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
• 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
• 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
• 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.”
• 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.
• 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?
• 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
• A number of different theoretical frameworks have
evolved to explain and analyze CG such as:
• The Agency Theory (Finance and Economics)
• Transaction Cost Theory (Economics and
Organizational Theory)
• 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
• 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)
• Talks about cost of transactions for a company and its relationship with the
management’s opportunism
• Bounded rationality of managers
• Cost of transactions
• Managers try to organize the transactions in their best interests.
• 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
• 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
• 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)
• linked to stakeholders theory is the concept of corporate Social
Responsibility (CSR) as well.
• While researches have found a positive relationship b/w revenues and CSR.
• However, it is very difficult to balance the interests of different
stakeholders.
• 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.
• 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
• Converging
• Diverging
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Governance is more than just board
processes and procedures
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Rights of the shareholders
Equitable treatment of shareholders
Disclosure and transparency
Role of stakeholders in CG
Responsibilities of the board
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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
• 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
• 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 lenders
• Have some means of protecting their interest
through legal documentation, are relatively at lower
risk but still require protection
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Society at Large
• 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. Shareholders
2. Board of Directors
3. Management
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CEO
Executive Directors
Senior Managers
4. 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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Issues in CG
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Distinguishing the role s of the board and mgt
Composition of the board and related issues
Separation of the roles of the CEO and chairperson
Boards functioning
Directors and executive remuneration
Disclosure and audit
Protection of shareholders rights and their
expectations
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Benefits of CG
• Creation and enhancement of a corporation’s competitive advantage
• Enabling a corporation perform efficiently by preventing fraud and
malpractices
• Providing protection to shareholders interest
• Enhancing the valuation of an enterprise
• Ensuring compliance of laws and regulations
• Benefits to society at large
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References
• Solomon, J. and Solomon, A. (2004). Corporate Governance
and Accountability. Chichester: John Wiley & Sons – Pages 130
• Butt, S. (2011). Corporate Governance (Second Edition). Azeem
Academy, Lahore – Pages 15-29
• Fernando (2012)- Chapter 1
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