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8/2/2019 Corporate Governance Final Document
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CORPORATE GOVERNANCE
Definition of corporate governance
Corporate governance refers to the rules, procedures, and administration of the firms contracts
with its shareholders, creditors, employees, suppliers, customers, and sovereign governments.Governance is legally vested in a board of directors who have a fiduciary duty to serve the interests
of the corporationrather than their own interests or those of the firms management
The main mechanisms for understanding corporate governance are the following:
1. The market for corporate control (i.e. a hostile takeover market and the market for partialcontrol).
2. Large shareholder and creditor monitoring. Corporate governance is a term that refers broadly to
the rules, processes, or laws by which businesses are operated, regulated, and controlled. The term
can refer to internal factors defined by the officers, stockholders or constitution of a corporation, aswell as to external forces such as consumer groups, clients, and government regulations.
A well-defined and enforced corporate
governance provides a structure that, at least in theory, works for the benefit of everyone
concerned by ensuring that the enterprise adheres to accepted ethical standards and best practices
as well as to formal laws. To that end, organizations have been formed at the regional, national,and global levels.
In recent years, corporate governance has received increased attention because of high-profile
scandals involving abuse of corporate power and, in some cases, alleged criminal activity bycorporate officers. An integral part of an effective corporate governance regime includes
provisions for civil or criminal prosecution of individuals who conduct unethical or illegal acts in
the name of the enterprise.
3. Internal control mechanisms, i.e. the board of directors, non-executive committees and the
design ofexecutive compensation contracts.
4. External mechanisms, i.e. product-market competition, external auditors and the regulatory
framework of thecorporate-law regime and stock exchan
1. Board of Directors
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o The board of directors is a corporation's primary rule-making body. Its members are
generally high-level professionals with strong management backgrounds and/or an
understanding of common financial and business practices. Members by and largehave a common stake in the corporation's success.
Policies and Actions
o Using complicated economic modeling of various hypothetical scenarios to predict
return on investment, the board develops a set of policies and actions for corporatemanagers and employees to carry out. Policies and actions are commonly profit-
driven. In other words, the main objective of a policy or action is to produce a
positive return on investment for the corporation as well as its shareholders andcustomers to which it's accountable.
Corporate Governance Structure
o For a board to be effective, it must also have a way to guarantee accountability.This is an important feature of whether or not the corporate governance structure issuccessful. For example, if a policy or action isn't properly carried out and/or the
results that were expected either didn't occur or fell short of the goal, there must be
a system in place to make adjustments. The board also determines these
correctional steps for management to administer to avoid future mistakes.
Shareholder Accountability
o Corporate governance ultimately determines the success or failure of a corporation.
It's therefore important that shareholder and customer input are appropriately
factored into all decisions made by the board. After all, it's the financial investmentof these groups that enables a corporation to operate. To ensure this occurs, the
board holds regular shareholder meetings to report on earnings and to discuss the
direction of the corporation. The shareholders are able to inform and guide thediscussion to ensure a favorable outcome.
Customer Accountability
o Customer feedback is collected in a less direct way than shareholder input, but is
just as important to a corporation's bottom line. Customer feedback is based onconsumer trends and the extent to which goods are bought and sold, which are
reflected by the corporation's quarterly profits. If a corporation does well, it's said tohave exceeded or met its earnings goals for the quarter. If a corporation performs
poorly, it's said to have underperformed its anticipated earnings goals for thequarter.
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2. Efficient, effective and sustainable corporations that contribute to the welfare of society
by creating wealth,
3. employment and solutions to emerging challenges.4. Responsive and accountable corporations
5. Legitimate corporations that are managed with integrity, probity and transparency
6. Recognition and protection of stakeholder rights7. An inclusive approach based on democratic ideals, legitimate representation and
participation
Fair, efficient and transparent administration of corporations to meet well-defined objectives.
Systems and structures of operating and controlling corporations with a view to achieving long-term
strategic goals that satisfy the owners, suppliers, customers and financiers while complying with
legal andregulatory requirements and meeting environmental and society needs;
An efficient process of value-creating and value-adding; and to ensure that:
2 The Board has set strategic objectives and plans and put in place proper management structures
[organization, systems and people] to achieve those objectives and plans.
The structures put in place function to maintain corporate integrity, reputation and responsibility
towardsall stakeholders.
The Board acts as a catalyst, initiating, influencing, evaluating and monitoring strategic decisions
andactions of management and holds management accountable.
Ensuring that the Board is not a mere formality which takes a back seat, leaving management to
make all
strategic decisions. The Board has established and put in place mechanisms to ensure that the corporation operates
within
the objects established by shareholders, the mandate given to it by society, utilizes the resourcesentrusted to it efficiently and effectively in pursuit of the stated mandate, and meets the legitimate
1. expectations of its various stakeholders.
PILLARS OF GOOD GOVERNANCE
In all fields of human endeavour, good governance is founded upon the attitudes, ethics, practices
and values of
the society regarding: Accountability of power based on the fundamental belief that power should be exercised to
promote human
well-being.
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Democratic values in respect of the sharing of power, representation and participation.
The sense of right and wrong, what is fair and just, work ethics, technology and continuing
corporate socialresponsibility.
Efficient and effective use of resources for the production of goods and services.
Protection of human rights and freedoms and the maintenance of essential order and security forthe person
and his/her property.
Recognition of the government as the only entity to which the society gives authority to usecoercive power
to maintain public order and national security, collect taxes, reallocate societys resources to meet
public
needs and to use that coercive power to confiscate assets, deprive a person of liberty or life; butprovided
always that such power and authority are not used to suppress, oppress and deny basic human
rights and
freedoms.
Attitudes towards the generation and accumulation of wealth through hard work and personal
effort.
Factors influencing corporate governance
1. The ownership structure
The structure of ownership of a company determines, to a considerable extent, how a Corporationis managed and controlled. The ownership structure can be dispersed among individual andinstitutional shareholders as in the US and UK or can be concentrated in the hands of a few large
shareholders as in Germany and Japan. But the pattern of shareholding is not as simple as the
above statement seeks to convey. The pattern varies the across the globe.
Our corporate sector is characterized by the co-existence of state owned, private and multinational
Enterprises. The shares of these enterprises (except those belonging to a public sector) are held byinstitutional as well as small investors. Specifically, the shares are held by
(1) The term-lending institutions
(2) Institutional investors, comprising government-owned mutual funds, Unit Trust of India andthe government owned insurance corporations
(3) Corporate bodies
(4) Directors and their relatives and(5) Foreign investors. Apart from these block holdings, there is a sizable equity holding by small
investors.
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2.The structure of company boards
Along with the structure of ownership, the structure of company boards has considerable influenceon the way the companies are managed and controlled. The board of directors is responsible for
establishing corporate objectives, developing broad policies and selecting top-level executives to
carry out those objectives and policies.
3. The financial structure
Along with the notion that the structure of ownership matters in corporate governance is the notion
that the financial structure of the company, that is proportion between debt and equity, hasimplications for the quality of governance.
