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Corporate Governance

A comprehensive presentation on Corporate Governance.

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Corporate Governance

  1. 1. Presented by: Maroof Hussain Sabri Rehan Zia Butt Badeea Tabassum
  2. 2. <ul><li>Various Definitions of Corporate Governance </li></ul><ul><li>Brief History of Corporate Governance </li></ul><ul><li>Brief Objectives of Corporate Governance </li></ul><ul><li>Objectives of Corporate Governance </li></ul><ul><li>Who are the parties to CG? </li></ul><ul><li>Principal Agent Problem </li></ul><ul><li>Principles of CG </li></ul><ul><li>Mechanisms & Controls </li></ul>
  3. 3. <ul><li>Systematic Problems of CG </li></ul><ul><li>Corporate Governance in Pakistan </li></ul><ul><li>Corporate Governance & Firm Performance </li></ul><ul><ul><li>A case study on companies listed on KSE </li></ul></ul>
  4. 4.
  5. 5. <ul><li>Potentially covers a large number of distinct economic phenomenon </li></ul><ul><li>Concept of Corporate Governance is poorly defined </li></ul><ul><li>Different definitions by different people that basically reflect special interest in the field </li></ul><ul><li>Best way to define is to list a few of the different definitions </li></ul>
  6. 6. <ul><li>“ Corporate Governance is about promoting corporate fairness, transparency and accountability” </li></ul><ul><li>J. Wolfensohn, president of the Word Bank, as quoted by an article in Financial Times, June 21, 1999 </li></ul>
  7. 7. <ul><li>“ Corporate Governance – which can be defined narrowly as the relationship of a company to its shareholders or, more broadly, as its relationship to society - …” </li></ul><ul><li>From an article in Financial Times (1997) </li></ul>
  8. 8. <ul><li>“ Corporate Governance is the system by which business corporations are directed & controlled. The CG structure specifies the distribution of rights & responsibilities among different participants in the corporation , such as, the board, managers, shareholders & other stakeholders, and spells out the rules & procedures for 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” </li></ul><ul><li>Organization for Economic Co-operation & Development, April 1999 </li></ul>
  9. 9.
  10. 10. <ul><li>A new name for an old problem </li></ul><ul><li>“ [B]eing managers of other peoples’ money but their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which ---[they] frequently watch over their own. Negligence & profusion, therefore, must always prevail more or less in the management of the affairs of a company.” </li></ul><ul><li>-Adam Smith, Wealth of Nations (1776) </li></ul>
  11. 11. <ul><li>1929, immediate aftermath of “Wall Street Clash” </li></ul><ul><li>1983, “The Separation of Ownership & Control” established “Agency Theory” </li></ul><ul><li>1 st Half of 1990s, </li></ul><ul><ul><ul><li>Wave of CEO dismissals by boards. </li></ul></ul></ul><ul><ul><ul><li>CALPERS – Institutional Shareholder activism </li></ul></ul></ul><ul><li>1997, East Asian Financial Crisis </li></ul>
  12. 12. <ul><li>Sarbanes-Oxley Act of 2002 </li></ul><ul><li>Role of institutional investors </li></ul>
  13. 13. <ul><li>Corporate Governance in Pakistan </li></ul><ul><ul><li>Code of Corporate Governance, March 2002 </li></ul></ul><ul><ul><li>Institute of Corporate Governance </li></ul></ul>
  14. 14. <ul><li>Stimulate the performance of companies </li></ul><ul><li>Limit insider’s abuse of power </li></ul><ul><li>Monitor manager’s behavior to ensure corporate accountability & protection of interest of society </li></ul><ul><li>Protection of investors </li></ul>
  15. 15.
  16. 16. <ul><li>Parties involved in CG include: </li></ul><ul><ul><li>Regulatory body </li></ul></ul><ul><ul><li>Other Stakeholders (Other than regulatory bodies) </li></ul></ul>
  17. 17. <ul><li>Regulatory body includes: </li></ul><ul><ul><li>CEO </li></ul></ul><ul><ul><li>Board of Directors </li></ul></ul><ul><ul><li>Management </li></ul></ul><ul><ul><li>Shareholders </li></ul></ul><ul><li>Other Stakeholders include: </li></ul><ul><ul><li>Suppliers </li></ul></ul><ul><ul><li>Employees </li></ul></ul><ul><ul><li>Creditors </li></ul></ul><ul><ul><li>Customers </li></ul></ul><ul><ul><li>Community at the Large </li></ul></ul>
  18. 18. <ul><li>Principal-Agent Problem </li></ul>
  19. 19. <ul><li>An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem. </li></ul>
  20. 20. <ul><li>Managerial Revolution </li></ul><ul><li>Modern Corporation </li></ul><ul><ul><li>Specialization </li></ul></ul><ul><ul><li>Residual interests </li></ul></ul><ul><li>Diversification of Investor Portfolios </li></ul><ul><li>Jobs & Earnings Security </li></ul><ul><li>Owners Control in Small Companies </li></ul><ul><li>Price of Shares </li></ul>
  21. 21. Hire Create
  22. 22. <ul><li>Principals & Agents have different interests </li></ul><ul><li>Shareholders lack direct control over corporations </li></ul><ul><li>Principals establish governance & control mechanism </li></ul><ul><li>Managerial Opportunism </li></ul>
  23. 23.
