CORPORATE GOVERNANCE
AND
THE ROLE OF BOARDS AND DIRECTORS
Professor Thomas Clarke
Director
UTS Centre for Corporate Governance
LAW VISION
MULTIMEDIA TRAINING

Outline
 Introduction
“Why governance? Why Now?”
 Definitions of Corporate Governance
“What is corporate governance and why is it important?”
 Cycles of Governance
“Will we ever learn? Or are disasters inevitable?”

Outline
 Boards and Directors
“Accountability and Strategic Direction?”
 The Duties of Boards and Directors
 Reform of Corporate Governance

INTRODUCTION

Epoch Making Challenges
 19th C Entrepreneurship
 20thC Management
 21st C Governance
(R.I. Tricker circa 1992)

“Why Governance?, Why now?”
 International deregulation of financial markets
 Increasing scale and activity of corporations
 Growth of investment institutions
 Effective monitoring necessary for security of investments
 Recognition that governance matters for accountability, performance and attracting capital.
 A general trend in society towards openness, transparency and disclosure.

Kenneth Lay
Chairman Enron
Jeff Skilling
CEO Enron
Bernie Ebbers
CEO Worldcom

Rene Rivkin
Geoff Dixon &
Margaret Jackson
CEO James
Hardie
Peter Macdonald

Definitions of Corporate Governance
DEFINITIONS OF CORPORATE GOVERNANCE

Definitions
 “Corporate Governance is the system by which companies are directed and controlled…”
(Cadbury Report, UK, 1992)
 “Involves a set or relationships between a company’s management, its board, its shareholders, and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.”
(OECD, Principles of Corporate Governance, 1999; 2004)

Berle and Means Model of Ownership and Control
Securities markets
Qu ar te rly
r ep o rts
SHAREHOLDERS
Institutional
Investors
S ha re
p ric e i nf or m at io n
Dividends
Supervisory power
Dept capital
Wages
Labour
In pu ts
M ar ke t P rice
Interest payments
G oo ds
&
S er vice s
Ma rke t p ri ce
National &
Local
Government
Adapted from: M. Blair, Ownership and Control (1995)

ASX Definition (2003:3)
 “Corporate governance is the system by which companies are directed and managed. It influences how the objectives of the company are set and achieved, how risk is monitored & assessed, & how performance is optimized.
 Good corporate governance structures encourage companies to create value (through entrepreneurialism, innovation, development & exploration) and provide accountability & control systems commensurate with the risks involved”

Corporate Governance Life Cycle
Founding
Entrepreneurs
Public Corporation
(Diffuse Shareholders)
Maturity Governance challenges
• Maintain alertness
• Board assessment
•Advance value commitments
Public Corporation
(Majority Shareholders)
IPO
(Initial Public Offering)
Growth Governance challenges:
•Risk management
•Develop board directors.
• Engage stakeholders.
Private
Company
Launch Governance Challenges:
• Raise capital
• Recruit board of directors
• Establish accountability
Source: Clarke T. (2006)
Time

In its broadest sense,
“Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals”.
The governance framework is there to
‘ encourage the efficient use of resources and equally to require accountability for the stewardship of those resources’.
The aim is to align as nearly as possible the interests of individuals, of corporations, and of society.
(Cadbury 2004)

Diversity in Corporate Governance
 National, regional and cultural differences
 Ownership structure and dispersion
 The industry and market environment of the corporation
 Firm size and structure
 Life cycle variations including origin & development, technology & periodic crises and new directions

Levels of Governance
(Dawson 2004)
 Business Ethics/Principles
 Procedures/Processes
 Practices/Behaviour

Return to Fundamentals?
‣
Justice Neville Owen (2003)
HIH Royal Commission of Inquiry Report
=
‣
Sir Adrian Cadbury (2004)

Boards of Directors

Boards of Directors

Context: Disclosure and Accountability
Roles and responsibilities of directors
Regulatory requirements
Post-GFC reforms
Board
Board evaluation processes Investor engagement

DIRECTOR’S DUTIES
The UK Company Law Reform Bill (2005)
To act within the powers conferred;
 to promote the success of the company for the benefit of its members. Directors must have regard to the long term and wider factors such as relationships with employees, suppliers, customers and the impact of the company’s operations on the community and environment;
 to exercise independent judgment;
 to exercise reasonable care, skill and diligence;
 to avoid conflicts of interest;
 not to accept benefits from third parties;
 to declare an interest in a proposed transaction with the company.

Board Judgement
The one element that is absolutely essential in the armoury of directors and boards is judgement:
 “Legally, the board is the highest authority in the company, the
‘ fountain of power’ , yet top management naturally tends to exercise that power…
 Critical judgement on management performance – requiring in-depth knowledge of, and intimacy with the affairs of the corporation – and at the same time to assure that this judgement is independent –
 The working style of the board must build its collective strength: the board needs the trusting familiarity of a close-knit group, yet members must be independent personalities who can resist
‘groupthink’ and raise critical questions of colleagues”
(Demb and Neubauer 1992:13-16).

BOARD DUTIES AND FUNCTIONS:
OECD Principles of Corporate Governance (2004)
 Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives, monitoring and implementation and corporate performance; and overseeing major capital expenditure, acquisitions and other divestitures.
 Monitoring the effectiveness of the company’s governance practices and making changes as needed.
 Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning.
 Aligning key executives and board remuneration with the longer term interests of the company and its shareholders.

BOARD DUTIES AND FUNCTIONS:
OECD Principles of Corporate Governance (2004:24-25)
 Ensuring a formal and transparent board nomination and election process.
 Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse of related party transactions.
 Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the independent audit and appropriate systems of control are in place, in particular systems for risk management, financial and operational control, and compliance with the law and relevant standards.
 Overseeing the process of disclosure and communications .