4. The institutional environment
The legal, regulatory, and political environment within which a company operates determines in
large measure the quality of corporate governance. In fact, corporate governance mechanisms areeconomic and legal institutions and often the outcome of political decisions. For example, the
extent to which shareholders can control the management depends on their voting right as definedin the Company Law, the extent to which creditors will be able to exercise financial claims on a
bankrupt unit will depend on bankruptcy laws and procedures
Combined Code compliance
The Board is committed to the highest standards of corporate governance set out in the CombinedCode on Corporate Governance published by the Financial Reporting Council in June 2008 (the
Code). The Board is accountable to the Companys shareholders for good governance and this
Report, together with the Directors Remuneration report, describes how the Board has applied themain principles of good governance set out in the Code during the year under review. It is the
Boards view that the Company has been fully compliant.
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Corporate governance is the set ofprocesses, customs,policies, laws, and institutions affecting the
way a corporation (orcompany) is directed, administered or controlled. Corporate governance alsoincludes the relationships among the many stakeholders involved and the goals for which the
corporation is governed. The principal stakeholders are the shareholders, the board of directors,
employees, customers, creditors, suppliers, and the community at large.Corporate governance also refers to the manner in which the power of a corporation is exercised in
the stewardship of the corporations total portfolio of assets and resources with the objective of
maintaining and increasing shareholder value and satisfaction of other stakeholders in the context
of its corporate mission. It is concerned with creating a balance between economic and social goals
and between individual and communal goals while encouraging efficient use of resources,
accountability in the use of power and stewardship and as far as possible to align the interests of
individuals, corporations and society. It is about promoting:
Fair, efficient and transparent administration of corporations to meet well-defined
objectives.
Systems and structures of operating and controlling corporations with a view to achieving
long-term strategic goals that satisfy the owners, suppliers, customers and financiers while
complying with legal and regulatory requirements and meeting environmental and society
needs (Private Sector Corporate Governance Trust, 1998)
Efficient corporate governance practices 1) attract investors (both local and foreign) and assure
them that their investments will be secure and efficiently managed, and in a transparent and
accountable process, 2) create competitive and efficient companies and business enterprises, 3)
enhance the accountability and performance of those entrusted to manage corporations and 4)
promote efficient and effective use of limited resources.
The objectives of the study are:
To examine the corporate governance practices and establish their role in business failure.
To study the agency problem and highlight its contributions in business failure.
Significance of the Study
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This study is has a lot of importance to the business community but will be of particular interest to
the following parties:
Corporate managers and directors who have been entrusted with the responsibility of
managing business profitably. The study will expose them to the code of good corporate
governance that should improve their understanding and performance, thereby reducing
chances of business failure.
Investors who entrust their capital with the corporate managers with expectation of
efficient management of the capital to yield good returns. The study will enable them
understand their role in instilling good corporate practices in the organizations where they
have invested their capital and also reduce cases of agency problem.
Business students who will constitutes future corporate teams. Study will expose them to
the concept of corporate governance and improve their capacity in understanding the
technicalities of corporate governance and business failure.
An important theme of corporate governance is to ensure the accountability of management of an
organization through mechanisms that try to reduce or eliminate the principal-agent problem. A
related thread of discussions focuses on the impact of a corporate governance system in efficiency,
with a strong emphasis on shareholders' welfare. There are yet other aspects to the corporate
governance subject, such as the stakeholder view.
Corporate governance is a system of structuring, operating and controlling a company with a view
to achieve long term strategic goals to satisfy shareholders, creditors, employees, customers and
suppliers, and complying with the legal and regulatory requirements, apart from meeting
environmental and local community needs.
In Gandhian principle of trusteeship, corporate governance is defined as the acceptance by
management of the indisputable rights of shareholders as the true owners of the corporation and of
their own role as trustees on behalf of the shareholders. It is about commitment to values, about
ethical business conduct and about making a distinction between personal & corporate funds in the
management of a company.
Principles of good corporate governance
Commonly accepted principles of corporate governance include:
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Principle 1: Performance Orientation
The principal objective of business enterprises is to enhance wealth for all shareholders by making
the most efficient use of resources. A company that meets this shareholder value creation objective
will have greater internally generated resources, improving its prospects for meeting its
environmental, community, and social obligations; pay taxes; reward, train, and retain key staff;
and enhance employee satisfaction. A key focus area is a companys human capital strategy, which
is a lead indicator of corporate success.
Principle 2: Nomination and Compensation Committees
A key success factor is the quality of leadership of an enterprise. A nomination committee with a
written mandate and terms of reference consistent with good practice may ensure the selection of
directors and a chief executive officer (CEO) of the highest caliber. A compensation committee
should set the compensation policy for directors and senior management, commensurate with
performance measured against comparable industry benchmarks and key performance indicators
such as economic value added.
Principle 3: Disclosure
To ensure transparency, companies annual reports should disclose true and fair accounting
information prepared in accordance with applicable standards; disclose and discuss all material
risks; disclose and explain the rationale for all material estimates; show manner of compliance, or
explain deviations, if any, with applicable corporate governance codes; discuss goals, plans, and
progress; and provide access to the register of shareholders showing beneficial ownership.
Disclosures should be timely and adequate to enable investors, third party analysts, or rating
agencies to assess the quality of corporate governance and the true financial condition of the
enterprise.
Principle 4: Audit Committee
Audit committees with the following attributes are more effective: composed solely of independent
directors, at least two of whom should have the requisite knowledge of accountancy, financial
analysis, and financial reporting; at least one member should have a good understanding of the
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business of the enterprise; have a written mandate and terms of reference; engage only independent
external auditors who should be answerable to the committee; and require that a suitable system of
internal control and risk management is entrenched into the fabric of the company.
Principle 5: Code of Conduct
All enterprises must have a written code of business conduct and establish systems to ensure that it
and all applicable laws are followed in letter and spirit.
Principle 6: Conflicts of Interest
Directors owe an obligatory duty to the company that requires them to act in the best interest of the
company. Actual and potential conflicts of interest should be identified, disclosed, and explained in
sufficient detail to enable valid judgments to be made on their adverse impact. The persons who
are conflicted should not participate in discussion and decision of the issue in question, nor be
entitled to vote on any resolution where they are conflicted. Related party contracts should be
disclosed in the annual report.
Principle 7: Environmental and Social Commitment
There is an inextricable relationship among the objectives of corporate performance, social
development, and environmental protection. Enterprises, to be sustainable, will need to recognize
and effectively deal with this triad of concerns, which, at times, may conflict with each other.
Principle 8: Conduct of the Board of Directors
Directors are expected to preserve and enhance shareholder value. Their effectiveness can be
enhanced if they are legally empowered, have the requisite qualifications for the board committees
on which they sit, make the needed time commitment, given the appropriate directorship training,
are suitably compensated, receive proper notice of meetings, have the right to propose agenda
items, consult each other privately in the absence of management and executive directors, and
provided with appropriate information to enable them to perform their monitoring role and
evaluate the performance of directors. They should be proactive and diligent.
Principle 9: Responsibilities of Investors
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The pursuit of good corporate governance in investee enterprises is a risk management tool.
