Session 11 slides - Strategic Case Study.pdf

Session 11 Strategic Case Study Paper 3.4 (ICAG Level 3) MSL Business School The ICAG Strategic Case Study (SCS) Syllabus Corporate Governance continued MSL Business School...

Session 11 Strategic Case Study Paper 3.4 (ICAG Level 3) MSL Business School The ICAG Strategic Case Study (SCS) Syllabus Corporate Governance continued MSL Business School Corporate Governance Approaches to Corporate Governance MSL Business School  The Scope of Corporate Governance Corporate Governance Issues So what are the key issues in corporate governance, which establish how well or badly a large company is governed? The main areas covered by codes of corporate governance are as follows: The role and responsibilities of the board of directors. The board of directors should have a clear understanding of its responsibilities and it should fulfil these responsibilities and provide suitable leadership to the company. Governance is therefore concerned with establishing what the responsibilities of the board should be, and making sure that these are carried out properly. The composition and balance of the board of directors. A board of directors collectively, and individual directors, should act with integrity, and bring independence of thought and judgment to their role. The board should not be dominated by a powerful chief executive and/or chairman. It is therefore important that the board should have a suitable balance, and consist of individuals with a range of backgrounds and experience. Financial reporting, narrative reporting and auditing. The board should be properly accountable to its shareholders, and should be open and transparent with investors generally. To make a board properly accountable, high standards of financial reporting (and narrative reporting) and external auditing must be upheld. The major ‘scandals’ of corporate governance in the past have been characterised by misleading financial information in the company’s accounts. Directors’ remuneration. Directors work for a reward. To encourage their commitment to achieving the objectives of their company, they should be given suitable incentives. Linking remuneration to performance is considered essential for successful corporate governance. However, linking directors’ pay to performance is complex, and remuneration schemes for directors have not been particularly successful. Directors’ pay is an aspect of corporate governance where companies are frequently criticised. The Scope of Corporate Governance Corporate Governance Issues Risk management and internal control. The directors should ensure that their company operates within acceptable levels of risk, and should ensure through a system of internal control that the resources of the company are properly used and its assets are protected. Shareholders’ rights. Shareholders’ rights vary between countries. These rights might be weak, or might not be exercised fully. Another aspect of corporate governance is encouraging the involvement of shareholders in the companies in which they invest, through more dialogue with the directors and through greater use of shareholder powers – such as voting powers at general meetings of the company. Disclosure. Keeping shareholders and other stakeholders informed about the company, through disclosures that go beyond the publication of audited financial statements. Corporate social responsibility and ethical behaviour by companies (business ethics) are also issues related to corporate governance.  The Scope of Corporate Governance Governance Issues for Other Types of Organisations In the UK, a Good Governance Standard was published by the Independent Commission for Good Governance in Public Service. This sets out six core principles of good corporate governance for public service corporations. 1. ‘Good governance means focusing on the organisation’s purpose and on outcomes for citizens and service users’. This means having a clear understanding of the purpose of the organisation, and making sure that users of the service receive a high-quality service and that taxpayers (who pay for the service) get value for money. 2. ‘Good governance means performing effectively in clearly defined functions and roles’. The governing body of the organisation is comparable to the board of directors in a company. It must be clear about what its responsibilities are, and it should carry these out. The responsibilities of executive management should also be clear, and the governing body is responsible for making sure that management fulfils its responsibilities properly. 3. ‘Good governance means promoting values for the whole organisation and demonstrating the values of good governance through behaviour’. Integrity and ethical behaviour are therefore seen as core governance issues in public sector entities. 4. ‘Good governance means taking informed, transparent decisions and managing risk’. Risk management and the responsibility of the governing body for the internal control system is as much a core feature of governance in public sector entities as in companies. 5. ‘Good governance means developing the capacity and capability of the governing body to be effective’. This issue is concerned with the composition and balance of the governing body. 6. ‘Good governance means engaging stakeholders and making accountability real’. In companies, the relationship between shareholders and the board of directors is an important aspect of governance, and companies and shareholders are encouraged to engage in constructive dialogue with each other. In public sector organisations, the constructive dialogue should exist between the governing body and the general public and particular interest groups. Stakeholders Shareholders and Directors The main stakeholder groups in a company are usually the shareholders and the directors of the company. The shareholders own the company and the directors are its leaders. The Shareholders The influence of shareholders over their company varies with circumstances. In a small company the shareholders and