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The proper governance of companies will become as crucial to the world economy as the proper governing of countries…. strong corporate governance produces good social progress.  The two go together.”

James Wolfensohn, 1999

Corporate Governance hit the news in 2001 and 2002 with the collapse of global corporations such as Enron, WorldCom, Global Crossing and the international accountants, Andersen.

  These were blamed on a lack of business ethics, shady accountancy practices and weak regulators.  They were a wake-up call for developed countries on corporate governance. 

Prior to this, commentators had focused on failings in developing countries - blaming the 1997-98 East Asian crisis on poor corporate governance, crony capitalism, poor management practice and lack of disclosure and transparency.

Corporate governance has come to encapsulate the blend of law, regulation and private-sector practice that enables companies to attract financial and human capital, to perform efficiently, and generate long-term economic value for their shareholders, whilst respecting the interests of stakeholders and society as a whole. 

Corporate governance- addressed at two levels:  The country level.  Various regulatory and enforcement mechanisms are important, such as the need for bankruptcy laws, property rights and an effective judiciary.  A corporation cannot operate effectively if it is unable to rely on legislation and its enforcement- good political governance.The corporation.  Corporate governance at the company level refers to the rules and regulations that shape its effective operation.

Corporate Governance is concerned with holding the balance between economic and social goals and between individual and communal goals.

The corporate 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, corporations and society - Sir Adrian Cadbury

The primary purpose of corporate leadership is to create wealth legally and ethically.

This translates to bringing a high level of satisfaction to five constituencies -- customers, employees, investors, vendors and the society-at-large.

The raison d'être of every corporate body is to ensure predictability, sustainability and profitability of revenues year after year.

- N R Narayana Murthy

development that meets the needsof the present without compromising

the ability of future generationsto meet their own needs’

Enhancement of Shareholder Value, keeping in view the Interests of other Stakeholders

CG a Way of Life rather than a Code

The Board of Directors Pivotal role Accountable to stakeholders Directs management

The Shareholders & Stakeholders To participate in appointment of directors To hold the BoD accountable for governance

through proper disclosures The Management

To act on the direction of the BoD To provide requisite information to the BoD for

decision making To implement and monitor control systems

Accountability

Fairness

Transparency

Independence

Ensure that management is accountable to the Board

Ensure that the Board is accountable to shareholders

Protect Shareholders rights

Treat all shareholders including minorities, equitably

Provide effective redress for violations

Ensure timely, accurate disclosure on all material matters, including the financial situation, performance, ownership and corporate

governance

Procedures and structures are in place so as to minimise, or avoid completely conflicts of interest

Independent Directors and Advisers i.e. free from the influence of others

1) The rights of the shareholder A corporate governance framework should

protect shareholders’ rights.

(2) The equitable treatment of shareholders All shareholders should be treated equally,

including minority and foreign shareholders.

(3) The role of the stakeholders in corporate governance

Good corporate governance recognises that it is in the long-term interest of the corporation to respect the rights and interests of the stakeholders. 

(4) Disclosure and transparency Need to ensure timely and accurate

disclosure of all material matters regarding the corporation including financial aspects, performance, ownership and governance.

(5) The responsibilities of the board BOD key to the strategic guidance of the

company and the effective monitoring of the management. 

Three internal governance mechanisms are: Ownership Concentration, representing the relative

amounts of stock owned by individual shareholders and institutional investors

The Board of Directors, or the individuals responsible for representing the firm’s owners by monitoring the strategic decisions of top-level managers

Executive Compensation, or the use of salary, bonuses and long-term incentives to align the interests of managers with those of shareholders (owners)

 

The external governance mechanism is:

The Market for Corporate Control, or the purchase of a firm that is underperforming relative to its industry rivals in order to improve its strategic competitiveness

1.Primary purpose is to prevent severe problems that may occur because of the separation of ownership and control in large firms by positively influencing managerial behavior.

2. Ability of governance mechanisms to direct top-level managers’ actions toward preferred shareholder objectives is dependent on the correct combination of mechanisms being used.

Growth of the large, modern public corporation is based primarily on the efficient separation of ownership and managerial control.

Shareholders make investments by purchasing stock (representing ownership), which entitles them to a share of the firm’s residual income.

The right to share in residual income also means that shareholders also must accept the risk that no residual profits will remain if the firm’s expenses exceed its income.

Shareholders can manage investment risk by investing in a diversified portfolio of firms.

In small firms, managers and owners are often one in the same, so there is no separation of ownership and control.

As firms grow larger, individual owners generally do not have access to sufficient capital to fund the growth of the business and seek other investors with which to share residual profits (and risk).

 

Ownership concentration is defined both by the number of large-block owners and by the total percentage of the firm’s shares that they own.

  Large-block shareholders are investors

who typically own at least five percent (5%) of the firm’s shares.

