Corporate Governance

Lecture 6
26.03.3018
 Director of United Nations Development
Programme (UNDP) for Pakistan Marc-André
Franche,

“You cannot have an elite that takes advantage of very cheap

and uneducated labour when it comes to making money, and
when it is time to party it is found in London, and when it’s
time to buy things it is in Dubai, and when it’s time to buy
property it invests in Dubai or Europe or New York. The elite
needs to decide do they want a country or not,” the only way
a critical change could happen in the country was when the
influential, the politicians and the wealthy, would sacrifice
short term, individual and family interests for the benefit of
the nation.
 Concept of religion and
corporations

Religion Corporations
Faith Business Ethics
Hope Corporate Governance
Charity Social Responsibility
What is Corporate Governance
 The word Corporate Governance is basically concerned through which
a company is managed and controlled. It deals with the setting of
rights and duties among different peoples being involved with the
company affairs. It also involves with the setting of company objectives
keeping in view the interest of stakeholders of the company (La Porta
et al, 2000).
 Corporate governance is the system by which business corporations
are directed and controlled. The corporate governance structure
specifies the distribution of rights and responsibilities among different
participants in the corporation, such as, the boards, managers,
shareholders and other stakeholders, and spells out the rules and
procedures or making decisions on corporate affairs.
 By doing this, it also provides the structure through which the
company objectives are set, and the means of attaining those objectives
and monitoring performance.
Corporate Governance
Corporate Governance System
Dimensions of Corporate Governance
 Evolution of Corporate Governance
 The concept of corporate governance is not too old. It has been
massively use in late 1980s. In early 1990s the various corporate
failure scandals in big companies in USA like IBM, Kodak, and
Honeywell etc. In early 2000s the big bankruptcies scandals in USA
based companies were Enron (Enron shareholders filed a $40 billion
lawsuit after the company's stock price, which achieved a high of
US$90.75 per share in mid-2000, plummeted to less than $1 by the
end of November 2001) and WorldCom which leaded towards the
founding of corporate governance code in USA and UK.
 In the beginning of the new millennium several companies in the USA
and elsewhere faced collapse because of because of corporate
misgovernance and unethical practices they indulged in. the then
existing regulatory framework seemed to be inadequate to deal with
the gigantic business conglomerates that committed deliberate frauds
Corporate Governance-Global Overview

• World com: $5.8 billion lost by shareholders and total lost was $ 48
billion (inflating profits etc).
• The founder Bernie Ebbers borrowed $408 million from the phone

America’s company to cover personal debts.

• Energy firm Enron created outside partnerships that helped hide its poor
financial condition. Executives earned millions of dollars selling company

hall of stocks.
• The accounting firm Anderson was accused of shredding enron
documents and was convicted for obstruction of justice.

shame---- • Energy company, Dynergy was under investigation for accounting and
trading malpractices In part related to California power crisis.
• Securities and exchange commission sued executives of garbage company

2002
waste management for massive accounting fraud from 1992-1997 that
resulted in a $17 billion restatement of earnings.
• Adelphia Communications made illegal loans to founder Rigas family
members and was under investigation for accounting malpractices.
• Southhern California software company Peregrine systems said it might
have overstated revenue by $100 million over three years.
 Academic point of view of
corporate governance
• From academic stand point corporate governance is seen as
one that addresses the problems that result from the separation
of ownership and control. Viewed form this perspective
corporate governance focuses on some structures and
mechanisms that would ensure the proper internal structure and
rules of the board of directors, creation of independent
committees, rules for disclosure of information to shareholders
and creditors, transparency of operations and an impeccable
process of decision making and control of management.

• A recent academic survey of corporate governance defined it as

fallows: Corporate governance deals with the ways in which
suppliers of finance to corporations assure themselves of getting
a return on their investment
Why Corporate Governance Matters
 Align the interests of individuals, corporations and society.
 Ensures fairness, transparency, accountability, sustainable
financial performance, increased shareholder confidence, access
to external finance and foreign investment, fair treatment of the
stakeholders in a company, maximization of shareholders’ value
and the enhanced reputation of a company, nation and economy.
 Efficient corporate governance practices lead to higher return
on capital employed, attraction of long-term capital, mitigation
of systematic risk, higher return for shareholders, improvement
in the confidence of domestic and foreign investors, reduction in
the cost of capital, stable flow of finance, availability of
international capital, and greater productivity. An effective and
efficient corporate governance framework depends on the legal,
regulatory, business and institutional environment.
Why Corporate Governance is Required?