directors might be the same individuals. In some companies, there may be a majority shareholder (controlling shareholder). A majority shareholder should be able to influence the decisions of the board of directors, because he has the power to remove directors who disagree with him. In quoted companies (stock market companies) the interests of shareholders are likely to be focused on the value of their shares and the size of dividends. However, the shareholders might have little influence over the decisions of the board of directors. The Directors The board of directors is a significant stakeholder group in a company because they have the power to direct the company. Directors act as agents for the company and represent the interests of the company. A board of directors consists of both executive and non-executive directors. Executive directors have executive responsibilities as managers in the company, in addition to their role as director. They are usually full- time employees of the company. Non-executives are not involved in executive management and are very much ‘part time’ and in many countries (for example the UK and US) they are not company employees. Since executive directors combine their role as director with their full-time job as company employee, their interests are likely to differ from those of the non-executive directors.  Stakeholders Shareholders and Directors The Directors (continued) On the board of directors, some individuals might have considerably more influence than others. Typically, the most influential members of the board are the company chairman (board chairman) and the managing director (often called the chief executive officer or CEO). The board of directors take many decisions as a group, but they also have individual interests in the company. Directors are therefore stakeholders in their company both as a unit and as separate individuals. Other internal stakeholders Employees can be an important internal stakeholder group. It might be possible to divide employees into sub-groups, each with a different set of interests and expectations, and each with a different amount of influence over the actions of the company. It might be appropriate to separate senior management and other employees into two separate stakeholder groups. Senior management might have a bigger interest in the profits and share price of the company because they belong to a share incentive scheme or share option scheme, or because they receive annual bonus payments based on the company’s profitability. Other employees who do not have such incentives will have much less interest in the financial performance of the company or its share price. Some employees might be able to demand large rewards from the company or might exercise strong influence because of their value to the company. In some companies, there might be a strong trade union influence. The ability of a company to alter its working practices, for example, may depend on obtaining the co-operation and support of the trade unions. Stakeholders External Stakeholders A company has external stakeholders as well as internal stakeholders. External stakeholders are individuals or groups who do not work for the company but who nevertheless have an interest in what the company does and who might be able to influence the way in which the company is governed. Lenders have an interest in a company to which they lend money. They expect to be paid what they are owed. Usually a lender will not be closely involved in the governance or management of a company, but they will monitor its financial performance and financial position. Lenders will also become significant stakeholders if the company gets into financial difficulties and is faced with the risk of insolvency. Suppliers have an interest in companies who are their major customers, although their influence over its governance might be small. Regulators have an interest in companies whose activities they are required to regulate. Some aspects of regulation have a major impact on the way in which a company is governed. For example, quoted companies must comply with the rules set by the securities regulator (such as the Securities Exchange Commission in Ghana and the US, and the Financial Conduct Authority in the UK). Government has a stake in companies. Companies are a source of tax revenue and also collect tax (income taxes and sales taxes) for the government from employees and customers. For some companies, such as companies that manufacture defence equipment, the government might have an influence as a major customer for the goods that the company produces. Customers, the general public or special interest groups might have a significant influence over a company, especially a company that relies for success on the high reputation of its products or services. Stock exchanges have an influence over the governance of quoted companies, because companies must comply with the rules of the stock exchange on which their shares are traded.  Stakeholders External Stakeholders A company’s auditors should also have some influence over the governance of a company, by making sure that the board of directors presents financial statements to the shareholders that present a true and fair view of the company’s financial position and performance. Investors are a major influence over companies whose shares are traded on a stock exchange. Investors decide what the market price of a company’s shares should be. A company needs to satisfy the expectations not only of its shareholders, but of the investing community in general, if it wishes to sustain or increase the share price (and so the total value of the company). Agency Theory The law of agency An agent is a person who acts on behalf of another person, the principal, in dealing with other people. In company law, the directors act as agents of the company. The board of directors as a whole, and individual directors, have the authority to bind the company to contractual agreements with other parties. Since most of the powers to act on behalf of the