Institutional investors, general partners, and fund managers have a binding duty to actively monitor
and vote on issues vital to the success of enterprises in which they invest as guardians of the
savings entrusted to them. Enterprises will find it helpful to communicate with them, deliver in a
timely manner true and fair disclosure reports, and remove impediments from voting by all
shareholders by taking advantage of modern communications and follow a one-vote for one-share
policy. The fair treatment of minority shareholders must be ensured and large institutional
investors should lead the pursuit of shareholder rights.
Principle 10: The Role of Directors in Turnaround Situations
Directors of troubled companies must play a proactive role in turnaround situations, but avoid
preferential treatment of creditors, or trade when the company is insolvent.
Issues involving corporate governance principles include:
internal controls and internal auditors
the independence of the entity's external auditors and the quality of their audits
oversight and management of risk
oversight of the preparation of the entity's financial statements
review of the compensation arrangements for the chief executive officer and other senior
executives
the resources made available to directors in carrying out their duties
the way in which individuals are nominated for positions on the board
A good corporate governance practice must includes a fair, efficient and transparent administration
and strive to meet certain well defined, written objectives. Corporate governance must go well
beyond law. The quantity, quality and frequency of financial and managerial disclosure, the degree
and extent to which the board of Director exercise their trustee responsibilities, and the
commitment to run a transparent organization.
2.1.5 Corporate Governance Guidelines and Codes of Practice
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Corporate governance principles and codes have been developed in different countries and issued
from stock exchanges, corporations, institutional investors, or associations of directors and
managers with the support of governments and international organizations. One of the most
influential guidelines has been the Organization for Economic Cooperation and Developments
(OECD) Principles of Corporate Governance developed in 1999 and revised in 2004. The OECD
remains a proponent of corporate governance principles throughout the world. Building on the
work of the OECD, the United Nations Intergovernmental Working Group of Experts on
International Standards of Accounting and Reporting (ISAR) has produced voluntary Guidance on
Good Practices in Corporate Governance Disclosure. This internationally agreed benchmark
consists of more than fifty distinct disclosure items across five broad categories:
Auditing
Board and management structure and process
Corporate responsibility and compliance
Financial transparency and information disclosure
Ownership structure and exercise of control rights
In Kenya, corporate governance guidelines and codes of practice have been developed across
various business sectors by regulatory institutions such as ICPAK, CMA among others. For
example, CMA have developed codes of practice that the management of all companies listed in
Nairobi Stock Exchange need to adhere to.
Alongside this, in response to the global development, Kenyan business sector through
Consultative Corporate Sector established Private Sector Initiative for Corporate Governance in
1999 with the key objective of:
Formulating and developing a code of best practice for corporate governance in Kenya;
Explore ways and means of facilitating the establishment of a national apex body to
promote corporate governance in Kenya;
Co-ordinate developments in corporate governance in Kenya with other initiatives in East
Africa, Africa, the Commonwealth and globally.
The body has formulated the following code of practices which have become the hallmark of
corporate governance practice in Kenya.
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1. Authority and Duties of Shareholders
Shareholders of the company shall jointly and severally protect, preserve and actively exercise the
supreme authority of the company in general meetings. They have a duty, jointly and severally, to
exercise that supreme authority to:
Ensure that only competent and reliable persons who can add value to the company are
elected or appointed to the Board of Directors;
Ensure that the Board of Directors is constantly held accountable and responsible for
the efficient and effective governance of the company.
Change the composition of a Board of Directors that does not perform to expectation
or in accordance with the mandate of the corporation.
2. Leadership of the Company
The Board of Directors shall exercise leadership, enterprise, integrity and sagacious judgment in
directing the company so as to achieve continuing prosperity for the company and shall always act
in the best interests of the company.
3. Role and Functions of the Board
The Board of Directors shall exercise all the powers of the company subject only to the limitations
contained in the law and the memorandum and articles of incorporation. In this regard, it is
expected that the Board of Directors shall fulfill the following functions:
Exercise leadership, enterprise, integrity and sound judgments in directing the corporation so
as to achieve continuing prosperity and to act in the best interest of the enterprise while
respecting the principles of transparency and accountability;
Ensure that through a managed and effective process, board appointments are made that provide
a mix of proficient directors, each of whom is able to add value and bring independent
judgment to bear on the decision-making process;
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Determine the corporations purpose and values, determine the strategy to achieve its purpose and
to implement its values in order to ensure it survives and thrives, and ensure that procedures and
practices are in place that protect the corporations assets and reputation;
Monitor and evaluate the implementation of strategies, policies, management performance
criteria and business plans;
Ensure that the corporation complies with all relevant laws, regulations and codes of best
business practice;
Ensure that the corporation communicates with shareholders and other stakeholders effectively;
Serve the legitimate interest of the shareholders and the corporation and account to them fully;
Identify the corporations internal and external stakeholders and agree on a policy, or policies
determining how the corporation should relate to them;
Ensure that no one person or a block of persons has unfettered power and that there is an
appropriate balance of power and authority on the board which is, inter alia, usually reflected by
separating the roles of the Chief Executive Officer and Chairman, and by having a balance
between executive and non-executive directors;
Composition of the Board
The Board shall include a balance of executive and non-executive directors (including independent
non-executive directors) such that no individual or group of individuals or interests can dominate
its decision taking.
The Board shall be chaired by an independent director who is not managing the
company.
There are two key tasks at the top of the company, that of running the Board and that of the Chief
Executive responsible for running the company. Therefore as a general rule, there is a clear
division of these roles to ensure that a balance of power and authority is maintained, and that no
one individual has unfettered powers of decision. Where these roles are combined, the reasons
thereof shall be publicly explained.
The roles of the Chairman are:
To lead the Board;
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To chair meetings of the Board and members, ensuring order, proper conduct of meetings,
affording participants a reasonable opportunity to speak, ensuring decisions are fairly made,
deciding on technicalities and to cast the deciding vote in case of ties;
To organize and facilitate a balance of internal and external relationships, and
To facilitate effective Board management.
Appointments to the Board
There will be formal and transparent procedures for nomination and appointment of new directors
to the Board. In this regard:
There shall be set up a search and nominations committee of the Board.
The Board of Directors will formally review its composition and performance at least
once every year to ensure that:
- The mix of membership is appropriate and compatible with the needs of the Board and company.
- Every non-executive director commits adequate time to his responsibilities and
contributes effectively.
Based on the priority needs of the Board and the Company, the nominations committee
will recommend to the Board qualified, competent fit and proper persons to be nominated for
election to the Board.
All directors shall be required to submit themselves for re-election at regular intervals and at
least once every three years.
Service contracts of Executive Directors shall not exceed three years but these are renewable
with the approval of shareholders on the recommendation of the Board.
Directors Remuneration
In order to avoid potential conflict of interest, the Board of directors shall set up independent
remuneration committee to determine the remuneration of respective individual executive
directors. The committee shall make a report to the shareholders every year.
The Committee shall:
Establish a formal and transparent procedure for developing policy on executive remuneration
and for fixing the remuneration packages of individual executive directors.
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Ensure that the level of remuneration shall be sufficient to attract and retain the quality and
calibre of directors needed to run the company successfully while the make up should be so
structured as to link corporate and individual performance.
