P1 GOVERNANCE, RISK & ETHICS

CHAPTER 1: APPROACHES TO CORP GOV DECEMBER 2011

CHAPTER 1: BASICS OF CORP GOV

CORP GOV BASIC PRINCIPLES

CORPORATE GOVERNANCE - Set of rships b/t a Cos Directors, $H and Stakeholders - Structure through which objs of cos set + means to obtain objs + monitor performance - Fundamental internal ctrl sys to guide behavior + promote best practice

Internal Benefits
Provides point of ref for behavior encourages best practice consistency efficiency + protects investments Top down approach (lead by eg) encourages appropriate culture towards risk mgt + governance reporting Provides insight into how the cos run extra assurance keep investors Transparency interactive w/ $H, mkts etc. Credibility uphold gd rep attract investments + customers 9 CORE PRINCIPLES

External Benefits

QUALITIES TO ENSURE BEST DECISIONS Integrity high moral code, straight dealing Fairness consensus before making decisions respect rights & views of any grp with legit interest Judgement (& discretion) to enhance orgs Prosperity Independence (NEDs) independent spirit ltd/restricted controlled links to the org i.e. everyone doesnt just agree with Chairman

QUALITIES TO ENSURE HONEST DISCLOSURE & TRANS Openness to provide info + comm/respond to qs Probity/Honesty Truthful + not misleading

Responsibility re: task completion [can be delegated] systematic correction of errors, failures, mismgt Accountability answerable [cannot be delegated]

Reputation

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CHAPTER 1: BASICS OF CORP GOV

AGENCY THEORY/PROBLEM
Information Asymmetry Agent has more info than the principal Differences in self interest
Self Interest S/T : dividends L/t : inv growth Other: ethical practices Self Interest S/T : max bonus L/t : nt gd 4 $H

PRINCIPAL ($HOLDERS)

Appoints (trusts)

AGENT (DIRs/MGRs/EEs)

Info Annual a/cs Press/PR Analyst reviews AGMs

Info All of Principals plus all ops

Agency solution (vs Agency Costs i.e. cost benefit analysis)

$Hs have right to remove the Dirs from Office Ultimately, they can vote in favour of a takeover or removal of indiv. Dirs/Board Expensive/time consuming/diff to exercise ctrls

Transaction Cost Theory (linked to Agency Theory bt lower down hierarchy)

Decision to make vs buy Keep as many trans in-house: Reduce uncertainty Avoid high purch. s Manage qlty EEs behave rationally to a point but then protect self interests Explains y Agency prob is more severe the larger the org becomes

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CHAPTER 1: BASICS OF CORP GOV

STAKE HOLDERS IN CORP GOV.

Stakeholder = ppl/grp/org that can affect/be affected by the actions/policies of an org

Stakeholder groups
INTERNAL CONNECTED EXTERNAL EEs, Mgt, Board $Hs, Customers, Suppliers, Lenders, Trade Unions, Competitors Govt, local govt, public, pressure grps, media

Stakeholder Groups - Mendelows Matrix

Low Low Minimal Effort Power Keep Informed Level of Interest High

Keep Satisfied Corp investor e.g. through financial rtns High

Key Players Vital suppliers + customers

Groups may move around matrix e.g. Institutional investor from Keep Satisfied to Key Player if expected rtns arent rcvd

Stakeholder Groups Alternative

ACTIVE PASSIVE Seek to participate in orgs activs e.g. some $Hs, regulators, pressure grps etc Opp. of above e.g. most $Hs, local communities and govt

PROBLEMS WITH STAKEHOLDER THEORY

Principle of company law incl. fiduciary and legal oblig. to max $H wealth if mgrs fulfill this it cant jeopardise ability Rec stakeholder and agency theory divergent interests doesnt absolve mgt from trying to rec interests Two motivations for considering stakeholders: o Instrumental consider stakeholders because of eco ben to the co o Normative based on idea that co has moral oblig 2wards stakeholders

