1 Corporate Governance BBA 361 Business Ethics and Corporate Governance S. Chan Department of Business Administration

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Corporate Governance

BBA 361 Business Ethics and Corporate Governance

S. Chan

Department of Business Administration

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What is Corporate Governance

1. Corporate governance refers to the rules and incentives by which the management of a company is directed and controlled to maximize the profitability and long-term value of the firm for shareholders while taking into account the interests of other legitimate stakeholders (Stone, Hurley, and Khemani 1998).

2.2. The systems by which the corporations are directed and The systems by which the corporations are directed and controlled (OECD 1998) controlled (OECD 1998) (Organisation for Economic Co-operation and Development )

3.3. It is about the processes used to direct and manage businIt is about the processes used to direct and manage business affairs which are consistent to the company objective ess affairs which are consistent to the company objective andand Balance of expected corporate behavior and social expectatio

n Accountability to relevant stakeholders

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Today’s Drives on Corporate Governance

1.1. Fast Changing Market EnvironmentFast Changing Market Environment Effective corporate governance mechanism is necessary to

respond to various challenges and constant changing.

2.2. Intense interaction among stakeholdersIntense interaction among stakeholders Stakeholders are increasingly active in exercising their

ownership right. High demand for a good practice of corporate governance to deliver transparency and accountability.(recent PCCW votes for selling ownership)

3. Change of Shareholders’ values3. Change of Shareholders’ values Shareholders are more willing to invest on a business with

a higher standard of corporate governance. Directors are nowadays expected to contribute to increasing shareholder’s values.

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Today’s Drives on Corporate Governance

4.4. Change in Regulatory FrameworkChange in Regulatory Framework It is essential to comply companies with the increasingly

regulated business environment. Compliance with law and regulation can ensure better corporate governance which prevents companies suffer from reputation damage due to malpractice,

5.5. Capital MarketCapital Market International capitals are more interested to go into the

companies which have good practice of governance and disclosure mechanism, where their capital could be properly invested and protected.

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Importance of Corporate GovernanceImportance of Corporate Governance

Corporate Governance stresses transparency and accountability,

Enhance healthy financial and quality stature which attract investment interests

Establish early warning of potential and critical risks

Build credibility and trust with stakeholdersPromote brand image and reputation, confidenceImportant to co’s sustainable growth,which

makes company become competitive

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Society-wide promotional forces to corporate governance1. Support from Government

2. Regulatory forces– Securities and Futures Commission, HK Exchanges

and Clearing Ltd amend requirements in corporate governance on listed companies.

3. Financial institutional forces– Banking Ordinance’s restriction on banking sector

owing significant part of corporate sector

– Institutional investors, life insurers, pension fund

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Society-wide promotional forces to corporate governance4. Practitioners

– Professional advisors, such as directors are well informed of their responsibilities and professionalism by various training and forums

– Independency of practitioners

5. Educational institutes – Incorporate importance of corporate governance into programm

es and courses

6. Professional bodies– HK Society of Accountants has a corporate governance committ

ee and published guidelines on disclosure in annual reports, HK Institution of Directors specialized in programmes for director professionalism.

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Issues of Corporate Governance for Listed Companies

1. Board Composition Allow different mixes of executive and non-executive dir

ectors Minimum three Independent Non-Executive Directors (IN

EDs 獨立非執行董事 ) for listed companies

2. Family Interests and Control Concerns about family controlled interests among listed c

ompanies in checks and balances, i.e. controlling shareholders may affect the overall interest of all shareholders.

Listing rules and the takeovers code help to address inter alia concerns particularly about equitable treatment for all shareholders.

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Forms of Corporate Governance

3.Roles of Chairman and CEOTrend of separation between Chairman and CEO, i.e. Chair

man and CEO of Kowloon Canton Railway

4.Independent Non-Executive Directors (INEDs) Increased number to three INED in listed companies.HKEx amended Listing Rules to include more guidelines to

determine independence of INEDs to protect minority interests.

Training to qualified INEDs on dedication, courage, knowledge and skills


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5. Remuneration Correlation of executive directors of listed company with

company performance and related scrutiny mechanisms. Listing Rules requires disclosure of directors’

remuneration on an individual basis.

6. Corporate Reporting Disclosure of financial information in accordance with

HK accounting and auditing standards

7. Audit Committee and Internal Controls Required a Audit Committee comprising of at least 3 non-

executive directors, one should be qualified in financial reporting. Internal controls covering financial, operational and compliance controls and risk management.