Ensure that the companys annual report contains a statement of the remuneration policy and
details of the remuneration and benefits of each director, including family- related benefits.
Disclosures of Information by Directors
On first appointment and at regular intervals (at least once every year), or at any time when
circumstances change, all directors shall, in good faith, disclose to the Board for recording and
disclosure to the external auditors, any business or other interests that are likely to create a
potential conflict of interest, including:
- All business interests (direct or indirect) in any other company, partnership or other business
venture.
- Membership in trade, business or other economic organizations.
- Their shareholding, share options and/or other interest in the company.
- Any interest (direct or indirect) in any transaction with the company.
- Any gifts, monies, commissions, benefits or other favours extended or received from whatsoever
party in respect of or in relation to any business dealings with the company. At any time when a
director resigns or is removed from office before the expiry of his term, he shall disclose to the
companys external auditors and if necessary to the shareholders (if the reason for removal or
resignation is refusal to compound fraud, corruption or other activities or behaviour incompatible
with the shareholders interests) the reasons for his resignation or removal.
Supply of Information to Directors
For Board members to exercise informed, intelligent, objective and independent judgments on
corporate affairs, they shall have access to accurate, relevant and timely information. In this regard:
There shall be established a formal procedure to enable independent directors to take
professional advice on any matter pertinent to their functions if and where they deem it necessary
and at the companys expense but subject always to the limitations, restrictions and conditions
stipulated by the Board.
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All directors shall have unlimited access to the advice and services of the Company Secretary
who has a statutory duty to advice the Board on maters of procedures, rules and regulations, and to
any other professional officer of the company.
It is the duty of every director to demand and obtain any information he deems critical to the
performance of his duties as a director.
Accounts: Audit and Disclosure
It is the statutory duty of directors, jointly and severally, to cause to be kept proper and
accurate books of accounts in respect to all sums of money received and expended by the
company, and the matters in respect of which receipt or expenditure takes place; all sales
and purchases by the company; and of all the assets and liabilities of the company, as
necessary to give with reasonable accuracy at anytime, the financial position of the
company at that time; and to lay before the companys annual general meeting, a profit
and loss account and a balance sheet reflecting a true and fair view of the profit or loss of
the company and of the state of affairs of the company.
Consequently the Board of Directors is responsible for:
- Maintaining adequate systems of financial management and internal control over
the company, including procedures designed to minimize the risk of fraud.
- Ensuring the integrity and adequacy of the accounting and financial systems.
- Ensuring that qualified, competent, fit and proper persons are employed to
undertake accounting and financial responsibilities.
- Ensuring that the company complies with the accounting standards applicable.
The Board shall present to the shareholders balanced and understandable assessment of the
companys position and prospects at least once a every year and preferably every six
months.
It shall also establish formal and transparent arrangements for maintaining an arms
length relationship with the external auditors, and ensure that there is timely and accurate
disclosure to the shareholders of any information that would materially affect either the
value or worth of their investment or earnings there-from including:
Material changes in ownership structures, take over bids, shareholders arrangements,
acquisitions, mergers, script splits and consolidations, or other arrangements.
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Extension of Scope and Duties of Auditors
The Board of Directors shall ensure that persons who are qualified, reliable and
independent of the Board and management are appointed as auditors. In light of
developments elsewhere, the Board shall endeavour to:
Extend the definition and scope of audit to cover:-
to provide an independent opinion to those with interest in the company that they
have received from those responsible for the direction and management of the
company an adequate account of:
- The proper conduct of the companys affairs;
- The companys financial performance and position;
- Future risks.
Facilitate an extension of Auditors duties in regard to:
- Reporting on whether the company has financial and other risk management
Controls.
- Evaluating and reporting on aspects of propriety and efficiency
- Reporting directly to the Board, regulatory authorities and shareholders as
appropriate, when illegal acts are discovered and to monitor basic ethical
behaviour particularly in regard to the public interest
Enhance the independence of the auditor from the Board and management;
Extend the liability of Auditors to third parties.
The Role of Audit Committees
A separate audit committee enables a Board to delegate to a sub-committee the
responsibility for a thorough and detailed review of Audit matters, enables the nonexecutive
directors to contribute an independent judgment and play a positive role in an
area for which they are particularly fitted, and offers the auditors a direct link with the
non-executive directors. The appointment of a properly constituted Audit Committee shall
therefore be an important step in raising standards of corporate governance.
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The Board shall establish an Audit Committee composed of independent nonexecutive directors
to keep under review the scope and results of audit, its effectiveness and the independence and
objectivity of the auditors.
The Audit Committee shall be given written terms of reference which deal adequately
with their membership, authority and duties and shall meet at least twice a year.
The Audit Committee will:
Review the half year and annual financial statements before submission to the
Board focusing particularly on:-
- Changes in accounting policies
- Significant adjustments arising from the audit
- Major judgmental areas
- Compliance with accounting standards, disclosure and legal requirements, and
- Subject the financial statements to independent critical appraisal
Consider appointment, remuneration and the resignation or dismissal of external
auditors.
Discuss and agree on the scope, nature and priorities of audit.
Rights of Shareholders
All shareholder rights shall be recognized, respected and protected.
Basic shareholder rights include:
To secure methods of ownership registration;
To convey or transfer shares;
To obtain relevant information on the corporation on a timely and regular basis;
To participate and vote in general shareholder meetings;
To elect members of the Board; and
To share in the residual profits of the company.
Shareholders have the right to participate in, and to be sufficiently informed on,
decisions concerning fundamental corporate changes such as:
Amendments to the statutes, or articles of incorporation or similar governing
documents of the company;
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The authorization of additional shares; and
Extra-ordinary transactions that in effect result in the sale of the company.
The Board of Directors shall ensure that there is equitable treatment of all
shareholders. In particular the Board shall ensure that:
All shareholders of the same class are treated equally.
Equitable treatment of all shareholders, including minority and foreign shareholders.
All shareholders shall have the opportunity to obtain effective redress for violation to
their rights.
Within any class, all shareholders should have the same voting rights. All investors
should be able to obtain information about voting rights affiliated with all classes of
shares before they purchase them. Any changes in voting rights within or between
classes of shares should be subject to shareholder vote.
Votes shall be cast by custodians or nominees in a manner agreed upon with the
beneficial owner of the shares.
The Shareholders in turn have a duty and are well advised to exercise the supreme authority
of the company in general meetings to hold the Board accountable for stewardship of the
company.
Responsibilities to Other Stakeholders
The Board of Directors and the company recognize the rights of stakeholders as
established by law and shall encourage active co-operation between the company and its
stakeholders in creating wealth, jobs and the sustainability of financially sound enterprises.
In this regard, the Board of Directors shall:
Ensure that the rights of stakeholders that are protected by law are respected.
Where stakeholder interests are protected by law, ensure that stakeholders have the
opportunity to seek effective redress for any violation of their rights.
Permit and facilitate performance-enhancing mechanisms for stakeholder participation.
Ensure that where stakeholders participate in performance-enhancing mechanisms,
they have access to all relevant information.