 Corporate Governance (C.G)is becoming increasingly important

to investors, because well-governed companies have lower risk
and fewer unexpected events. Well-governed companies are
better at protecting shareholders’ rights and providing better
assurance that management will act in the best interest of the
company and of all its shareholders.
 From national perspective, C.G facilitates the development of
stronger capital markets (Rs 9 Trillion-dealing in shares,
bonds, and other long-term investments), reduces risk, and
improves a country’s ability to mobilize, allocate and
monitor investments, which ultimately fosters economic
growth.
 Importance of Corporate Governance
 Corporate governance basically provides the guidelines to the
board of directors of the company to make rules and regulations
and policies of the companies and then make sure that policies of
the companies have been carried out effectively
 In companies where effective corporate governance practices have
been adopted, which present high level of transparency in these
companies.
 It also enhanced the confidence of share holders of the companies.
Companies with high level of corporate governance practices lead
to be progressed by leaps and bounds.
 It also enhanced confidence among the prospective investors who
are willing to invest in the companies.
 Importance of Corporate Governance
 Corporate Governance increases the efficiency of the business by
setting a business culture that stimulates directors, managers and
entrepreneurs in order to maximize an operational efficiency of a
company that can ensure high profits on investment and long term
growth of the company.
 It is a system which makes sure the true accountability of the
directors, managers, and people involves in the management of the
company by keeping an eye on every activity being performed by
the managers to be liable for every activity. Corporate Governance
makes sure that the managers must perform their duties with extra
care and attention in the best benefit of the company as well as
stakeholders involves with the company.
 Theories of Corporate Governance
Agency Theory
 Agency Theory argues that managers merely act as custodians of the
organization and its operational activities and places upon them the burden of
managing in the best interest of the owners of that business.
 To understand the relationships between agents and principals. The agent
represents the principal in a particular business transaction and is expected to
represent the best interests of the principal without regard for self-interest. The
different interests of principals and agents may become a source of conflict, as
some agents may not perfectly act in the principal's best interests.
 Stakeholder Theory
 This theory centers on the issues concerning the stakeholders in an
institution. It stipulates that a corporate entity invariably seeks to
provide balance between interests of its diverse stakeholders in order to
ensure each interest constituency receives some degree of satisfaction.
 According to Freemen any individual/group effected by the achievement
of the corporation's purpose, two aspect; i) what is purpose of the Firm
and ii) what responsibility bears management for stakeholders.
 Recourse Dependency Theory
 The basic proposition of resource dependence theory is the need
for environmental linkages between the firm and outside
resources. In this perspective, directors serve to connect the
firm with external factors by co-opting the resources needed to
survive Thus, boards of directors are an important mechanism
for absorbing critical elements of environmental uncertainty
into the firm. The organization’s need to require resources and
these leads to the development of exchange relationships or
network governance between organizations.
 Stewardship Theory
 In contrast to agency theory, stewardship theory presents a different
model of management, where managers are considered good stewards
who will act in the best interest of the owners.The fundamentals of
stewardship theory are based on social psychology, which focuses on
the behaviour of executives.
 The steward’s behavior is pro-organizational and collectivists, and has
higher utility than individualistic self-serving behavior and the
steward’s behavior will not depart from the interest of the
organization because the steward seeks to attain the objectives of the
organization According to Smallman (2004) where shareholder wealth
is maximized, the steward’s utilities are maximized too, because
organisational success will serve most requirements and the stewards
will have a clear mission
 Social contract Theory
Theory Among other theories reviewed in corporate governance
literature social contract theory, sees society as a series of social
contracts between members of society and society itself .There is a
school of thought which sees social responsibility as a contractual
obligation the firm owes to society An integrated social contract
theory was developed by Donaldson and Dunfee (1999) as a way for
managers make ethical decision making, which refers to macro
social and micro social contracts. The former refers to the
communities and the expectation from the business to provide
support to the local community(macro), and the latter refers to a
specific form of involvement(micro).
 Legitimacy Theory
 Another theory reviewed in the corporate governance literature is
legitimacy theory. Legitimacy theory is defined as “a generalized
perception or assumption that the actions of an entity are
desirable, proper, or appropriate with some socially constructed
systems of norms, values, beliefs and definitions” (Suchman 1995).
Similar to social contract theory, legitimacy theory is based upon
the notion that there is a social contract between the society and
an organization. A firm receives permission to operate from the
society and is ultimately accountable to the society for how it
operates and what it does, because society provides corporations
the authority to own and use natural resources and to hire
employees (Deegan 2004).
Political Theory
 Political theory brings the approach of developing voting support
from shareholders, rather by purchasing voting power. Hence
having a political influence in corporate governance may direct
corporate governance within the organization. Public interest is
much reserved as the government participates in corporate
decision making, taking into consideration cultural challenges
(Pound, 1983).
 The political model highlights the allocation of corporate power,
profits and privileges are determined via the governments’ favor.
The political model of corporate governance can have an immense
influence on governance developments. Over the last decades, the
government of a country has been seen to have a strong political
influence on firms. As a result, there is an entrance of politics into
the governance structure or firms’ mechanism (Hawley and
Williams, 1996).
Models of corporate Governance
 The Anglo American Model
 German Model
 The Japanese Model
 Indian Model of Governance
 Pakistan Model
The Anglo American Model

