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Models of Corporate Governance


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Models of Corporate Governance
Efforts made for Effective Corporate Governance
Cadbury Committee
Sarbanes Oxley Act, 2002
Global Corporate Governance
External Auditor
Trends in Governance in Major MNC’s
Other European Model

Published in: Education

Models of Corporate Governance

  2. 2. CORPORATE GOVERNANCE SYSTEMS The need of governance system is based on the assumption that the separation between the owners of a company and its management provides self interested executives the opportunity to take actions that benefits themselves with the cost of their actions borne by the owners. (Agency Cost) In order for governance systems to be economically effective, companies should try to decrease agency cost above and beyond the direct cost compliance and indirect cost on managerial decision making.
  3. 3. Management Shareholder s Board of Directors
  4. 4. Efforts made for Effective Corporate Governance Cadbury Committee Help to raise the standards of corporate governance and the level of financial reporting and auditing. ‘Code Of Best Practices’ were issued to provide a benchmark set of recommendation on governance. Sarbanes Oxley Act, 2002 Under this, CEOs and CFOs found to have made material misrepresentation in the financial statement were made subject to criminal penalties. Third Party Organizations The Corporate library Institutional Shareholder Services and Governance Metrics International`
  5. 5. Institutional Shareholder Services and Governance Metrics International  GMI Ratings is the leading independent provider of global corporate governance and ESG ratings for companies worldwide.  Ratings are built on extensive research and modeling that incorporates a broad spectrum of Environmental, Social and Governance (ESG) metrics as well as incorporating accounting transparency issues, to support the goal of identifying companies at risk. Exhibit 2: page 177
  6. 6. Global Corporate Governance United States and Britain Share Holder Centric Model of Corporate Governance Germans and other European Nations Stake Holder Centric Model of Corporate Governance Japanese Model Focuses on Business Relationship Korean Model Roots from Korean War Chinese Model Reflects the Transition from Communism to Capitalistic system Indian Model Influenced by a History of Powerful Family Ownership
  7. 7. United States The Boards of directors served as the most important controlling mechanism. The CEO of most US corporations were professionals. The Board had primary four responsibilities: 1. The selection of CEO 2. The selection of candidates for BODs. 3. Evaluation and review of company’s strategy, operational execution, capital structure and published financial statements. 4. Ensuring that the company was in compliance with all applicable laws and regulations.
  8. 8. The BODs typically included executive(CEO or any other senior official) and non executive directors. NYSE listing rules required that non- executive directors meet outside the presence of executive directors. NYSE rules required that company have a majority of independent board members. Family member and significant share holder can also served on board.
  9. 9. External Auditor The external auditor reviewed the internal controls of the company to assess whether it employed sound practices in keeping its accounts and also tested selected accounts to determine whether they complied with GAAP. If auditor found no reason of materially misleading, the firm expressed an unqualified opinion. External auditors were also required to perform an assessment of the company’s internal controls. And if material misleading discovered, the CEO and CFO could be subject to criminal liability, punishable by fines and prison. Management, too, was required to perform the same assessment. So they employed internal auditors who were
  10. 10. Governance Regulations and Procedures Securities and Exchange Commission through Securities and Exchange Act 1934 to protect interest of investors investing in primary and secondary markets, and to keep a check on executives who violated securities law. Companies were given rights to amend their own law (bylaws) for better functioning. Companies listed on stock exchanges should have minimum 3 independent directors who are financially literate and of whom one should be a ‘financial expert’. Companies cannot directly appoint directors but through voting right of shareholders.
  11. 11. Liability • Company law protects shareholders liability to the extent of their investment. • Companies directors can personally be sued for their misconduct like insider trading, misallocation of funds etc. • Directors often purchase Director’s and Officer’s liability insurance (D&O). • Example: Rajat Gupta of Goldman Sachs was accused for insider trading and was later on sent for imprisonment and was fined.
  12. 12. United Kingdom 1) The British model shared the most similarities with the us laws. 2) The companies act 1985 which consolidated seven companies act passed by parliament between 1985 and 1983, which has very few governance requirements on companies. 3) Among those companies they have to required to have a board with minimum two director for publicly traded companies have responsibility for certain administrative function, including the production of annual financial report, 4) The tradition of common law of both U.K & U.S led to great deal of flexibility in the development of corporate governance
