Corporate Governance – Principles, Policies and Practices 3e

1. Corporate Governance – Principles, Policies and Practices 3e Chapter 18 The Future of Corporate Governance

2. The Future of Corporate Governance • In which we consider: • the frontiers of corporate governance • beyond the frontiers of corporate governance • new corporate governance policies and practices • society’s changing expectations

3. CG frontiers – some unresolved issues The paradox of the unitary board Corporate governance involves two countervailing responsibilities: • performance: strategy formulation and policy making • conformance: executive supervision and accountability These two responsibilities potentially conflict • “marking their own examination” The two tier board resolves the dilemma with two boards: • the executive board responsible for performance • the supervisory board responsible for conformance

4. CG frontiers – some unresolved issues The paradox of the unitary board The dilemma met in unitary boards by having independent directors: • with independence strictly defined to exclude any interests • able to take an objective, independent view • providing a counterweight to the executive directors • independent directors also form the audit committee

5. CG frontiers – some unresolved issues A paradox • The greater a director's independence the less he is likely to know about the company • The more an INED knows about the company, the greater his potential contribution, the less his perceived independence

6. Report of the US Commission on Corporate Governance 2010 – 10 core governance principles 10 core governance principles • The board’s fundamental objective is to build long-term sustainable growth in shareholder value • corporate management - critical role in corporate governance • good corporate governance should be integrated with the company’s business strategy • Shareholders have a responsibility to vote their shares • over-reliance on legislation and rules may not be in the best interests of shareholders, companies or society

7. Report of the US Commission on Corporate Governance 2010 – 10 core governance principles 6. a critical component of good governance is transparency 7. independence is an important attribute for board members but non-independent outside directors can add expertise, diversity and knowledge 8. proxy advisory firms should be transparent and accountable 9. the SEC should work with exchanges to ease the burden of proxy voting 10. SEC and/or the NYSE should periodically assess the impact of major governance reforms

8. CG frontiers – some unresolved issues Can outside independent directors be genuinely independent? In unitary board countries: - CG codes call for independent non-executive directors - The codes define 'independence' in detail But can any director be genuinely independent when INEDs: - nomination came from existing members of that board - had the approval of CEO and chairman - feel commitment and loyalty to them - have to form an effective team with the CEO and the other directors - work closely with executive directors on strategic and other issues - determine the issues they are supposed to be monitoring - become enmeshed in the board culture

9. CG frontiers – some unresolved issues Can outside directors be genuinely independent? In two-tier board countries: • supervisory board consists entirely of outside directors • but members of supervisory boards represent the interests of stakeholder groups So how can a supervisory board member apply independent judgement if: • their allegiance is to the groups they represent • their interests may be in conflict • the relationships within the board can be adversarial

10. CG frontiers – some unresolved issues Should CG be based on principles or rules? In the United States: - listed companies must obey SOX Act rules and SEC and stock exchange regulations - US accounting standards also rule-based In the United Kingdom, the Commonwealth and 'OECD-code' countries: - listed companies follow country's corporate governance principles (comply with code or explain why not) and international accounting standards The rules versus principles debate has a long way to go

11. CG frontiers – some unresolved issues Should chief executive officer ever be board chairman? In the United States - - chairman and CEO of listed companies frequently a single individual - independent directors provide constraints In the United Kingdom, the Commonwealth and 'OECD-code' countries: - codes require roles of chairman and CEO to be separated - avoids domination and risk-taking by a powerful individual Which is preferable: - a leader providing single-minded leadership - shared responsibility with reduced risk The duality question remains unanswered

12. CG frontiers – some unresolved issues How should directors’ remuneration be determined? • Top management of large listed corporations wield enormous power. • Some claim directors pursue their own agendas and extract huge rewards. • Major investors and investigative media have challenged director rewards. • Concern that some rewards are excessive • particularly when not related to performance. • Some even apparently rewarded for failure.

13. CG frontiers – some unresolved issues Should a retiring CEO ever become chairman of the board? FOR allowing a retiring CEO to become chairman: - Accumulated experience - CEO known by fellow directors and senior managers - CEO known and trusted by investors, customers, employees etc. - Personal qualities - integrity, leadership, other skills - known - Risks with a new chairman reduced AGAINST allowing a retiring CEO to become chairman: - Chairing the board different from being CEO - Success as CEO does not guarantee success as chairman - Past experience quickly decays in rapidly changing world - Problems establishing good relations with the new CEO The answer remains ambiguous

14. CG frontiers – some unresolved issues Should shareholders be able to nominate directors? In 19th century, shareholders nominated directors. Now in listed companies shareholders' interests vary. • Directors choose new directors • Shareholders' approve but do not nominate • Recent proposals in US and UK for shareholders to propose candidates • Suggestion not welcomed in many board rooms • Determining who joins the board is a power base