company are given to the board of directors, the directors (and the management of a company) have extensive powers in deciding what the company should do, what its objectives should be, what its business strategies should be, how it should invest and what its targets for performance should be. The powerful position of the directors raises questions about the use of this power, especially where the owners of the company (its shareholders) and the directors are different individuals. How can the owners of the company make sure that the directors are acting in the best interests of the shareholders? If the directors act in ways that the shareholders do not agree with, what can the shareholders do to make the directors act differently? Fiduciary duty of directors As agents of the company, directors have a fiduciary duty to the company. A fiduciary duty is a duty of trust. A director must act on behalf of the company in total good faith, and must not put his personal interests before the interests of the company. If a director is in breach of this fiduciary duty he could be held liable in law, if the company were to take legal action against him. Legal action by a company against a director for breach of fiduciary duty would normally be taken by the rest of the board of directors or, possibly, a majority of the shareholders acting in the name of the company.  Agency Theory Agency law and challenging the actions of directors In practice, it is very difficult for shareholders to use the law to challenge the decisions and actions of the company’s directors. If shareholders believe that the directors are not acting in the best interests of the company, their ability to do something about the problem is restricted. The shareholders can vote to remove any director from office, but this requires a majority vote by the shareholders, which might be difficult to obtain. In a court of law, shareholders would have to demonstrate that the directors were actually acting against the interests of the company, or against the clear interests of particular shareholders, in order to persuade the court to take legal measures against the directors. In summary, although there is a legal relationship between the board of directors and their company, the shareholders cannot easily use the law to control the decisions or actions that the directors take on behalf of the company. Agency Theory Concepts in agency theory: the agency relationship Whereas agency law deals with the legal relationship between a company and its directors, the theory of agency deals with the relationship between: a company’s owners and its managers (directors). Agency theory is based on the idea that when a company is first established, its owners are usually also its managers. As a company grows, the owners appoint managers to run the company. The owners expect the managers to run the company in the best interests of the owners; therefore a form of agency relationship exists between the owners and the managers. The agency relationship Agency theory was developed by Jensen and Meckling (1976). They suggested a theory of how the governance of a company is based on the conflicts of interest between the company’s owners (shareholders), its managers and major providers of debt finance. Each of these groups has different interests and objectives. The shareholders want to increase their income and wealth. Their interest is with the returns that the company will provide in the form of dividends, and also in the value of their shares. The value of their shares depends on the long-term financial prospects for the company. Shareholders are therefore concerned about dividends, but they are even more concerned about long-term profitability and financial prospects, because these affect the value of their shares.  Agency Theory The agency relationship (continued) The managers are employed to run the company on behalf of the shareholders. However, if the managers do not own shares in the company, they have no direct interest in future returns for shareholders, or in the value of the shares. Managers have an employment contract and earn a salary. Unless they own shares, or unless their remuneration is linked to profits or share values, their main interests are likely to be the size of their remuneration package and their status as company managers. The major providers of debt have an interest in sound financial management by the company’s managers, so that the company will be able to pay its debts in full and on time. Jensen and Meckling defined the agency relationship as a form of contract between a company’s owners and its managers, where the owners (as principal) appoint an agent (the managers) to manage the company on their behalf. As a part of this arrangement, the owners must delegate decision-making authority to the management. The owners expect the agents to act in the best interests of the owners. Ideally, the ‘contract’ between the owners and the managers should ensure that the managers always act in the best interests of the owners. However, it is impossible to arrange the ‘perfect contract’, because decisions by the managers (agents) affect their own personal welfare as well as the interests of the owners. This raises a fundamental question. How can managers, as agents of their company, be induced or persuaded to act in the best interests of the shareholders? Agency Theory Agency Conflicts Agency conflicts are differences in the interests of a company’s owners and managers. They arise in several ways. Moral hazard. A manager has an interest in receiving benefits from his or her position as a manager. These include all the benefits that come from status, such as a company car, a private chauffeur, use of a company airplane, lunches, attendance at sponsored sporting events, and so on. Jensen and Meckling suggested that a manager’s incentive to obtain these benefits is higher when he has no shares, or only a few shares, in the company. The biggest problem is in large companies. Effort level. Managers may work less hard than they would if