  24. 24. <ul><li>Honesty </li></ul><ul><li>Trust & Integrity </li></ul><ul><li>Openness </li></ul><ul><li>Performance Orientation </li></ul><ul><li>Responsibility & Accountability </li></ul><ul><li>Mutual Respect </li></ul><ul><li>Commitment to the Organization </li></ul><ul><li>Key Elements of Good Corporate Governance </li></ul>
  25. 25. <ul><li>Rights & equitable treatment of shareholders </li></ul><ul><li>Interests of other stakeholders </li></ul><ul><li>Role & responsibilities of the board </li></ul><ul><li>Integrity & ethical behavior </li></ul><ul><li>Disclosure & transparency </li></ul><ul><li>Commonly accepted principals of corporate governance </li></ul>
  26. 26. <ul><li>Issues involving corporate governance principles include: </li></ul><ul><ul><li>internal controls and the independence of the entity's auditors </li></ul></ul><ul><ul><li>oversight and management of risk </li></ul></ul><ul><ul><li>oversight of the preparation of the entity's financial statements </li></ul></ul><ul><ul><li>review of the compensation arrangements for the chief executive officer and other senior executives </li></ul></ul><ul><ul><li>the resources made available to directors in carrying out their duties </li></ul></ul><ul><ul><li>the way in which individuals are nominated for positions on the board </li></ul></ul><ul><ul><li>dividend policy </li></ul></ul>
  27. 27. <ul><li>Misunderstanding & Ambiguity </li></ul><ul><ul><li>Ambiguous & misunderstood phrase </li></ul></ul><ul><ul><li>Sometimes confined to corporate management </li></ul></ul><ul><li>Corporate Governance </li></ul><ul><ul><li>Much broader to meet certain objectives </li></ul></ul><ul><ul><li>Interplay of many factors </li></ul></ul><ul><li>Corporate Governance: </li></ul><ul><li>An Ambiguous & Misunderstood Phrase </li></ul>
  28. 28.
  29. 29. <ul><li>Designed to reduce the inefficiencies that arise from </li></ul><ul><ul><li>Moral Hazard </li></ul></ul><ul><ul><li>Adverse Selection </li></ul></ul>
  30. 30. <ul><li>Internal corporate governance controls monitor activities and then take corrective action to accomplish organizational goals. Examples include: </li></ul><ul><ul><li>Monitoring by the board </li></ul></ul><ul><ul><li>Remuneration </li></ul></ul><ul><li>Internal Corporate Governance Controls </li></ul>
  31. 31. <ul><li>Monitoring by the board </li></ul><ul><ul><li>Legal Authority to safeguard invested capital </li></ul></ul><ul><ul><li>Regular board meetings </li></ul></ul><ul><ul><li>Different board structures optimal for different firms </li></ul></ul><ul><ul><li>Non-executive directors </li></ul></ul><ul><ul><ul><li>More independent </li></ul></ul></ul><ul><ul><ul><li>May not increase performance </li></ul></ul></ul><ul><ul><li>Executive directors </li></ul></ul><ul><ul><ul><li>superior knowledge </li></ul></ul></ul><ul><ul><ul><li>Look beyond the financial criteria </li></ul></ul></ul><ul><li>Internal Corporate Governance Controls </li></ul>
  32. 32. <ul><li>Remuneration </li></ul><ul><ul><li>Performance based </li></ul></ul><ul><ul><li>Cash or Non Cash Payments or benefits </li></ul></ul><ul><ul><li>Prevent mistakes & opportunistic behaviour </li></ul></ul><ul><li>Internal Corporate Governance Controls </li></ul>
  33. 33. <ul><li>External corporate governance controls encompass the controls external stakeholders exercise over the organization. </li></ul><ul><li>External Corporate Governance Controls </li></ul>
  34. 34. <ul><li>Examples are: </li></ul><ul><ul><li>competition </li></ul></ul><ul><ul><li>debt covenants </li></ul></ul><ul><ul><li>demand for and assessment of performance information (especially financial statements) </li></ul></ul><ul><ul><li>government regulations </li></ul></ul><ul><ul><li>managerial labor market </li></ul></ul><ul><ul><li>media pressure </li></ul></ul><ul><ul><li>takeovers </li></ul></ul><ul><ul><li>telephone tapping </li></ul></ul><ul><li>External Corporate Governance Controls </li></ul>
  35. 35.