15. CG frontiers – some unresolved issues Should institutional investors exert power over listed companies? Calls for institutions to vote shares and “exercise power” • Some fund managers prefer to 'vote with their feet’ by selling shares • Institutions first responsibility is to their investors • Voting must be in the interests of beneficial owners • Some regulators now require institutions to say if and how they voted • Institutions’ involvement in governance could increase their risk • They might be accused of receiving insider information • Could they be held accountable if a company fails

16. CG frontiers – some unresolved issues Can external auditors really be independent? Independent external auditor's role in corporate governance is fundamental But can the auditor be seen to be truly independent of the company when: • the company appoints the auditor • the company pays the auditor • the company is a client of the auditor • the auditor may be economically dependent on the client

17. CG frontiers – some unresolved issues Can external auditors really be independent? (cont’d) Auditors serve two masters - the shareholders and the directors Potential conflict of interest satisfying the interests of: - shareholders (an external check on the directors) - the directors (working closely with them) Audit of large companies world-wide dominated by just four firms, which raises a number of concerns

18. The future of corporate governance • Drivers of change • US influences • - SOX, SEC, NYSE, other organizations • - institutional investors, CalPers etc. • international drivers • - OECD, World Bank, IMF, other nations • - global economic crises • recognition of cultural aspects • - differentiation accepted • influence of China, India and Russia

19. The future of corporate governance • Drivers of change (continued) • recognition of complexity of ownership chains • development of new organisational forms • right of owners to nominate directors • disincentive to go public • governance of private equity, sovereign and hedge funds • societal expectations and government actions • drive for gender diversity on boards • demand for genuine independence of external auditors • new theories of corporate governance • need for a new paradigm of corporate governance • corporate collapse and CG responses • - fraud, company domination, economic problems

20. The future of corporate governance Theoretical developments Boundaries of agency theory recognised New research possibilities - inter-personal relations and board behaviour - board as team, board style and culture - director interpersonal networks - CG as an information process - psychology of boards - politics of boards - power as measurable force - board leadership - traits and competencies New models, frameworks, concepts - new insights, new thinking, better understanding

21. The future of corporate governance New organisational forms Complex groups seen as dynamic networks - not static structures, organic not mechanical Organisations defined by information networks - not legal boundaries New typology of corporate entities defined New forms of societal organisations developed - linking equity companies, non-government organisations and community groupings

22. The future of corporate governance New governance practices and processes (1) Board leadership recognised as fundamental Quantifiable corporate governance norms (beyond codes of best practice) Reporting on compliance with norms - to regulating authorities (sanctions) - to all stakeholders likely to be affected Information and control systems - directors better access to knowledge - stakeholders better access to information - greater transparency - data, information, knowledge

23. The future of corporate governance New governance practices and processes (2) Director performance - better measurement linked with remuneration Better protection for investors 21st century board - more flexible less formal and rigid - more transparent less secretive - more transient, more participative, less bounded New ways to govern (Shann Turnbull - Australia) CG applied to SMEs, partnerships, joint ventures, cultural, sports, health, housing entities

24. The future of corporate governance • Society’s changing expectations of entities • Society expects more of corporate entities • Balance performance with conformance • - need for entrepreneurial risk-taking • whilst protecting stakeholders • Measure corporate governance • - CSR KPIs as well as long-term $ profit • Sustainability • - UN sustainability initiatives too diffuse • - taken up at country level

25. The future of corporate governance • Society’s new expectations of directors • Higher levels of professionalism • Continuous learning and personal development • New focus on trust • - honesty, integrity, openness • - balance CSR with wealth creation • Corporate leadership • - in governing body and committees • Corporate leadership • - in society

26. The future of corporate governance The implications • New governance demands on organisations • New ways of working for boards • New challenges for directors and boards

27. The future of corporate governance New governance demands Acceptable wealth generation • meeting market and societal needs • socially responsible • socially accountable • strategic risk management Business as societal partnership between individuals, enterprises, and the state

28. The future of corporate governance New ways of working for boards New board styles - more transient, flexible, and adaptable New board level information systems - new ways to access knowledge - internal and external information New communication systems - between directors - between board and management - between organisation, investors, and other stakeholders

29. The future of corporate governance New challenges for directors Continuous learning The learning board Board review - strategy for director development Chairman’s leadership role Continuous self-development www opportunities – access information, new learning opportunities, new tools Professional developments Learning from experience Every director’s personal responsibility

30. The future of corporate governance If the 19th century was the century of the entrepreneur

31. The future of corporate governance If the 19th century was the century of the entrepreneur and the 20th century was the century of management

32. The future of corporate governance If the 19th century was the century of the entrepreneur and the 20th century was the century of management then the 21st century is the century of corporate governance