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8. Transparency and Disclosure Any stringent change of interest need to notify Stock Ex. Disclosure of annual financial reports High level of transparency and disclosure is a

conscientious act of accountability

9. Shareholder Activism Attendance and questions raised by shareholders during

annual general meetings indicates minority shareholders rights, transparency and corporate governance.


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General non-statutory Duties of BOD (htt

p://www.hkex.com.hk/listing/dirduty/Non-Statutory.htm)

Principle 1: Duty to act in good faith for the benefit of the company as a whole

A director of a company must act in good faith in the best interests of the company. This means that a director owes a duty to act in the interests of all its shareholders, present and future. In carrying out this duty, a director must (as far as practicable) have regard to the need to achieve outcomes that are fair as between its members.

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Principle 2: Duty to use powers for a proper purpose for the benefit of members as a whole

A director of a company must exercise his powers for a “proper purpose”. This means that he must not exercise his powers for purposes that are different from purposes for which they were conferred. The primary and substantial purpose of the exercise of a director’s powers must be for the benefit of the company. If the primary motive is found to be for some other reasons (e.g. to benefit one or more directors and to gain control of the company), then the effects of his exercise of his power may be set aside. This duty can be breached even if he has acted in good faith.

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Principle 3: Duty not to delegate powers except with proper authorization and duty to exercise independent judegementExcept where authorized to do so by the company’s memorandum and articles of association (the “constitution”) or any resolution, a director of a company must not delegate any of his powers. He must exercise independent judegement in relation to any exercise of his powers.

Principle 4: Duty to exercise care, skill and diligenceA director of a company must exercise the care, skill and diligence that would be exercised by a reasonable person with the knowledge, skill and experience reasonably expected of a director in his position. In determining whether he has fulfilled this duty,the court will also consider whether he has exercised the care, skill and diligence that would be exercised by a reasonable person with any additional knowledge, skill and experience which he has.

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Principle 5: Duty to avoid conflicts between personal interests and interests of the company

A director of a company must not allow personal interests to conflict with the interests of the company.

Principle 6: Duty not to enter into transactions in which the directors have an interest except in compliance with the requirements of the lawA director of a company has certain duties where he has a material interest in any transaction to which the company is, or may be, a party. Until he has complied with these duties, he must not, in the performance of his functions as a director, authorize, procure or permit the company to enter into a transaction. Furthermore, he must not enter into a transaction with the company, unless he has complied with the requirements of the law.

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Principle 6: (con’t)

-The law requires a director to disclose the nature of his interest in respect of such transactions. Under certain circumstances the constitution may prescribe procedures

to secure the approval of directors or members in respect of proposed transactions. A director must disclose the relevant interest to the extent required. Where applicable, he must secure the requisite approval of other directors or members.

Principle 7: Duty not to gain advantage from use of position as a director

A director of a company must not use his position as a director to gain (directly or indirectly) an advantage for himself, or someone else, or which causes detriment to the company.

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Principle 8: Duty not to make unauthorized use of company’s property or informationA director of a company must not use the company’s property or information, or any opportunity that presents itself to the company, of which he becomes aware as a director of the company. This is except where the use or benefit has been disclosed to the company in general meeting and the company has consented to it.

Principle 9: Duty not to accept personal benefit from third parties conferred because of position as a directorA director or former director of a company must not accept any benefit from a third party, which is conferred because of the powers he has as director or by way of reward for any exercise of his powers as a director. This is unless the company itself confers the benefit, or the company has consented to it by ordinary resolution, or where the benefit is necessarily incidental to the proper performance of any of his functions as director.

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Principle 10: Duty to observe the company’s memorandum and articles of association and resolutions A director of a company must act in accordance with the company’s constitution. He must also comply with resolutions that are made in accordance with the company’s constitution.

Principle 11: Duty to keep proper books of accountA director of a company must take all reasonable steps to ensure that proper books of account are kept so as to give a true and fair view of the state of affairs of the company and explain its transactions.To avoid breaching the fraudulent trading provisions in section 275 of the Companies Ordinance (Cap. 32), a director must not

allow the company to incur further credit knowing that there is no reasonable prospect of avoiding insolvency.