This model is also called unitary board model in which all

directors participate in a single board comprising both executive
and non-executive directors in varying proportions.

This approach is share holder oriented

It is also called Anglo-Sexon approach to corporate Governance

being the basis of corporate governance in America, Britain,
Canada, Australia and other common wealth countries.
Features of Anglo-American Model

The ownership of companies is more or less equally divided between individual shareholders and institutional
shareholders.

Directors are rarely independent of management.

Companies are typically run by professional managers who have negligible ownership stakes. There is a fairly
clear separation of ownership and management.

Most institutional investors are reluctant for certain activities. They view themselves as portfolio investors
interested in investing in a broadly diversified portfolio of liquid securities. If they are not satisfied with a
company’s performance, they simply sell the securities in the market and quit.

The disclosure norms are comprehensive, the rules against insider trading are tight, and the penalties for price
manipulations stiff, all of which provide adequate protection to the small investor and promote general market
liquidity. Incidentally, they also discourage large investors from taking an active role in corporate governance.
German Model
 It is also known as two-tier board model. Corporate
governance in the German model is exercised through two
boards, in which the upper board supervises the executive
board on behalf of stakeholders and is typically societal-
oriented.
 In this model, although shareholders own the company, they
do not entirely dictate the governance mechanism. They elect
50 percent of members of supervisory board and the other
half is appointed by labor unions ensuring that employees and
laborers also enjoy a share in the governance. The supervisory
board appoints and monitors the management board.
The Japanese Model

 This is the business network model, which reflects the cultural

relationships seen in the Japanese keiretsu network(grouping of
enterprises, order of succession is a set of companies with interlocking
business relationships and shareholdings. It is a type of informal business
group, The keiretsu maintained dominance over the Japanese
economy for the second half of the 20th century),
 THE boards tend to be large, predominantly executive and often
ritualistic/CEREMONIAL. The reality of power in the enterprise
lies in the relationships between top management in the
companies in the keiresu network. The approach bears some
comparison with Korean chaebolT(here are several dozen
large Korean family-controlled corporate groups which fall under
this definition).
Features of Japanese Model

The president who consults both

the supervisory board and the
executive management is included.

