conflicts of
interest between shareholders and company management.
Corporate Law: Law principles and practice
Relevant economic concepts cont …
Incomplete contracting
Incomplete contracting refers to the gaps in the formal
contractual arrangement and to all the facets of the
relationship that make it work smoothly or work at all.
Asymmetric information
The term ‘asymmetric information syndrome’ was coined
by the US economist Joseph Stiglitz. Stiglitz refers to ‘the
differences in information between, say, the worker and
his employer, the lender and the borrower, the insurance
company and the insured’.
Corporate Law: Law principles and practice
Relevant economic concepts cont …
Navigating the moral hazards
The term moral hazard was originally used in the
insurance context to refer to the tendency of people with
insurance cover to paradoxically reduce the care and
attention they take to avoid or reduce insured losses.
In agency cost discussions relevant to corporate
governance, moral hazard arises when agents (such as
managers) discover information that is valuable to the
principal (the company) after the principal has contracted
for the agent’s services.
Corporate Law: Law principles and practice
Relevant economic concepts cont …
Aligning the interests of managers and shareholders
The need to align interests arises due to this misalignment
of interests between shareholders (as principal) and their
agents within the firm (the managers and directors) and
also to incomplete contracting. The solutions are based on
implementing:
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effective mechanisms for monitoring
sound accountability practices
incentive and pay schemes that optimally align
interests.
Corporate Law: Law principles and practice
Improving communication within companies
Incomplete contracting, asymmetric information and
moral hazard are, in reality, styles of inefficient
communication.
Corporate governance in a systemic sense is aimed at
developing more complete and more efficient
communication.
Good governance is to keep steadily improving the
communication mechanisms within companies to reduce
the asymmetries and to continue to close the gap in
matters of contract, and in so doing successfully diminish
the scope of the moral hazards inherent in a wealthgenerating entity.
Corporate Law: Law principles and practice
Social, cultural and other forces that determine
corporate governance systems
Jonathon Charkham has noted that:
‘No system [of corporate governance] … can be
understood without first looking at the salient features of
the particular society in which it developed. Everyone is
to some extent imprisoned by their history, social,
political, and economic.’
Corporate Law: Law principles and practice
International corporate governance developments
The UK has been the leader in developing corporate
governance systems, as evidenced by:
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the number of references to British developments on
leading commercial law firm websites
the number of UK-based, but internationally operated,
law firms setting up new offices in Australia
the rapidly international nature of much commercial,
corporate and resources work.
Corporate Law: Law principles and practice
Developments in the European Union
The European Commission published in 2011 a corporate
governance green paper titled The EU Corporate
Governance Framework. This framework proposes
several potential reforms, including:
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shareholder voting on executive remuneration
improvements to board diversity
better models for sustainable growth for companies
a more robust international financial and banking
system in the wake of the global financial crisis.