they were the owners of the company. The effect of this ‘lack of effort’ could be lower profits and a lower share price. The problem will exist in a large company at middle levels of management as well as at senior management level. The interests of middle managers and the interests of senior managers might well be different, especially if senior management are given pay incentives to achieve higher profits, but the middle managers are not. Earnings retention. The remuneration of directors and senior managers is often related to the size of the company, rather than its profits. This gives managers an incentive to grow the company, and increase its sales turnover and assets, rather than to increase the returns to the company’s shareholders. Management are more likely to want to re-invest profits in order to make the company bigger, rather than pay out the profits as dividends. When this happens, companies might invest in capital investment projects where the expected profitability is quite small, and the net present value might be negative.  Agency Theory Agency Conflicts Risk aversion. Executive directors and senior managers usually earn most of their income from the company they work for. They are therefore interested in the stability of the company, because this will protect their job and their future income. This means that management might be risk- averse, and reluctant to invest in higher-risk projects. In contrast, shareholders might want a company to take bigger risks, if the expected returns are sufficiently high. Shareholders often invest in a portfolio of different companies; therefore it matters less to them if an individual company takes risks. Time horizon. Shareholders are concerned about the long-term financial prospects of their company, because the value of their shares depends on expectations for the long-term future. In contrast, managers might only be interested in the short-term. This is partly because they might receive annual bonuses based on short-term performance, and partly because they might not expect to be with the company for more than a few years. Managers might therefore have an incentive to increase accounting return on capital employed (or return on investment), whereas shareholders have a greater interest in long-term value as measured by net present value. Agency Theory Agency Costs Agency costs are the costs of having an agent to make decisions on behalf of a principal. Applying this to corporate governance, agency costs are the costs that the shareholders incur by having managers to run the company instead of running the company themselves. Agency costs do not exist when the owners and the managers are exactly the same individuals. Agency costs start to arise as soon as some of the shareholders are not also directors of the company. Agency costs are potentially very high in large companies, where there are many different shareholders and a large professional management. Agency costs can therefore be defined as the ‘value loss’ to shareholders that arises from the divergence of interests between the shareholders and the company’s management. There are three aspects to agency costs: They include the costs of monitoring. The owners of a company can establish systems for monitoring the actions and performance of management, to try to ensure that management are acting in their best interests. An example of monitoring is the requirement for the directors to present an annual report and accounts to the shareholders, setting out the financial performance and financial position of the company. These accounts are audited, and the auditors present a report to the shareholders. Preparing accounts and having them audited has a cost. Agency costs also include the costs to the shareholder that arise when the managers take decisions that are not in the best interests of the shareholders (but are in the interests of the managers themselves). For example, agency costs arise when a company’s directors decide to acquire a new subsidiary, and pay more for the acquisition than it is worth. The managers would gain personally from the enhanced status of managing a larger group of companies. The cost to the shareholders comes from the fall in share price that would result from paying too much for the acquisition.  Agency Theory Agency Costs The third aspect of agency costs is costs that might be incurred to provide incentives to managers to act in the best interests of the shareholders. These are sometimes called bonding costs. These costs are intended to reduce the size of the agency problem. Directors and other senior managers might be given incentives in the form of free shares in the company, or share options. In addition, directors and senior managers might be paid cash bonuses if the company achieves certain specified financial targets. The remuneration packages for directors and senior managers are therefore an important element of agency costs. Agency costs: Summary Agency costs can be summarised as follows Monitoring costs: Costs of measuring, observing and controlling the behaviour of management. Some costs are imposed by law (annual accounts, annual audit) and some arise from compliance with codes of corporate governance. + Bonding costs: Costs of arrangements that help to align the interests of the shareholders and managers. + Residual loss: Losses occur for the owners, such as the losses arising from a lower share price, because the managers take decisions and actions that are not in the best interests of the shareholders. Monitoring costs and bonding costs will not prevent some residual loss from occurring. Agency Theory Reducing the Agency Problem Jensen and Meckling argued that when they act in the interest of the shareholders, managers bear the entire cost of failing to pursue goals that are in their own best interests, but gain only a few of the benefits. Incentives should therefore be provided to management to increase their willingness to take ‘value- maximising decisions’ – in other words, to take decisions that benefit the shareholders by maximising the value of their shares. Several methods of reducing the agency problem have been suggested. These include: Devising a remuneration package for executive directors and senior managers that gives them an incentive to act in the best interests of the shareholders. Remuneration packages may therefore provide rewards for achieving a mixture of both long-term and short-term financial targets and non-financial targets. Having a large proportion of debt on the long-term capital structure of the company. Having a board of directors that will monitor the decisions taken for the company by its executive management. In addition, agents (management) should be held accountable to the principal (shareholders).  