Importance of the lending bank is

highlighted.
 Indian model of Governance
The Indian companies are governed by the Company’s Act of 1956 which follows
more or less the UK model. The pattern of private companies is mostly that of
closely held or dominated by a founder, his family and associates. India has
adopted the key tenants of the Anglo-American external and internal control
mechanism after economic liberalization.
Islamic Model of Corporate Governance
Corporate Efficiency Pyramid Model
Strategic implications of corporate governance
 Simply put, bad corporate governance leads to bad strategy
formulation and implementation.
 If strategy is about matching the firm’s internal resources and
capabilities with opportunities from the external environment,
then corporate governance should ask the following sorts of
questions…
 Do we have the right strategy, given what we do well?
 Is our strategy matched to the external environment (economy, social
expectations, etc.)?
 Are we capable of executing the strategy?
 Do we have the right top management team?
 If the answer to one or more of these questions is “no,” what do we need to
change?
Bad strategy makes it harder for firms to fulfill their economic and
ethical responsibilities to stakeholders, including shareholders and
employees!
Ethical issues in corporate governance
There are several key strategic and ethical issues in
corporate governance, including
• how to align the interests of top managers and
shareholders,
• the proper level and function of executive compensation,
• who monitors the top management team and how that
monitoring occurs, and
• inclusion of shareholders and non-shareholder
stakeholders.
0
Other ethical models
 Ethical theories
Consequentialism: The end justifies the means – so if the outcome of actions is
moral or ethical then the steps taken to achieve it are moral or ethical, whatever
they may be. This derives some of its beginnings from utilitarianism propounded
by, among others, John Stuart Mill (1806–1873), which held that the moral worth
of an action was derived from the amount of good it did to society or for the
benefit of individuals – the greatest good of the greatest number.
Deontology: This theory was largely based on the writings of Immanuel Kant
(1724–1804) who held that there were moral absolutes and that, for an outcome
to be moral or ethical, all the actions leading up to it must be moral or ethical. We
should behave in a moral or ethical way based upon universal principles of
morality and ethics.
Contractualism: This theory is based on the notion that individuals can agree
what is moral and what is not in a form of social contract; so an immoral act is one
that is wrong by any set of social principles that no one would reasonably reject. In
this case there are no moral absolutes, but also the end does not necessarily justify
the means so, broadly, this sits somewhere in the middle.
Agents of Ethics
Islamic Ethical Principles in Corporate Governance
 Corporate Governance Mechanism
A. Boards of Directors
I. Size of Board
II. Board Composition
III. CEO Duality
IV. Audit Committee
B. Ownership Structure
I. Internal Ownership
II. External Ownership
III. Institutional Ownership
IV. Family Controlled Business
Contd…….

External Governance Mechanisms

A. The Takeover Market
I. Domestic
II. International
B. The Legal System
I. Civil Laws
II. Criminal Laws
III. Corporate Laws
Principles of corporate governance
 Corporate Governance in South Asia
 The practice of good corporate governance in South Asia is ongoing.
Pakistan, India and Sri lank realized the significance of corporate
governance for developing corporate sector in the country. Sri Lanka
has code of corporate governance, India issued in 1998 while Pakistan
issued its code of corporate governance in 2002
 The four countries were comparatively analyzed by Sobhan & Sendy
(2003) provided numerous lessons of experience with key factors of
corporate governance and found significant results from four countries
report on corporate governance. They stated that corporate
governance cannot be implemented in isolation from other reforms
i.e. macro-micro economics, accounting, law, banking and institutional
and nor these reforms become more efficient without corporate
governance. Therefore, it is a dire need to understand the different
sectors of the markets.
 Corporate Governance in Pakistan
 Securities and Exchange Commission of Pakistan (SECP) developed the
code of Corporate Governance in the year 2002. This code was
developed with the mutual work of SECP and Institution of Chartered
Accountants of Pakistan (ICAP). All companies which are listed on
stock exchanges of Pakistan and compulsory to comply with the
provision of the code of Corporate Governance. The Companies
Ordinance 1984 also gives a governance mechanism which is the
required to follow by the companies.
 Companies Ordinance, 2016 repealed 1984.
 Pakistan and Switzerland Tuesday signed the revised Agreement on
Avoidance of Double Taxation with respect to taxes on income.
 Pakistan signed the Multilateral Convention on Mutual Administrative
Assistance in Tax Matters with the Organization of Economic
Cooperation and Development (OECD)
 Contd……..
 Corporate governance comprises the public and private institutions
including formal and informal which govern the relationship between
those who manage and those who invest resources in corporation. These
institutions particularly follow corporate laws, securities regulations,
stock market listing requirements, accepted business practices and
prevailing corporate ethics (Omran, 2004).
 Therefore, modifications in Pakistan corporate governance are likely to
have significant consequences for conducting and establishing structure
of country business. The issue of corporate governance in banking sector
is considered as very important for developing economies. The State
Bank of Pakistan (SBP) redesigned the regulatory framework for
governing commercial banking industry and stated guidelines for
efficient corporate governance.
CSR refers to operating a business in a manner that accounts for the social and environmental impact
created by the business. CSR means a commitment to developing policies that integrate responsible
practices into daily business operations, and to reporting on progress made toward implementing
these practices
Elements of CSR