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Reference:

Stone, Andrew, Kristin Hurley and R. Shyam Khemani. 1998. “The Business Environment and Corporate Governance: Strengthening Incentives for Private Sector Performance.” Background paper for the World Bank’s 1998 Annual Meetings Program of Seminars.

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Background of Enron: 能源巨人安隆能源巨人安隆

The world’s biggest energy trading company which provide modern energy management service

Head Office ： Houston of USRange of Business ： 3500 branches in over 40 c

ountriesNumber of Employees ： more than 21000 In 2000 total assets was 655 億 US$, sales turno

ver more than 1,000 億 US$. US’s 7th giant corporate.

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Enron’s Business

Wholesales and risks management services

Energy Services (wind, coal, oil business)

Broadband ServicesTransportation Services (gold, chemicals,

papers, plastics, etc.)

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Enron‘s Reputation and Brand

Consecutively elected as “the most creative company in US” for 6 years since1996

2000 年，獲得 Financial Times 所頒發的「年度能源公司獎」及「最大膽的投資成功決策獎」

Elected as the first 100 best company

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Before it was Enron

Set up Houston Natural Gas in 1983Kenneth Lay became CEO in 1984, planned to m

erge with 英特北 (Inter North), changed the name to Enron Corp.

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Energy release from US

US Gov’t released energy control in late 80’s Jeffrey Skilling joint in1989, suggested the plan f

or Gas Bank ( 瓦斯銀行 )Started a new business model “Natural Gas Futu

res Transaction” ( 天然氣期貨交易 ), thus became a new competitive business in the market

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New business model and aggressive expansion

Utilized new financial tools to increase the flow of the energy products , make these products more “financialized”. However, the fluctuation of retail prices, stock price, interest rates and other currency changes would impose higher risks to these energy products.

Dramatic increase in revenue and profits

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Aggressive Expansion

Enron established it’s the first overseas electric power station in England in 1991

Moved its business to South America (Argentina) in 1992

In 1992 Enron extended its business to Europe and Russia and gradually pushed itself from a biggest energy company in the US to the World.

Over expansion

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印度－大柏 (Dabhol) 電力公司

Approved by Indian government to establish electricity power station in 1992.

Indian currency depreciated in 2002 and price of natural gas increased. Enron’s only customer refused to purchase its electricity, business suspended.

Indian government discontinued partnership relationship with Dabhol in 2001 because its over high operation costs.

Started getting slump

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英國－埃瑟裏克斯 (Azurix)水處理公司

Purchased water sewerage company (Wessex) in England in 1998

Lack of experience, purchased water related assets at too high prices, but the British government reduce the water prices in 2001.

Started getting losses

Started getting losses

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Development to E-Business

November1999 establishment of Enron online

Establish a electronic platform for E-business, transaction of natural gas, electricity, materials like paper, metal through internet.

Its outstanding sales performance made Enron the best E-Business in the world.

Non-stop increase in stock prices

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Broadband market

Established broadband services in 2000Invested 1000million US$ in purchasing

broadband facilities, servers and networks.Loss 109 million in broadband business in

2001

Dramatic losses

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Hints of Loss

During 1999to 2001, the management started selling company shares which amounted US$110millions, without telling the public.

14 August 2001sudden resignation of the CEO due to personal reason.

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Exposure of Crisis

Economic depression in 2001, leading to dramatic drop in Enron’s share prices, in 16 Oct 2001annual report revealed a loss of 618 millions US$

Invested by Securities & Investments Commission in 8 November, Enron admitted its faults accounting statement in the past 4 years.

Sought for financial help

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Dynegy 公司的購併案

11 月 9 日同意以約 80 億美元的代價購併 Enron

11 月 27 日 S&P 宣佈將 Enron 的債信評等降至「垃圾」等級，安隆股票單日暴跌 85% ，收 0.61 美元， Enron 短期債務將因垃圾債信評等而升至 39 億美元

Dynegy 宣佈終止收購 Enron 之計劃

Dismissed

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Reasons for ENRON’s Failure

Insider trading, conflict of interests of BOD Lack of independent accounting executive oversight the

board Lack of independency of Auditors. Objective financial stat

ement could not be given Lack of transparency Over expansion Complex business

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ENRON’s Impact

Rise of awareness of corporate governanceGive this reason, World.com and other business

being discovered cooked the books.Rise of independency of auditors, board of

director

Documents

1 Corporate Governance BBA 361 Business Ethics and Corporate Governance S. Chan Department of Business Administration