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Mechanisms and controls in corporate governance
Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise
from moral hazard and adverse selection. For example, to monitor managers' behaviour, an
independent third party (the external auditor) attests the accuracy of information provided by
management to investors. An ideal control system should regulate both motivation and ability.
Internal corporate governance controls
Internal corporate governance controls monitor activities and then take corrective action to
accomplish organizational goals. Examples include:
Monitoring by the board of directors: The board of directors, with its legal authority to
hire, fire and compensate top management, safeguards invested capital. Regular board
meetings allow potential problems to be identified, discussed and avoided. The ability of
the board to monitor the firm's executives is a function of its access to information.
Executive directors possess superior knowledge of the decision-making process and
therefore evaluate top management on the basis of the quality of its decisions that lead to
financial performance outcomes.
Internal control procedures and internal auditors: Internal control procedures are
policies implemented by an entity's board of directors, audit committee, management, and
other personnel to provide reasonable assurance of the entity achieving its objectives
related to reliable financial reporting, operating efficiency, and compliance with laws and
regulations. Internal auditors are personnel within an organization who test the design and
implementation of the entity's internal control procedures and the reliability of its financial
reporting.
Balance of power: The simplest balance of power is very common; require that the Chief
Executive Officer be a different person from the Chief Finance Officer. This application of
separation of power is further developed in companies where separate divisions check and
balance each other's actions. One group may propose company-wide administrative
changes, another group review and can veto the changes, and a third group check that the
interests of people (customers, shareholders, employees) outside the three groups are being
met.
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Remuneration: Performance-based remuneration is designed to relate some proportion of
salary to individual performance. It may be in the form of cash or non-cash payments such
as shares and share options or other benefits.
ii. External corporate governance controls
External corporate governance controls encompass the controls external stakeholders exercise over
the organisation. Examples include:
competition
debt covenants
demand for and assessment of performance information (especially financial statements)
government regulations
managerial labour market
media pressure
takeovers
Challenges to Corporate Governance
Supply of accounting information: Financial accounts form a crucial link in enabling
providers of finance to monitor directors. Imperfections in the financial reporting process
will cause imperfections in the effectiveness of corporate governance. This should, ideally,
be corrected by the working of the external auditing process.
Financial reporting is a crucial element necessary for the corporate governance system to
function effectively. Accountants and auditors are the primary providers of information to
capital market participants. The directors of the company should be entitled to expect that
management prepare the financial information in compliance with statutory and ethical
obligations, and rely on auditors' competence.
Current accounting practice allows a degree of choice of method in determining the method
of measurement, criteria for recognition, and even the definition of the accounting entity. The
exercise of this choice to improve apparent performance imposes extra information costs
on users. In the extreme, it can involve non-disclosure of information.
One area of concern is whether the auditing firm acts as both the independent auditor and
management consultant to the firm they are auditing. This may result in a conflict of
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interest which places the integrity of financial reports in doubt due to client pressure to
appease management. The power of the corporate client to initiate and terminate
management consulting services and, more fundamentally, to select and dismiss accounting
firms contradicts the concept of an independent auditor.
Changes enacted in the United States in the form of the Sarbanes-Oxley Act in response to
the Enron situation prohibit accounting firms from providing both auditing and
management consulting services. The Enron collapse is an example of misleading financial
reporting. Enron concealed huge losses by creating illusions that a third party was
contractually obliged to pay the amount of any losses. However, the third party was an
entity in which Enron had a substantial economic stake.
However, good financial reporting is not a sufficient condition for the effectiveness of
corporate governance if users don't process it, or if the informed user is unable to exercise a
monitoring role due to high costs.
2.1 AGENCY PROBLEM
Agency problem arises whenever one party (principal) contracts another party (agent) to act on his
behalf. The principal will cede authority to the agent in order for the agent to execute his tasks. The
agent is normally compensated for providing the service. Agency problem occurs since agents tend
to act in their own interest rather than wholly in the interest of the principal.
Agency Theory
Agency theory has its roots in economic theory by Alchian and Demsetz (1972) and further
developed by Jensen and Meckling (1976).
Agency theory is defined as the relationship between the principals, such as shareholders and
agents such as the company executives and managers. In this theory, shareholders who are the
owners or principals of the company, hires the gents to perform work. Principals delegate the
running of business to the directors or managers, who are the shareholders agents (Clarke, 2004).
Below diagram explain this theory.
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The theory reduces the corporation to two participants of managers and shareholders and suggests
that employees or managers in organizations can be self-interested. Shareholders expect the agents
to act and make decisions in the principals interest. On the contrary, the agent may not necessarily
make decisions in the best interests of the principals (Padilla, 2000). In this theory, the agent may
be succumbed to self-interest, opportunistic behavior and falling short of congruence between the
aspirations of the principal and the agents pursuits.
Agency theory was introduced basically as a separation of ownership and control. Holmstrom and
Milgrom (1994) the agents will only focus on projects that have a high return.
This theory can be employed to explore the relationship between the ownership and management
structure. However, where there is a separation, the agency model can be applied to align the goals
of the management with that of the owners. Due to the fact that in a family firm, the managementcomprises of family members, hence the agency cost would be minimal as any firms performance
does not really affect the firm performance (Eisenhardt, 1989). The model of an employee
portrayed in the agency theory is more of a self-interested, individualistic and are bounded
rationality where rewards and punishments seem to take priority (Jensen & Meckling, 1976). This
theory prescribes that people or employees are held accountable in their tasks and responsibilities.
Employees must constitute a good governance structure rather than just providing the need of
shareholders.
2.2.2 Agency Problem in Kenya
Agency problem in Kenya is evidence mostly in large corporations with government connections.
The problems range from either deliberate or incompetent investment decisions to unethical
practices by the directors.
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Pan African Paper Mills (EA) Ltd is one recent case of agency problem. The major shareholders of
the company were Birla Group of India (54.3%) and the government of Kenya (34%). Since 1970,
the company has been under the management of Oriental Paper Industries having been appointed
by the majority shareholders, Birla Group at a fixed annual payment of Kshs.96 million.
Investigations by various media houses including Nation Media Group established that Oriental
Paper Industry was fully owned by the leading directors of Birla Group, and according to a report
dated 14th April 2009, prepared by a committee appointed by the government to evaluate the status
of the company, the Indian management company was paid even when there was nothing to show
for it by Pan African Paper Mills (EA) Ltd managers. The report also pointed out that there no
evidence of set benchmarks againstwhich to measure performance as the company has never had a
strategic plan. (Daily Nation, Feb. 8, 2010).
The Indian managers were on the Pan Paper Mills payroll as well which was a clear case of double
payment according to the report. The Orient also enjoyed additional fees pegged on sales and net
profit.
The Indians, The Vice President of Oriental, Mr. Saha and his team left a month after realising that
they had run down the company to the point where they could not even pay Kenya Power and
Lighting Company for power consumed. In January 2009 KPLC switched off electricity supply
over an unpaid bill of Sh201 million.
That triggered a chain reaction, which saw short-term lenders including Kenya Commercial
Bank, Barclays Bank Kenya, Ecobank Kenya and Bank of Baroda Kenya place the company
under receivership in March last year.