Board Structure and Performance
Board systems and structure
Board Composition
Board Performance
 Independence
 Diligence
 Competence
 Ethics
 Board structure
 Productive meetings
 Succession planning system
 Financing reporting/risk management
 Strategic information systems
 Performance evaluation/compensation systems
 Superior strategic guidance
 Accountable organisations
 High quality senior executives
 Long term financial success
Corporate
Performance
Source: Epstein & Roy (2004). Determinants of Board Performance, page 4.

The Dysfunctional Board
CULTURE
An adversarial atmosphere in the boardroom or an unmotivated board with a tendency to group-think
COMPOSITION
Skill deficits or lack of genuine independence on the board
Chair
CEO
CHARACTERISTICS
Conflicts of interest or factional interests on the board, perhaps due to a dominant shareholder
PROCESS
Poor chairmanship – a chair who is too weak, too autocratic or too close to the CEO
Poor processes leading to inefficient use of time

The Effective Board
CULTURE
Honest, Respectful
Transparent
Constructive challenge
Chair
CEO
CHARACTERISTICS
Engaged
Non-adversarial
Independent
COMPOSITION
Diversity
Experience
PROCESS
Secretarial support
Information
Committees

Boards Best Practices (ASX 2007).
 1 . Lay solid foundations for management and oversight . Recognize and publish the respective roles and responsibilities of board and management.
 2. Structure the board to add value . Have a board of an effective composition, size and commitment to adequately discharge its responsibilities and duties.
 3. Promote ethical and responsible decision-making . Actively promote ethical and responsible decision-making.
 4. Safeguard integrity in financial reporting . Have a structure to independently verify and safeguard the integrity of the company’s financial reporting.
 5. Make timely and balanced disclosure . Promote timely and balanced disclosure of all material matters concerning the company.

 6. Respect the rights of shareholders . Respect the rights of shareholders and facilitate the effective exercise of those rights.
 7. Recognize and manage risk . Establish a sound system of risk oversight and management and internal control.
 8. Remunerate fairly and responsibly . Ensure that the level and composition of remuneration is sufficient and reasonable and that its relationship to corporate and individual performance is defined.
** 2009 Update: The ASX Corporate Governance Council (Council) proposes to expand the Corporate Governance Principles and Recommendations to adopt and disclose a diversity policy that includes measurable objectives relating to gender.

BOARDS OF DIRECTORS

Direction
Vertical integration
Method
Internal
Organic growth
Finance
Equity –
Public and/or private
Structure
U- form
Single plant,
Single product
Horizontal integration
Debt-
Bank, public
M- form
Geography,
Product.
Mergers and
Acquisitions,
Spin-off and divestitures
Diversification
Related or unrelated
Retained earnings
Diversification geographic
Inter-organisational e.g. joint ventures,
Franchising,
Alliances.
Trade credit
And networks
H- form
Matrix

The Two Primary Functions of the Board

Reform of Corporate Governance

 The ideal portrayal of the board is as an active, deliberative and decisive forum for the business: “ Boards of directors collectively determine, through the decisions they make, the fate of the corporation…The principal work of a board of directors is to make decisions.”
Leblance & Gillies (2005).
 However there is much evidence that in the past boards of directors enjoyed a fairly passive existence, carrying out their duties, if at all, in a largely nominal way.
Mace (1971); Lorsch & MacIver (1989).

The Enron Legacy

Enron Asleep at The Wheel
 Fiduciary failure
 High risk accounting
 Inappropriate conflicts of interest
 Extensive undisclosed off the books activities
 Excessive compensation
 Lack of independence

The Transformation from Management
Control to Independent Boards
Management Controlling the Levels of Power
NON- EXECUTIVES
Chairman
&
Chief Executive
Investors relations
Board
Appointments
E X E C U T I V E S
Executive
Remuneration
Auditing of
Accounts

The Transformation from Management
Control to Independent Boards
The Board Controlling the Levers of Power
EXECUTIVES
Investors relations
Senior
Independent directors
Chairman Audit
Committee
Chief
Executive
Nomination
Committee
Remuneration
Committee
N O N - E X E C U T I V E S
Board
Appointments
Executive
Remuneration
Auditing of
Accounts
Source: Taylor (2004)

Post-GFC Reforms
New Focus on Board Performance & Effectiveness
Revised UK Corporate Governance Code published June 2010:
 To encourage boards to be well balanced and avoid “group think”, there are new principles on the composition and selection of the board, including the need to appoint members on merit, against objective criteria, and with due regard for the benefits of diversity, including gender diversity.
 To promote proper debate in the boardroom, there are new principles on the leadership of the chairman, the responsibility of the non-executive directors to provide constructive challenge, and the time commitment expected of all directors.
 To help enhance the board’s performance and awareness of its strengths and weaknesses, the chairman should hold regular development reviews with each director and board evaluation reviews in FTSE 350 companies should be externally facilitated at least every three years. (FRC, 2010)

Cycles of Governance
CYCLES OF GOVERNANCE

Cycles of
Governance

Cycles of Governance
 “Corporate Governance crisis and reform is essentially cyclical”.
 “Waves of corporate governance reform and increased regulation occur during periods of recession, corporate collapse and re-examination of the viability of regulatory systems”.
 “During long periods of expansion, active interest in governance diminishes, as companies and shareholders become again more concerned with the generation of wealth, than in its retention”.
(Clarke, T. (2004). Theories of Corporate Governance, Routledge.