Corporate Governance: An Overview

• Corporate governance refers to the processes that monitor, manage, and oversee sustainability-related issues.
• Governance can pertain specifically to sustainability-related matters.
• Broadly, governance includes the mechanisms that shareholders use to monitor managers.
• Governance mechanisms encompass board oversight, executive compensation, shareholder rights, and accounting practices.
• Corporations are central to the modern economic system.
• There is a separation of ownership and control in corporations.
  • Shareholders have ownership.
  • CEOs and management have control.
• Shareholders have limited liability.
• Ownership interests are traded in equity markets.
• Agency problems arise when shareholders delegate control to management.
  • Management may not act in the shareholders' best interests.
  • Corporate governance aims to reduce these agency problems.
• When a firm performs poorly due to bad management:
  • Accounting and auditing reveal this poor performance, reflected in the stock price.
  • Those who care about the performance are the shareholders, and the board of directors.
  • Shareholders can sell their shares, and the board can pressure or replace the CEO, which requires independent directors.

CG Mechanisms

• Shareholders, the board, and the CEO/management must work together effectively.
• Shareholders:
  • Elect directors.
  • Vote on management and shareholder proposals.
  • Engage with the board and senior management.
• The board:
  • Selects the CEO.
  • Sets the tone at the top.
  • Oversees corporate strategy, risk management, financial reporting, capital allocation, governance, and compliance.
• CEO & Senior Management:
  • Run business operations.
  • Lead strategic planning.
  • Provides recommendations for capital allocation.
  • Identifies and manages risks.
  • Provides financial reports.
  • Implements capital allocations and operating plans.
  • Selects managers.
  • Plans for business resiliency.
• The Lead/Presiding Director chairs meetings of independent directors.
• The Audit Committee selects and oversees the outside auditor and oversees financial reports, compliance, etc.
• The Nominating/Corporate Governance Committee establishes director qualifications, conducts succession planning, and oversees board functioning.
• The Compensation Committee advises on compensation, and sets compensation policies for the CEO and senior management, aligning it with shareholder interests.
• The Business Roundtable (BR) in the US includes over 200 CEOs, promotes public policy and offers 8 corporate governance principles as a benchmark.
• Primary responsibilities of the board include:
  • Selecting the CEO.
  • Setting the tone.
  • Overseeing the CEO and management team.
• Management runs the business to build long-term value.
• Management produces financial statements for investors under board oversight.
• The board's audit committee selects and oversees the outside auditor, financial reporting, internal controls, risk management, and compliance.
• The board's nominating committee oversees board composition and succession.
• The board's compensation committee sets compensation policies for the CEO and senior management to align with long-term value creation.
• The board and senior management should engage with long-term shareholders to build long-term value.
• The HKEX's Corporate Governance Code (Appendix C of Listing Rules) has detailed guidance on each mechanism.

Governance Issues in ESG

• Include issues related to the Board, pay, shareholders, and accounting.

Board Independence and Composition

• Requires independence from management and large shareholders.
• Demands diversity in gender, ethnicity, age, and professional backgrounds.
• A mix of skills, experiences, and perspectives is needed among directors.
• HKEX Listing Rules:
  • Requires at least three independent non-executive directors (INEDs) on every board.
  • INEDs should represent at least one-third of the board.
  • A director is not independent if:
    • They have or had a material interest in the company's business.
    • They are connected to a director, the CEO, or a substantial shareholder.
• Cathay Pacific targets no more than 70% of directors of the same gender by the end of 2027, and 65% of senior positions by 2025.

Board Committees

• Audit, compensation, and nominating committees are required.
• In HK, all three committees should include a majority of INEDs.

Audit Committee Roles

• Must have at least three members, one of whom must be an INED with appropriate qualifications.
• Recommends appointment, and removal of the external auditor to the board.
• Approves remuneration and any questions of resignation or dismissal.
• Monitors the external auditor's independence and audit effectiveness.
• Monitors the company's financial reporting, risk management and internal control systems.

Remuneration Committee Responsibilities

• The chair must be an INED.
• Recommends the company's director, and senior management remuneration policy to the board.
• Reviews and approves management's remuneration proposals.
• Best practices include linking executive directors' pay to corporate and individual performance.

Nomination Committee Roles

• Chaired by the board chairman or an INED.
• Reviews board structure, size, and composition annually and makes recommendations for changes.
• Identifies qualified board member candidates and makes recommendations to the board.
• Assesses the independence of independent non-executive directors.
• Makes recommendations on director appointments and succession planning.
• Board reform Ongoing in HK.
• HKEX released consultation paper in June 2024, with a concluding report expected in Dec 2024.
• Proposed Changes:
  • Designating a lead INED when the board chair is not independent.
  • Strengthening board independence by no longer considering INEDs serving more than nine years as independent.
  • Promoting diversity by requiring the nomination committee to comprise directors of different genders.

HK CG Reform (Issued in Dec. 2024)

• Concluded that electing a "lead INED" should be voluntary.
• INEDs must not concurrently hold more than 6 Hong Kong-listed company directorships (3-year transition period from July 2028).
• A board must not include an INED who has served more than 9 years (with a phase-in period of 6 years, starting from July 2031).

Executive Compensation (Pay)

• Covers the CEO and senior executives.
• Components should include:
  • Salary.
  • Annual bonuses tied to short-term targets.
  • Long-term incentives like stock options and restricted shares.
• Objectives:
  • Attract and retain capable executives.

Shareholder Rights and Engagement

• Include the right to vote on major corporate decisions, receive dividends, access company information, and participate in annual meetings.
• Shareholder engagement occurs through:
  • Earnings announcement calls for financial analysts.
  • Annual general meetings (AGMs). Shareholders can vote on direction elections and management proposals; submit proposals for voting.
  • Interactions between a company and its shareholders thru investor relations.

Accounting

• Should provide relevant, accurate, and timely information about financial, operational, and ESG performance.
• Disclosure made through financial statements, sustainability reports, and other regulatory documents.
• Assurance being either mandatory (financial statements), or voluntary (ESG reports).
• An audit committee and auditor independence monitors the external auditor.