  13. 13. Along with the Higgs report were combined with those of the Cadbury committee in 2003 and that became the combined code. This committee include at least half of the board of directors should be non-executive should appoint a lead independent directors who serves as a liaison with shareholders, the nomination committee should be headed by non executive directors, and executive director Together, the Cadbury and Higgs report had the effect of shaping the board of directors into a monitoring and control body as much as a strategy setting body. Two-thirds of the U.K’S 350 largest companies did not
  14. 14. This committee recommended a set of self regulated standards of governance known as the code of bet practices. The critics of the Cadbury committee report claimed that the voluntary adoption of governances practices did not go for enough to raise oversight standards. Another critic of the Cadbury report believed the enforcement mechanism of relying on shareholders to protest lack of compliance was weak and did not go far enough.
  15. 15. Germany German Law mandated that corporations under a two tired board structure which separated the oversight and the management functions The management board(Vorstand) was responsible for day to day decision making on such matters as product development, manufacturing, supply chain etc. Supervisory board(Aufischtrat) responsible for appointing members to the management board, approval of financial statement, mergers, payment of dividend etc. The supervisory board was requited by law to the one-third of its members as labor representative if the company had at
  16. 16. Other European Model European nation employed a stakeholder model, with a large emphasis on labor, environmental and other societal factors. The Dutch two-board system operated similarly to the Anglo-Saxon model. The British and the Dutch had a fierce competitive rivalry that reached back to the 1600s, the two countries shared a particular similarity in their method of conducting business. A unique breed of organization called the British-Dutch company evolved in which a corporation operated under a joint charter that divided its governance between the
  17. 17. Japan The Japanese model of corporate governance had its root in post world war II reconstruction at the end of the war, the powerful industrial and financial conglomerates that in large part accounted for the country's economic strength. In 2007, Toyota Motor Corp had a 30-member board of directors, all of these board members had extensive experience working at the company. Toyota developed a system of adjunct committees that provided additional advisory or monitoring services for the board. The influence of major banks in the governance system was waning, with individual shareholders taking their place
  18. 18. South Korea Corporate Model named “ CHAEBOL” - A large conglomerate. Working under group head quaters or founding family. In 2007, largest Chaebol was “Samsung Group” which is diversified into more than 30 businesses from electronics to ship building, textiles, insaurance etc. Other Major Companies: Hyundai, LG Group, S.K Group Post Korean War: 1) Chaebol = Help in Economic Development. 2) Government = Encouraging expansion, diversification, Rapid succession, incentive for efficiency in business.
  19. 19. Asian Financial Crises – 1997 Step to bring Economic stability and investors confidence: 1) Chaebol subsidiaries working independently. 2) Companies to become self sufficient. 3) Reduction in barriers to foreign ownership. 4) Elimination of Transfer of funds. Not all companies followed Chaebol. Example : - Posco: 1) Privatized and sold to public in 2000. 2) Increase in outside directors from 9 to 15 3) 2006: Different CEO and Chairman
  20. 20. China Communist Economy  Capitalist Economy. Company Law of the People’s Republic of China: 1) Board Of Directors: 5 to 19 members. 2) Board of Supervisors: more than 3 members of which 1/3rd or more be employee representatives. 3) No BOD member as BOS. 4) Audit and Compensation committee only if they are listed on stock exchanges like NYSE Etc.
  21. 21. 14% Shares ( NYS, SSE, HKSE ) 86% Shares (China National Petroleum Corporation) PetroChina • 12 Member of which 7 current rest affiliated with CNPC of which 3 were independent, Non-Executive directors. Board of Directors • 7 members of which two are directors of CNPC, two independent directors and one employee representative. Board of Supervisors
  22. 22. India India with its 20 million shareholders, is one of the largest emerging markets in terms of the market capitalization. Corporate Governance SEBI K. Birla Clause 49 (1999) N.R Narayan Murthy (2004) CII Corporate Governance Code 1998
  23. 23. Clause49 Independent Directors Non-Executive Directors Board of Directors Audit Committee Whistler Blower Policy Subsidiary Companies Disclosures Certifications
  24. 24. Trends in Governance in Major MNC’s Hewlett Packard 2006 Global Citizenship Report. Lawsuits and Financial Liability decreasing effectiveness of the board. Professional Management at Publically Traded Companies. Eg Porsche AG “The bar has been significantly raised by governance reforms and the idea that there’s a stewardship for public capital”