  36. 36. <ul><li>Demand for information </li></ul><ul><li>Monitoring Costs </li></ul><ul><li>Supply of accounting information </li></ul>
  37. 37.
  38. 38. <ul><li>SECP’s Efforts </li></ul><ul><ul><li>Code of Corporate Governance in Pakistan </li></ul></ul><ul><ul><li>Pakistan Institute of Corporate Governance </li></ul></ul>
  39. 39. <ul><li>Introduced in march 2002 </li></ul><ul><li>First step towards systematic implementation of principles of good CG </li></ul><ul><li>Incorporated in listing regulations of the stock exchanges </li></ul><ul><li>Applicable to all public listed companies </li></ul><ul><li>Compilation of “best practices” for the direction & control of business & management </li></ul>
  40. 40. <ul><li>The Code encourages representation of independent non-executive directors and those representing minority interests on the boards of directors of listed companies. As a further guarantee of compliance with this provision, the Code requires that the chairman of a listed company &quot;shall preferably be elected from among the non-executive directors of the company and that the board of directors shall clearly define the respective roles and responsibilities of the chairman and chief executive, whether or not these offices are held by separate individuals or the same individual.&quot; </li></ul><ul><li>Salient Features of Code of Corporate Governance </li></ul>
  41. 41. <ul><li>The Code requires every listed company to establish an audit committee that will comprise not less than three members, including the chairman. Majority of the members of the committee, it is further directed, &quot;shall be from among the non-executive directors of the company” To further enhance their role, it requires that the chairman of the audit committee be preferably a non-executive director. </li></ul><ul><li>Salient Features of Code of Corporate Governance </li></ul>
  42. 42. <ul><li>It reinforces the powers, responsibilities and functions of the board of directors, formalizes the corporate decision making process and requires adequate documentation of policies and decisions of directors. </li></ul><ul><li>Salient Features of Code of Corporate Governance </li></ul>
  43. 43. <ul><li>It also seeks to strengthen the corporate working of listed companies by stipulating that: </li></ul><ul><ul><li>Appointment and removal, remuneration and terms of reference of the CFO and Company Secretary shall be determined by the CEO subject to the approval of the Board of directors. </li></ul></ul><ul><ul><li>New appointments of CFO and Company Secretary must be made in accordance with the prescribed qualifications. </li></ul></ul><ul><ul><li>(Continued) </li></ul></ul><ul><li>Salient Features of Code of Corporate Governance </li></ul>
  44. 44. <ul><ul><li>The financial statements, presented to the Board for consideration, shall bear the signatures of the CEO and CFO. </li></ul></ul><ul><ul><li>The Company Secretary shall furnish a Secretarial Compliance Certificate as part of the annual return, to be filed with the registrar </li></ul></ul><ul><li>Salient Features of Code of Corporate Governance </li></ul>
  45. 45. <ul><li>Furthermore, a statement of compliance with the Code of Corporate Governance is required to be published by companies to set out the extent of compliance with the Code. The statutory auditors of listed companies have been made responsible for reviewing and certifying this statement. </li></ul><ul><li>Salient Features of Code of Corporate Governance </li></ul>
  46. 46. <ul><li>The Pakistan Institute of Corporate Governance (PICG) is a not-for-profit company, limited by guarantee and without share capital, setup under section 42 of the Companies Ordinance, 1984. The Institute is charged with promoting good corporate governance practices in Pakistan. </li></ul><ul><li>PICG is involved in training and education, creating awareness, undertaking research, publishing guidelines and other resource material, and provides a forum for discussion on corporate governance. </li></ul>
  47. 47.