They are jointly owed Sh1.4 billion with the balance of Sh9 billion owed to long-term lenders and
suppliers including KenolKobil that moved to court in November 2009 seeking orders to have the
companys assets sold over failure to pay Sh530 million for supply of petroleum products.
The report cast doubt over Paper Mills ability to carry the existing total debt. Since 2001 Pan
Paper has not repaid any of its debts, while it stopped paying interest on loans in 2005.
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This is a perfect example of agency problem. The board acting in total disregard of the
sharehholders interest, the biggest casualty being the Kenyan taxpayers through the government
34%. The aim of the government was to get a fair return for its investment whereas Pan Paper
director had their own personal interests, to enrich themselves.
Another case of agency problem in Kenya was in NSSF. This institution is the custodian of the
social funds contributed by the Kenya workers for their old age/retirement benefits. The
contributions of the workers places them (workers) in the position of shareholder. The workers,
like the shareholders in other companies would expect a better yield from their contributions in
NSSF.
In endeavour to achieving this objective, NSSF invests these funds in various securities. However
in the 2008, NSSF was found to have engaged in underground deal with a security company,
Discount Securities, where it lost over 2 billion shillings of the contributors money.
The minister for Labour and Human Resource Development in their audit established that the
management of NSSF could not account for over Sh2 billion of the funds paid to Discount
Securities for investment purposes. This forced the minister to suspend the entire NSSF Board of
Trustees.
Capital Markets authority established that the transactions were done off the stockbrokers books
and were neither disclosed in the Discount Securities Ltd returns to the Authority nor did NSSF
ever raised any concern to the Authority on the matter.
The managing trustee was later, in April 2009, charged in court with two cases of fraud involving
over Kshs.149 million.
This is another case of agency problem where the directors have gone against the interest of the
contributors (shareholder) to involve in both risky and fraudulent investment.
This report is contained in the Daily Nation Newspapers of 17 th November 2008 and 21st April
2009.
BUSINESS FAILURE
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Overview of Business Failure
Business failure is directly linked to inadequate organizational leadership and unlawful practices of
fraud, conspiracy, falsifying documents, and embezzlement, examples being WorldCom
which has been classification as being one of the biggest corporate scandals in Unites
States history (Braun, Warder, & Zekany, 2004).
In 2001, the financial condition of the company began to decline because of the slowing
telecommunications industry, which eventually put pressure on the companys executive
officers to increase profits (Jonesington, 2007). Unfortunately, the executive officers made
decisions to commit accounting fraud by falsifying documents to reflect a positive cash
flow rather than a negative cash flow. All the individuals involved plead guilty to fraud and
conspiracy charges (Jonesington, 2007).
The reason for WorldComs company failure is not due to poor financial conditions in the
telecommunications industry, but due to the lack of leadership, management, and
organization in the company structure to solve the financial problems. The market
conditions of the telecommunications industry dropped significantly to affect not only
WorldCom, but also other companies. However, a prediction for the telecommunications
industry was improvement within the next 5 to 10 years, which it did for some companies
(Braun, Warder, & Zekany, 2004). If WorldCom made decisions with the benefit of the
organization in mind it would have seen improvements in the market and the companys
financial statements.
The study of Professor Kaira D. Carter of the University of Phoenix has established that the key
underlying factor in business failure is poor corporate governance practices which are evidenced in
inept business performance in such critical areas as marketing, finance, human resource, planning
among others.
2.3.2 Causes of Business Failure
The study outlined the following as the immediate causes of business failure
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Lack of clear objectives
Successful organisations have clearly focused and communicated objectives that enable
everyone in the organisation to pull in the same direction.
Poor management
Weak and inexperienced management is one of the major causes of business failure. Managers
have to work extremely hard, and to understand their customers needs, and the business that they
are in if they are to be successful.
Poor human resource relations
Often a cause of failure. Successful businesses motivate their employees to work hard to help the
business to succeed.
Poor marketing
Successful modern businesses are ones that understand and meet the requirements of their
customers. Detailed market planning and market research is therefore an essential for new
businesses, to find out details such as the potential size of the market, the extent of competition, as
well as consumer preferences and tastes.
Cash flow problems
Many businesses struggle through poor cash flow management. It is all very well having a good
idea and a good product but it is also necessary to be able to meet short term cash outflows. Many
businesses try to grow too quickly, and end up borrowing too much money externally, resulting in
crippling interest repayment charges.
Poor business planning
Business planning should cover aspects such as marketing, finance, sales and promotional plans, as
well as detailed breakdowns of costings and profit predictions. It is often said that failing to plan, is
planning to fail.
Lack of finance
Insufficient finance often means that businesses are unable to take opportunities that are available
to them, or have to compromise - going for high cost solutions to problems, rather than lower cost
ones that would yield greater competitive advantage.
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Failure to embrace new technologies and new developments
In a fast changing world leading businesses are ones that make best use of advanced modern
technologies in an appropriate way. Firms that operate with outdated technologies and methods
frequently find themselves at a cost disadvantage over more dynamic rivals.
Poor choice of location
Location is a very important business decision. A good location is one that appeals to large
numbers of customers, while at the same time minimizing costs. For example in retailing it is often
a mistake to choose a low cost location, that is not visible to customers. However, conversely there
are considerable cost advantages to out-of-town retailers that customers are prepared to travel to
visit.
Business failure in Kenya and the Roles of Corporate Governance and Agency ProblemAs stated in the introductory part of this literature, the 1990s and early 2000s saw a lot of major
business enterprises closing down. These included Rivertex, Kenya Co-operative Creameries,
Farm Machinery Distributors, East African Tanning Extract, Kenya Meat Commission, Kisumu
Cotton Mills, Euro Bank, Daima Bank, Trust Bank and recently Pan Paper Mills, just to mention a
few. Most of these organizations were closely associated with the government and thus their
boards were made mostly of government appointees based in their close association with the senior
government officials. Such boards had the following weaknesses;
First, they were composed of individuals with no professional management skills, secondly, they
were bound by their political patronage to act in the interest of the political forces and not the
organizations and thirdly, a number of individuals on such boards were people with very poor
integrity rating.
With weak regulatory system, the organization experienced very poor corporate governance
practices; lack of integrity, poor corporate culture, weak policies among others.
The major reasons for the collapse of these institutions as highlighted earlier are;
Weak corporate governance practices.
Poor risk management strategies.
Lack of internal control.
Weakness in regulatory and supervisory systems.
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Technical incompetence of the boards.
Conflict of interests between the organization strategies and the top managements self
interests.
However, the recent years have seen most of Kenya large corporations adopting international
codes of corporate governance practices. Such awards as Company of the Year (COYA) encourage
most organizations to improve their corporate culture so as to remain competitive. The awards also
recognizes the chief executive officers who have performed well entrenching the best corporate
practices in their organizations. Such awards have great impacts on CEOs public ratings and their
future career development and thus most of them have now fully embarked on corporate image
building.