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CHAPTER 1: BASICS OF CORP GOV

MAJOR ISSUES
Fiduciary duties of Dirs Dirs remuneration and reward Board composition and balance Reliability of FR Risk mgt and int ctrl Rights and responsibilities of $H Business ethics Corp Social Responsibility (CSR) Compulsory voluntary best practice

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CHAPTER 2: APPROACHES TO CORP GOV

PRINCIPLES OR RULES
PRINCIPLES RULES Comply or explain disclosure investors make Mandatory compliance non-compliance is vs informed decision on how to proceed penalized by a regulator UK Combined code 2010 vs US Sabanes Oxley (SOx) 2002 Flexibility Unambiguous Adaptability (across jurisdiction) Easier to monitor Avoids loopholes vs Std, consistent comparability Companies feel compelled to comply to avoid having to explain Principles (in Hampel Report) too broad No leeway if situation is illogical Too vague Enforcement can be difficult Too much choice $H bill of Rights introd in 09 maybe 1st step to vs FT Apr 07 article on Combined Code concerns re supersede SOx box-ticking culture (investors lack time to analyse) box-ticking culture rather than gain real Unfair burden on small businesses understanding of the impact/importance of gov Both do not address systematic risk enough Lehman Bros & Northern Rock Failures US claims creating norms easier in UK due to smaller scale

INFLUENCED BY OWNERSHIP
INSIDER Rship based (family owned) Small # of major $H Reduced Agency problem Easier to influence mgt, policy strategy due to rship May be more willing to take l/t view of investment vs vs OUTSIDER British & American Systems Widely dispersed $ ownership Separation of o/ship & mgt = Agency problem = impetus for robus legal/gov to protect $H $H have voting rights to exercise ctrl Threat of hostile takeovers = disciplining mechanism Increased Agency problem Agency costs Larger $H s/t priorities (sell shares)

vs

Discrimination against minority $H Less likely to dev. Formal gov structures Reluctant to employ external 4 influential posns (NEDs) More prone to misuse of funds

vs

CHAPTER 2: APPROACHES TO CORP GOV

CORP GOV DEV. IN UK

Evolutionary process Developed in light of eco, political & other developments No dramatic changes over time Cadbury Report 1992 Voluntary code of best practice NEDs Audit Committee Greenbury Report 1995 Focussed on Director remuneration Hampel Report 1998 9 Major principles Combined Code 1998 Code of best practice Turnbull Report 1998 Risk Mgt & Internal Ctrl Smith Report 2003 Focussed on Audit Committees Higgs Report 2003 Role of NEDs Combined Code 2006 and 2008 2006 updated 2008 revision removing 2 minor restrictions 2010 UK Corp Gov Code

CORP GOV IN OTHER JURISDICTIONS

S.African King Report o Emphasises fairness to all (after apartheid) o Focuses on disclosure Singapore Code o Similar to UK Corp Gov Code (comply or explain) OECD (Org for Eco Dev) o Guidance to countries/govts o Wide consultation w/ 30 members o Incl focus on transparency & Board responsibilities ICGN (Intl Corp Gov Network) o Guidance to companies o Promotes comm. b/t investors & companies to stimulate eco growth

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CHAPTER 2: APPROACHES TO CORP GOV

SARBANES OXLEY ACT 2002 (SOX)

Still operates based on 9 major principles Public Co Accounting Oversight Board = power to investigate cos (FSA in UK doesnt) Auditors o Prohibited from non-audit work for client Enron - (UK can only discourage it) o Partners must rotate every 5 years o Committee responsible for appointment, compensation and oversight of Auditors o Must incl. 1 financial expert Lawyers o Must whistle blow on any wrongdoings found (client) CEO & CFO must certify appropriateness of FSs (failure = prosecution) Not strong on some issues + too rigid on others Dirs less likely to consult lawyers A/c firms have lost almost all non-audit revenue streams Affects all cos on US stock market discourages cos from being listed

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