Agency Theory Reducing the Agency Problem Providers of debt Jensen and Meckling argued that the problems of the agency relationship are bigger in companies that are profitable but have low growth in profits. These companies generate a large amount of free cash flow. Free cash flow is cash that can be spent at the discretion of management, and does not have to be spent on essential items such a payment of debt interest, taxation and the replacement of ageing non-current assets. It is in the interest of shareholders that free cash flow should be either: invested in projects that will earn a high return (a positive net present value), or paid to the shareholders as dividends. The directors and other senior managers of a company might want to invest free cash flow in projects that will increase the size of the company. These could be projects that will earn a high return. In a low-growth company, however, it is likely that managers will want to invest in projects that increase the size of the company but are only marginally profitable and would have a negative net present value. One way of reducing this problem would be to have a high proportion of debt capital in the capital structure of the company. Interest must be paid on debt, and this reduces the free cash flow. Management must also ensure that new investments are sufficiently profitable so that the company can continue to pay the interest costs on its debt capital. Agency Theory Reducing the Agency Problem The board of directors A different method of reducing the agency problem is to make the board of directors more effective at monitoring the decisions of the executive management. A board will be ineffective at monitoring the decisions of management if it is dominated by the chief executive officer (CEO). This is because the CEO is the head of the executive management team. The board would be especially ineffective in a monitoring role if the CEO is also the chairman of the board. Fama and Jensen (1983) argued that an effective board must consist largely of independent non-executive directors. Independent non- executive directors have no executive role in the company and are not full- time employees. They are able to act in the best interests of the shareholders. Independent non-executive directors should also take the decisions where there is (or could be) a conflict of interest between executive directors and the best interests of the company. For example, non-executive directors should be responsible for the remuneration packages for executive directors and other senior managers. Jensen also argued (1993) that the board of directors becomes less effective as it grows in size. This is because a large board is often slow to react to events and will often be incapable of taking action quickly when it is needed. The directors on a large board are also less likely to be critical of each other than directors on small boards. These ideas for reducing the agency problem are contained in codes of corporate governance, and will be considered in more detail in later chapters.  Agency Theory Ethics and Agency Theory Agency theory may be summarised as follows. In many companies there is a separation of ownership from control. Professional managers are appointed to act as agents for the owners of the company. Individuals are driven by self-interest. Conflicts of self-interest arise between shareholders and managers. Managers, because they are driven by self-interest, cannot be relied on to act in the best interests of the shareholders. This creates problems in the agency relationship between shareholders and management. These agency problems create costs for the shareholders. The aim should be to minimise these costs, by improving the monitoring of management and/or providing management with incentives that bring their interests closer to those of the shareholders. Concepts of agency theory are now applied in various codes of corporate governance, in many different countries. In brief, agency theory suggests that the prime role of the board is to ensure that executive behaviour is aligned with the interests of the shareholder-owners. Otherwise, self-interested managers will use their superior information to line their own pockets. This is the justification for the separation of the chairman and CEO roles, huge senior executive salaries and the over-riding requirement for [independence of non-executive directors], and much more’ (Simon Caulkin, The Observer, 27 November 2005). There is an ethical aspect to agency theory. The theory is based on the view that individuals cannot be trusted to act in any way that is not in their own best interests. Agency Theory Agency Conflicts in Other Types of Organisation Agency relationship – Public sector Managers are also agents acting for principals in public sector organisations so once again there is potential for agency conflicts. The principals in this relationship are the taxpayer and the electorate (often one and the same) and are likely to be concerned with value for money. There are problems associated with making an assessment of whether an organisation is indeed providing value for money: The principals are a heterogeneous group consisting of a large number of individuals. The group might not agree what actually constitutes value for money or even if the service is required at all. The government must make political decisions as to how public money should be spent in a way that they believe is best for the country. Citizens in a democracy then have an opportunity to vote against a government if they are unsatisfied with its performance in making these decisions. Another problem in the governance of public sector organisations is how to establish strategic objectives and then monitor the success of the public sector organisation in achieving these. It is normal in most countries to have a limited audit of public sector organisations to ensure the integrity and transparency of their financial transactions, but this does not always extend to an audit of its performance or ‘fitness for purpose’.  