Private Sector Corporate Governance Trust (Kenya) in conjunction with The Global Corporate
Governance Forum and The Commonwealth Association for Corporate Governance and the Kenya
regulatory institutions such as Capital Markets Authority, Institute of Certified Public Accountants
of Kenya have also played key roles in promoting prudent corporate governance which has greatly
reduced the cases of business failure in Kenya.
With this development, the strong corporate governance practices has greatly reduced agency
problem in most organizations and thus its contribution to business failure in Kenya is equally
reduced.
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3.0 STUDY METHODOLOGY
3.1 Research Design
The study seeks to investigate the relationship between corporate governance practices, agency
problem and business failure in Kenya. This study has been conducted mainly through
survey and empirical approaches.
3.2 Population
The study targeted ten firms in Kenya that have closed due to problem related to corporate
governance. The sample respondents are expected to be the CEOs, departmental heads and
employees of these organizations.
3.3 Data Collection
The study made use of both primary and secondary data in particular same corporate governance
measures that were not publicly available are to be obtained by the use of questionnaires
and interviews techniques. The questionnaires are to be in three sets; for CEOs,
departmental heads and employees. The interview schedules are to be used to supplement
the results from the questionnaires. It will also give opportunity for probing slightly for
more details that the questionnaires. The interview schedules to consist of unstructured
items for interviewing before distribution of the questionnaires.
3.4 Data Analysis Techniques
The data to be generated from closed ended questionnaire are to be recorded, coded, numbered and
classified under different variables for easy identification and then summarized in answer
summary sheets.
4.0 CONCLUSION AND LIMITATIONS
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From Global Investor Opinion Survey of over 2000, McKinsey found that 80% of the respondents
would pay a premium for well-governed companies. They defined a well-governed company as
one that was responsive to investors' requests for information on governance issues.
Other studies have linked broad perceptions of the quality of companies to superior share price
performance. Business Weekenlisted institutional investors and experts to assist in differentiating
between boards with good and bad governance and found that companies with the best corporate
governance practices had the highest financial returns.
Agency problem arise out of the managements quest to satisfy their personal interest relative those
of the shareholders. However with the good corporate governance whereby the directors
understand their roles as agents of the principals with the key responsibility of safeguarding the
interest of the principal through maximization of the firms value, upholding integrity and honesty
and respecting the shareholders right to information regarding the firms business activities, the
agency problem would be greatly reduced.
This points to the fact that good corporate practice is directly correlated and is the key determinant
of business success.
Limitations
Despite its immense role in business in Kenya, corporate governance has not captured the interest
of Kenya business researchers and writers and thus there is great scarcity of materials for study on
Kenya.
CODE ON CORPORATE GOVERNANCE
. PREAMBLE1. This Code supersedes and replaces the Combined Code issued by the
Hampel Committee on Corporate Governance in June 1998. It derivesfrom a review of the role and effectiveness of non-executive directors by
Derek Higgs1 and a review of audit committees2 by a group led by Sir
Robert Smith.
2. The Financial Services Authority has said that it will replace the 1998
Code that is annexed to the Listing Rules with the revised Code and willseek to make consequential Rule changes. There will be consultation on
the necessary Rule changes but not further consultation on the Code
provisions themselves.
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3. It is intended that the new Code will apply for reporting years beginning on
or after 1 November 2003.
4. The Code contains main and supporting principles and provisions. The
existing Listing Rules require listed companies to make a disclosure
statement in two parts in relation to the Code. In the first part of thestatement, the company has to report on how it applies the principles in
the Code. In future this will need to cover both main and supporting
principles. The form and content of this part of the statement are notprescribed, the intention being that companies should have a free hand to
explain their governance policies in the light of the principles, including
any special circumstances applying to them which have led to a particular
approach. In the second part of the statement the company has either toconfirm that it complies with the Codes provisions or where it does not
to provide an explanation. This comply or explain approach has been
in operation for over ten years and the flexibility it offers has been widely
welcomed both by company boards and by investors. It is forshareholders and others to evaluate the companys statement
5. While it is expected that listed companies will comply with the Codes
provisions most of the time, it is recognised that departure from the
provisions of the Code may be justified in particular circumstances. Everycompany must review each provision carefully and give a considered
explanation if it departs from the Code provisions.
6. Smaller listed companies, in particular those new to listing, may judge thatsome of the provisions are disproportionate or less relevant in their case.
Some of the provisions do not apply to companies below FTSE 350. Such
companies may nonetheless consider that it would be appropriate toadopt the approach in the Code and they are encouraged to consider this.
Investment companies typically have a different board structure, which
may affect the relevance of particular provisions.
7. Whilst recognising that directors are appointed by shareholders who are
the owners of companies, it is important that those concerned with the
evaluation of governance should do so with common sense in order topromote partnership and trust, based on mutual understanding. They
should pay due regard to companies individual circumstances and bear
in mind in particular the size and complexity of the company and thenature of the risks and challenges it faces. Whilst shareholders have
every right to challenge companies explanations if they are unconvincing,
they should not be evaluated in a mechanistic way and departures fromthe Code should not be automatically treated as breaches. Institutional
shareholders and their agents should be careful to respond to the
statements from companies in a manner that supports the comply or
explain principle. As the principles in Section 2 make clear, institutional
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shareholders should carefully consider explanations given for departure
from the Code and make reasoned judgements in each case. They should
put their views to the company and be prepared to enter a dialogue if theydo not accept the companys position. Institutional shareholders should be
prepared to put such views in writing where appropriate.
8. Nothing in this Code should be taken to override the general requirements
of law to treat shareholders equally in access to information.
9. This publication includes guidance on how to comply with particular parts
of the Code: first, Internal Control: Guidance for Directors on the
Combined Code3, produced by the Turnbull Committee, which relates to
Code provisions on internal control (C.2 and part of C.3 in the Code); and,second, Audit Committees: Combined Code Guidance, produced by the
Smith Group, which relates to the provisions on audit committees and
auditors (C.3 of the Code). In both cases, the guidance suggests ways
of applying the relevant Code principles and of complying with therelevant Code provisions.
10. In addition, this volume also includes suggestions for good practice from
the Higgs report.
11. The revised Code does not include material in the previous Code on the
disclosure of directors remuneration. This is because The Directors'
Remuneration Report Regulations 20024 are now in force and supersedethe earlier Code provisions. These require the directors of a company to
prepare a remuneration report. It is important that this report is clear,
transparent and understandable to shareholders.
CODE OF BEST PRACTICE
SECTION 1 COMPANIES
A. DIRECTORS
A.1 The Board
Main Principle
Every company should be headed by an effective board, which is
collectively responsible for the success of the company.
Supporting Principles
The boards role is to provide entrepreneurial leadership of the company
within a framework of prudent and effective controls which enables risk to
be assessed and managed. The board should set the companys strategic
aims, ensure that the necessary financial and human resources are in
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place for the company to meet its objectives and review management
performance. The board should set the companys values and standards
and ensure that its obligations to its shareholders and others areunderstood and met.
All directors must take decisions objectively in the interests of thecompany.
