Corporate Governance

1. LESSON TWO
KEY CORPORATE DIMENSIONS DIMENSIONS AND ELEMENTS

2. INTRODUCTION
•This lecture seeks to identify the main dimensions
and the elements of corporate governance. Three
main dimensions of corporate governance are in
focus: management oversight, financial quality and
equity control. It is expected that at the end of the
discussion, the student should be able to:

3. Introduction CONT’D
•Explain the main dimensions of
corporate governance
•Identify the main elements involved in
each of the corporate governance
dimensions

4. CORPORATE GOVERNANCE DIMENSIONS
•Three main corporate governance dimensions:
•Management oversight
•Financial Quality
•Equity control

5. MANAGEMENT OVERSIGHT
•This refers to the monitoring role of the board so as to
control the agency conflict between shareholders and
management. The main elements under this dimension
of corporate governance are board independence;
duality of the role of Board Chair and Chief Executive
Officer (CEO); board size; board meetings; nomination
committee; and remuneration committee.

6. Board Independence
•The efficacy of the board of directors is directly linked
to its independence from the company’s executive
management
•The presence of independent directors on the board
has been found to:
•Mitigate agency costs
•Fraud
•Promote disclosure

7. Duality of the Role of Board Chair and
Chief Executive Officer (CEO)
•CEO duality is a governance practice in which the
chairperson of the board of directors is also the
Chief Executive Officer of the firm
•Research has shown that it undermines:
•Disclosures
•Firm performance
•The monitoring role of the board

8. Board Size
•This refers to the number of persons that make up
the board. In other words, the number of directors
that serve on the board of the firm.
•The effect of board size on firm performance
remains a debatable issue

9. Board Meetings
•The knotty question that remains to be
answered is:
•Are frequent meetings of the board a
prerequisite for its effectiveness?
•Is it in the interest of shareholders for the
board to meet frequently?

10. Nomination Committee
•A nomination committee with a written mandate and
terms of reference consistent with good practice may
guarantee the selection of directors and CEO of the
highest caliber. In line with good practice, the committee
must consist of independent directors.
•Should the CEO be a member of the nomination
committee?

11. Remuneration Committee
Firms should have remuneration
committees primarily comprising
outside directors.
Should the CEO be a member of the
remuneration committee?

12. FINANCIAL QUALITY
•This relates to how shareholders’ funds are
protected. Under this subsection we discuss audit
committee independence; financial expertise of audit
committee members; audit committee meetings; size
of audit committee; audit committee charter; and
identity of external auditor.

13. Audit Committee Independence
•This committee is responsible for the financial
matters of the firm
•For effectiveness, it should be made up of non-
executive directors/independent directors
•Audit committee independence reduces fraud

14. Financial Expertise of Audit Committee Members
Knowledge in accounting and finance is key to the audit
committee’s work
Experience in auditing helps in effective control evaluation
decisions that are consistent with the requirements of the
external auditors
External auditors consider the information provided by
Audit committee with financial expertise more reliable

15. Audit Committee Meetings
• Do frequent meetings of the audit
committee have any significance?
•Frequent meetings:
•Prevent earnings management
•Promote financial disclosures

16. Size of the Audit Committee
The number of audit committee members could influence
the committee’s efficiency and productivity
A minimum of three directors is recommended
Bigger size has been found to correlate with effective
control over the reporting process
 However, bigger size can lead to social loafing

17. Audit Committee Charter
•This is the policy document that spells out the mandate
of the audit committee. It spells out the role, structure,
and composition of the audit committee
•It provides a clear vision of the necessary responsibilities
and duties of the audit committee
•It improves the flow of information between the audit
committee, the internal auditor, external auditor, and
management

18. Identity of External Auditor
•Who the external auditors of the firm are is one of the
important elements of the financial control dimension of
the firm.
•Evidence exists that companies with a Big Six auditor have
a higher level of disclosure. Pittman and Fortin (2004)
show that companies audited by a Big Six auditor have a
lower cost of debt.

19. EQUITY CONTROL
This refers to how the shares or stock of the
company are distributed to ensure the mitigation
of the agency costs. Under this subsection we are
looking at two elements: block holders and insider
ownership of shares.

20. Block holders
•Block holders are owners of a large amount of a company's shares
and/or bonds, or block. In terms of shares, these owners are
often able to influence the company with the voting rights
attached to their shares.
•Presence of block holders can:
•Restrict expropriation of minority shareholders
•Promote effective monitoring of management
•Increase firm value
•However, it can undermine minority interests

21. Insider Ownership
•Stock ownership by managers and directors can
align the interests of both agents and principals.
Jensen (1993) finds that insider ownership increases
company performance.
•Some studies have found the relationship between
firm performance and insider ownership to be non-
linear

22. Insider Ownership Cont’d
•Kole (1995) suggests that managerial
ownership could affect company value
differently, depending on company size.