Agency Theory Agency Relationships - Summary Corporate Governance Other Theories of Corporate Governance MSL Business School  Transaction Cost Theory Transaction cost theory attempts to explain companies not just as ‘economic units’, but as organisations consisting of people with differing views and objectives. A large part of the theory is concerned with what makes an organisation grow to the size that it achieves: how many operations does it undertake ‘in house’ and how much does it buy in from external suppliers. When a firm does work ‘in-house’, it needs a management structure and a hierarchy of authority. Senior management are at the top of this hierarchy. According to the theory of transaction cost economics, the structure of a firm and the relationship between the owners of a firm and its management depends on the extent to which transactions are performed internally. From a governance perspective, traditional economic theory is based on the assumption that all behaviour is rational, and that profit maximisation is the rational objective of all businesses. Transaction cost economics changes these assumptions, by trying to allow for human behaviour, and the fact that individuals do not always act rationally. Transaction cost theory is based on two assumptions about behaviour: Bounded rationality: humans act rationally, but only within certain limits of understanding. This means for example that the managers of a company will in theory act rationally in seeking to maximise the value of the company for its shareholders, but their ‘bounded rationality’ might make them act differently. There are limits to rational thinking. Opportunism: individuals act in a self-interested way, and ‘with guile’. In other words, people will not always be honest and truthful about their intentions and will sometimes be opportunistic. Opportunism is ‘an effort to realise individual gains through a lack of candour or honesty in transactions.’ An individual might try to take advantage of an opportunity to gain a benefit at the expense of someone else. This self-interest needs to be controlled. When managers act in their own interests, they act against the interests of the shareholders. Other Theories of Corporate Governance Stewardship theory In the stewardship theory of corporate governance, it is recognised that the directors of a company have a stewardship role. They look after the assets of the company and manage them on behalf of the shareholders. As stewards of the company and as agents for the shareholders, the board of directors should be accountable to the shareholders. In order for the directors to show their accountability to the shareholders, it is a general principle of company law that the directors are required to prepare annual financial statements, which are presented to the shareholders for their approval. Resource dependency theory Resource dependency theory looks at how the resources of an organisation affect its governance and behaviour. The basic argument of resource dependence theory can be summarised as follows: Organisations depend on resources (such as materials, labour and capital), many of which are under the control of other organisations. Resources are a basis of power. Legally independent organisations may therefore depend on other organisations for the resources they need. Power and dependence on resources are directly linked Within organisations, the personal success of managers is tied to customer demand. Managers are seen to succeed when demand grows, which means that customers are the ultimate resource on which companies depend.  Other Theories of Corporate Governance Managerial hegemony theory and class hegemony theory Class hegemony theory is a Marxist-based theory that considers the business elite (the ‘upper class’) as a group of individuals who control the governance of companies to perpetuate their power base. Managerial hegemony theory is similar to class hegemony theory in that the system of governance under the board of directors is seen as the tool of management. It argues that the real power in corporate governance lies with management and that they can take advantage of shareholder weakness to pursue their self-interest. Psychological and organisational perspective theory A number of behavioural and psychological theories of corporate governance have also been developed. A psychological theory approach takes the view that governance depends largely on informal structures and behaviours within an organisation. Decisions by a board of directors and the performance of the board are influenced by inter-personal tactics and relationships. Outcomes are often the result of a bargaining process between interested parties. An organisational perspective theory is based on the view that the performance of the board of directors, company ownership and remuneration and other incentives for executives may differ according to the legal system and institutional characteristics in a specific country. Stakeholder theory The stakeholder theory of corporate governance is that governance depends on the inter-relationships and relative strength of the different stakeholders of a company. Stakeholder theory is explained in a previous section. Other Theories of Corporate Governance System theory A system theory approach to governance considers a company as an overall system, consisting of inter-linked sub-systems. Governance depends on how these sub-systems (and sub-sub-systems etc) interlink with each other.  