As part of their role as members of a unitary board, non-executivedirectors should constructively challenge and help develop proposals on
strategy. Non-executive directors should scrutinise the performance of
management in meeting agreed goals and objectives and monitor the
reporting of performance. They should satisfy themselves on the integrityof financial information and that financial controls and systems of risk
management are robust and defensible. They are responsible for
determining appropriate levels of remuneration of executive directors and
have a prime role in appointing, and where necessary removing,executive directors, and in succession planning.
Code Provisions
A.1.1 The board should meet sufficiently regularly to discharge its duties
effectively. There should be a formal schedule of matters specificallyreserved for its decision. The annual report should include a statement of
how the board operates, including a high level statement of which types
of decisions are to be taken by the board and which are to be delegated
to management.
A.1.2 The annual report should identify the chairman, the deputy chairman
(where there is one), the chief executive, the senior independent directorand the chairmen and members of the nomination, audit and
remuneration committees. It should also set out the number of meetings
of the board and those committees and individual attendance by directors.
A.1.3 The chairman should hold meetings with the non-executive directors
without the executives present. Led by the senior independent director,
the non-executive directors should meet without the chairman present atleast annually to appraise the chairmans performance (as described in
A.6.1) and on such other occasions as are deemed appropriate.
A.1.4 Where directors have concerns which cannot be resolved about the
running of the company or a proposed action, they should ensure that
their concerns are recorded in the board minutes. On resignation, a nonexecutivedirector should provide a written statement to the chairman, for
circulation to the board, if they have any such concerns.
A.1.5 The company should arrange appropriate insurance cover in respect of
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of sufficient size that the balance of skills and experience is appropriate
for the requirements of the business and that changes to the boards
composition can be managed without undue disruption.
To ensure that power and information are not concentrated in one or two
individuals, there should be a strong presence on the board of bothexecutive and non-executive directors.
The value of ensuring that committee membership is refreshed and thatundue reliance is not placed on particular individuals should be taken into
account in deciding chairmanship and membership of committees.
No one other than the committee chairman and members is entitled to be
present at a meeting of the nomination, audit or remuneration committee,but others may attend at the invitation of the committee.
July 2003 The Combined Code
6
5 Compliance or otherwise with this provision need only be reported for the year in which theappointment is made.
Code provisions
A.3.1 The board should identify in the annual report each non-executive director
it considers to be independent6. The board should determine whether thedirector is independent in character and judgement and whether there are
relationships or circumstances which are likely to affect, or could appear
to affect, the directors judgement. The board should state its reasons if it
determines that a director is independent notwithstanding the existence ofrelationships or circumstances which may appear relevant to its
determination, including if the director:
_ has been an employee of the company or group within the last fiveyears;
_ has, or has had within the last three years, a material business
relationship with the company either directly, or as a partner,shareholder, director or senior employee of a body that has such a
relationship with the company;
_ has received or receives additional remuneration from the company
apart from a directors fee, participates in the companys shareoption or a performance-related pay scheme, or is a member of the
companys pension scheme;
_ has close family ties with any of the companys advisers, directors orsenior employees;
_ holds cross-directorships or has significant links with other directors
through involvement in other companies or bodies;_ represents a significant shareholder; or
_ has served on the board for more than nine years from the date of
their first election.
A.3.2 Except for smaller companies7, at least half the board, excluding the
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chairman, should comprise non-executive directors determined by the
board to be independent. A smaller company should have at least two
independent non-executive directors.A.3.3 The board should appoint one of the independent non-executive directors
to be the senior independent director. The senior independent director
should be available to shareholders if they have concerns which contactthrough the normal channels of chairman, chief executive or finance
director has failed to resolve or for which such contact is inappropriate.
July 2003 The Combined Code7
6 A.2.2 states that the chairman should, on appointment, meet the independence criteria set out in
this
provision, but thereafter the test of independence is not appropriate in relation to the chairman.7 A smaller company is one that is below the FTSE 350 throughout the year immediately prior to
the
reporting year.
A.4 Appointments to the Board
Main Principle
There should be a formal, rigorous and transparent procedure for
the appointment of new directors to the board.
Supporting Principles
Appointments to the board should be made on merit and against objective
criteria. Care should be taken to ensure that appointees have enoughtime available to devote to the job. This is particularly important in the
case of chairmanships.
The board should satisfy itself that plans are in place for orderlysuccession for appointments to the board and to senior management, so
as to maintain an appropriate balance of skills and experience within the
company and on the board.
Code Provisions
A.4.1 There should be a nomination committee which should lead the process
for board appointments and make recommendations to the board. Amajority of members of the nomination committee should be independent
non-executive directors. The chairman or an independent non-executive
director should chair the committee, but the chairman should not chair thenomination committee when it is dealing with the appointment of a
successor to the chairmanship. The nomination committee should make
available8 its terms of reference, explaining its role and the authoritydelegated to it by the board.
A.4.2 The nomination committee should evaluate the balance of skills,
knowledge and experience on the board and, in the light of this evaluation,
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prepare a description of the role and capabilities required for a particular
appointment.
A.4.3 For the appointment of a chairman, the nomination committee should
prepare a job specification, including an assessment of the time
commitment expected, recognising the need for availability in the event ofcrises. A chairmans other significant commitments should be disclosed to
the board before appointment and included in the annual report. Changes
to such commitments should be reported to the board as they arise, andincluded in the next annual report. No individual should be appointed to a
second chairmanship of a FTSE 100 company9.
July 2003 The Combined Code
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A.4.4 The terms and conditions of appointment of non-executive directors
should be made available for inspection10. The letter of appointment
should set out the expected time commitment. Non-executive directorsshould undertake that they will have sufficient time to meet what is
expected of them. Their other significant commitments should bedisclosed to the board before appointment, with a broad indication of the
time involved and the board should be informed of subsequent changes.
A.4.5 The board should not agree to a full time executive director taking on more
than one non-executive directorship in a FTSE 100 company nor the
chairmanship of such a company.
A.4.6 A separate section of the annual report should describe the work of the
nomination committee, including the process it has used in relation to
board appointments. An explanation should be given if neither an externalsearch consultancy nor open advertising has been used in the
appointment of a chairman or a non-executive director.
A.5 Information and professional development
Main Principle
The board should be supplied in a timely manner with information in
a form and of a quality appropriate to enable it to discharge its
duties. All directors should receive induction on joining the board
and should regularly update and refresh their skills and knowledge.
Supporting Principles
The chairman is responsible for ensuring that the directors receive
accurate, timely and clear information. Management has an obligation to
provide such information but directors should seek clarification or
amplification where necessary.
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The chairman should ensure that the directors continually update their
skills and the knowledge and familiarity with the company required to fulfil
their role both on the board and on board committees. The companyshould provide the necessary resources for developing and updating its
directors knowledge and capabilities.
Under the direction of the chairman, the company secretarysresponsibilities include ensuring good information flows within the board
THE COMBINED CODE ON CORPORATE GOVERNANCE
July 2003
CONTENTS
Pages
The Combined Code on Corporate Governance
Preamble 1-3
Section 1 COMPANIES 4-19A Directors 4-11
B Remuneration 12-14C Accountability and Audit 15-17
D Relations with Shareholders 18-19
Section 2 INSTITUTIONAL SHAREH