 

Diffuse ownership (characterized as a large number of shareholders with small holdings and few if any large-block shareholders)

produces weak monitoring of managerial decisions

makes it difficult for owners to coordinate their actions effectively

may result in levels of diversification that are beyond the optimum level desired by shareholders (especially when this condition is combined with weak monitoring)

The board of directors is a group of elected individuals whose primary responsibility is to act in the owners’ interests by formally monitoring and controlling the corporation’s top-level executives.

 As a result, if the board of directors is appropriately structured and operates in an effective manner, it can protect owners from managerial opportunism.

Because of the board’s importance, the performance of individual board members as well as that of entire boards is being evaluated more formally and intensely.

As a result, many boards have voluntarily initiated changes, including:

increasing the diversity of board members’ backgrounds

strengthening internal management and accounting control systems

establishing and consistently using formal processes to evaluate the board’s performance

The compensation of top-level managers generates great interest and strongly held opinions.

Part of the reason for this is that CEO pay is an indirect but tangible way to assess governance processes in large corporations.

Executive compensation is a governance mechanism that seeks to align managers’ and owners’ interests through salary, bonus, and especially through long-term incentive compensation such as stock options.

Alignment is sought by: more closely tying managerial

compensation to firm performance increasing the use of long-term incentive

compensation, based primarily on stock options but also including arranging for senior-level managers to borrow the funds necessary to acquire a high level of ownership

Developing and implementing an effective incentive compensation program is quite challenging because:

Strategic decisions made by top-level managers are complex and non-routine. There is a tendency to link compensation to more measurable outcomes such as financial performance.

Decisions made by top-level managers are likely to affect firm performance over an extended period of time. Thus it is difficult to assess the effect of current decisions using current period performance.

Many variables (or outside factors) intervene between management behavior and firm performance (e.g., uncontrollable shifts in the environment).

The market for corporate control is composed of individuals and firms who buy ownership positions in (or take over) potentially undervalued firms.

This is either to establish diversified firm, merge two previously separate firms, and usually replace the target firm’s management team to revamp the strategy that caused low firm performance.

 Corporate Governance in Japan

 Corporate governance in Japan is affected by the concepts of obligation, family, and consensus.

In Japan, obligation goes beyond principles but is more a product of specific causes, events, and relationships. It can mean returning a service for one that has been rendered.

The concept of family goes beyond the American concept to include the firm—individuals see themselves as members of a company family.

And the family concept is extended to include members of the firm’s keiretsu, a group of firms that are tied together by cross-shareholdings, interrelationships, and interdependencies.

 Consensus represents one of the most important influences on governance structure in Japan.

Corporate Governance in Germany Many private German firms, the owner and

manager are the same person.

In publicly traded firms there often is a dominant shareholder.

Banks are major shareholders in companies that they financed , either sought new capital in the stock market or defaulted on loans.

  The changes in governance in many

countries represent the 21st-century competitive landscape, where markets are shrinking, customer demands are becoming more similar, and shareholder value is becoming a more significant focus of managerial agents.

This will result in more uniform governance

structures.

In France and US, anger has been growing over the lack of information on top executive compensation.

A recent report recommended that the positions of CEO and chairman of the board be held by two individuals.

It also recommended reducing the tenure of board members and to disclose their pay.

In South Korea, principles of corporate governance are being adopted to provide proper board and management incentives to pursue the interests of both the company and the shareholders and to facilitate effective monitoring.

Changes in corporate governance are occurring even in transitional economies, such as China and Russia, though implemented more gradually.

The use of stock-based compensation plans has influenced foreign companies to invest (particularly in China).

What relevance does it have to Africa where there are few public listed companies

Most companies are non-listed, private family owned businesses where the shareholders and the managers are often the same people

In 1994, The King Report in South Africa also included within its Code of Corporate Governance requirements on sustainability and ethical standards

This was due to the context of a developing country and business ethics in Africa

And in Kenya????????

Avoidance of business scandals, which damage trust in business.

Value placed on good corporate governance by institutional investors.

Growing involvement of the private sector in service delivery.

 

Need for systems to prevent and deter corruption in developing countries.

The deregulation and integration of capital markets.

Recognition of the importance of harnessing domestic savings for economic growth.

The risk of financial crisis and contagion.

  Governance mechanisms are focused on

ensuring that managers work effectively toward meeting their obligation to maximizing shareholder wealth.

However, shareholders are only one group of the firm’s stakeholders.

  

Over the long-term, the demands of other key stakeholders—such as employees, customers, suppliers, and the community—also must be satisfied in order to maximize shareholder wealth.

 For that reason, and others, governance mechanisms must be carefully designed and implemented so that managers’ attention is not focused on maximizing short-term returns and to ensure that they consider the interests of all stakeholders.