Corporate Governance Corporate Governance & the Board of Directors MSL Business School Corporate Governance Ghana’s Code of Best Practices has six main sections: The mission, responsibilities and accountability of the board of directors Committees of the Board Relationship to shareholders and stakeholders Financial affairs and auditing Disclosures in annual reports Code of ethics Principles-based and rules-based corporate governance Most codes of corporate governance are principles-based. This means that they consist of a number of core principles, supported by guidelines or provisions indicating how the principles should be applied in practice. All countries have some rules-based corporate governance, which means that there are rules and regulations, backed by law. Some countries have more extensive corporate governance laws than others, and so are ‘rules-based’ systems. The main example of a rules-based system is the USA and the Sarbanes-Oxley Act (SOX’). Ghana’s Code is not rules-based, because it is a voluntary code. However, it does not set out any corporate governance principles. It might be described as a voluntary set of indicative rules.  International Statements of Corporate Governance Principles Some international codes or statements of principles on corporate governance have been issued. They are directed mainly at countries that have not yet developed codes of their own. An international statement of principles seeks to establish minimum standards of corporate governance that should apply in all countries. Its main aim is therefore to raise standards in the ‘worst’ countries towards the standards that already exist in the ‘best’ countries. International statements of corporate governance principles include: the OECD Principles of Corporate Governance the Principles for Corporate Governance in the Commonwealth (the CAGC Guidelines). The result of encouraging better standards of corporate governance should be that: better governance will attract more investment from global investors companies will benefit from more investment finance, to increase their profits national economies will benefit from having strong and profitable companies. Objectives of the OECD Principles The OECD Principles are published by the Organisation for Economic Co-operation and Development, and they are intended to: assist governments of countries to improve the legal, regulatory and institutional frameworks for corporate governance in their countries, and provide guidance to stock exchanges, investors and companies on how to implement best practice in corporate governance. Content of the OECD Principles Principle 1 The OECD Principles (2015) provide guidance through recommendations and annotations across six chapters. Principle I: Ensuring the basis for an effective corporate governance framework “Effective corporate governance requires a sound legal, regulatory and institutional framework that market participants can rely on when they establish their private contractual relations. This corporate governance framework typically comprises elements of legislation, regulation, self-regulatory arrangements, voluntary commitments and business practices that are the result of a country’s specific circumstances, history and tradition. The desirable mix between legislation, regulation, self-regulation, voluntary standards, etc., will therefore vary from country to country. The legislative and regulatory elements of the corporate governance framework can usefully be complemented by soft law elements based on the “comply or explain” principle such as corporate governance codes in order to allow for flexibility and address specificities of individual companies.” This principle is concerned with the framework for good corporate governance that is provided by the stock market and financial intermediaries, the regulation of the markets and the information that is available to investors about companies (‘transparency’ in the markets). It is useful to think about this principle in terms of countries that fail to provide transparency in markets, or stock markets that function efficiently, or markets in which the rule of law is fair and properly applied.  Content of the OECD Principles Principle 2 Principle II: The rights and equitable treatment of shareholders and key ownership functions “The corporate governance framework should protect and facilitate the exercise of shareholders’ rights and ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.” Shareholders have “basic shareholder rights, including the right to information and participation through the shareholder meeting in key company decisions.” There should also be disclosure of control structures, such as different voting rights. Issues relating to the rights and equitable treatment of shareholders include the use of information technology at shareholder meetings, and shareholder participation in decisions on executive remuneration. This Principle is concerned with the basic rights of shareholders, which should include the right to transfer the ownership of their shares, the right to receive regular and relevant information about the company, the right to vote at general meetings of company shareholders, the right to share in the company’s profits , the right to remove directors from the board and the right to participate in decisions about executives’ remuneration. These basic shareholder rights might seem ‘obvious’. However, there are countries in which these rights do not properly exist, especially for foreign shareholders. For example the laws of a country may permit a company to insist that shareholders wishing to vote at a general meeting of the company must attend the meeting and cannot be represented by a proxy. This requirement in effect would remove the right to vote of most foreign investors, who do not have the time to attend general meetings in person in countries around the world.