  48. 48. <ul><li>The real purpose of CG is same as that of eating the carrots. </li></ul><ul><li>All the efforts are useless, if there is no improvement in firm’s performance </li></ul>
  49. 49. <ul><li>A CASE STUDY OF KARACHI STOCK EXCHANGE </li></ul><ul><li>BY </li></ul><ul><li>PAKISTAN INSTITUTE OF DEVELOPMENT ECONOMICS </li></ul><ul><li>RESEARCHERS </li></ul><ul><li>ATTIYA Y. JAVED </li></ul><ul><li>ROBINA IQBAL </li></ul>Relationship Between Corporate Governance Indicators & Firm Value
  50. 50. Objectives <ul><li>Whether variation in firm-specific governance is associated with differences in firm value in case of Pakistani stock market. </li></ul><ul><li>A corporate governance index (CGI) is developed as a proxy for firm-level governance quality with a variety of different governance practices adopted by listed firms </li></ul><ul><li>Tobin’s Q is used as valuation measure. </li></ul>
  51. 51. Data & Sample <ul><li>Sample </li></ul><ul><ul><li>50 firms listed on KSE </li></ul></ul><ul><ul><li>Representative of Non-Financial Sectors </li></ul></ul><ul><ul><li>Active in their sector </li></ul></ul><ul><ul><li>Comprises more than 80% of Market Capitalization </li></ul></ul><ul><li>Data </li></ul><ul><ul><li>Annual Reports of companies for year 2003, 04 & 05 </li></ul></ul><ul><ul><li>Tobin’s Q, CGI & other control variables are constructed and average is taken out for these three years. </li></ul></ul>
  52. 52. Tobin’s Q <ul><li>Tobin’s Q is used as Valuation Measure </li></ul><ul><li>Tobin’s Q = Market Value/Asset Value </li></ul><ul><li>For Evaluation of Market Tobin’s Q </li></ul><ul><li>= Value of Stock Market/Corporate Net Worth </li></ul>
  53. 53. Construction of CGI <ul><li>Broad, multifactor corporate governance rating is done from data </li></ul><ul><li>Index Construction: </li></ul><ul><ul><li>22 governance proxies are selected </li></ul></ul><ul><ul><li>These indicators are categorized into three main themes or sub-indices </li></ul></ul><ul><ul><ul><li>Eight factors for the board </li></ul></ul></ul><ul><ul><ul><li>Seven for ownership & shareholdings </li></ul></ul></ul><ul><ul><ul><li>Seven for transparency, disclosure & Audit </li></ul></ul></ul>
  54. 54. Weighting <ul><li>Weighting is based on subjective judgments </li></ul><ul><li>Guided by empirical literature & financial experts </li></ul><ul><li>Scoring </li></ul><ul><ul><li>Maximum Score is 100, if a factor is observed </li></ul></ul><ul><ul><li>80 if largely, 50 for partially and 0 if not observed </li></ul></ul><ul><li>Getting CGI </li></ul><ul><ul><li>Average is taken out to arrive at rating of one sub-index </li></ul></ul><ul><ul><li>Taking average of three sub-indices, CGI for particular firm is obtained </li></ul></ul>
  55. 55. Methodology <ul><li>The empirical specification of the model is </li></ul><ul><li>Where </li></ul><ul><ul><li>Q is the measure of Firms Performance </li></ul></ul><ul><ul><li>CGI is vector of governance index </li></ul></ul><ul><ul><li>Xi is a vector of firm characteristics for three years </li></ul></ul>
  56. 56. Estimation Technique <ul><li>In exploring that good corporate governance causes higher firm valuation, an important issue is endogenity. </li></ul><ul><li>The firms with higher market value would be more likely to choose better governance structure because of two reasons. </li></ul><ul><ul><li>First, firm’s insiders believe that better governance structure will further raise firm value. </li></ul></ul><ul><ul><li>Second, firms adopt good governance to signal that insider behave well. </li></ul></ul>
  57. 57. Set of Control Variables <ul><li>Along with three governance indices, board, shareholdings and disclosure, a set of control variables are used, which include </li></ul><ul><ul><li>size (ln assets) </li></ul></ul><ul><ul><li>leverage (debt/total asset ratio) and </li></ul></ul><ul><ul><li>growth (average sale growth) </li></ul></ul>
  58. 58. Set of Instruments <ul><li>This endogenity problem in estimation is resolved by applying Generalized Method of Moments as estimation technique. </li></ul><ul><li>The instruments: </li></ul><ul><ul><li>Age is natural logarithm of number of years of listing at KSE </li></ul></ul><ul><ul><li>Profit is logarithm of net income/total assets </li></ul></ul><ul><ul><li>DFOR is dummy variable which is one if the firm has foreign investment and zero otherwise </li></ul></ul><ul><ul><li>DN is a dummy variable if the firms has block holder zero </li></ul></ul><ul><ul><li>DKSE, is a dummy variable if the firm is included in KSE 100 index and zero otherwise </li></ul></ul>
  59. 59. Summary Statistics of CGI <ul><li>This table provides the summary statistics of distribution of Corporate Governance index, and the sub-indices (Board, Shareholdings and Disclosure). The table also presents the pair-wise correlation between the indices </li></ul>Mean Max Min SD CGI Board Rights Disc CGI 54.30 70.42 30.89 7.99 1.00 Board 55.58 87.50 25.00 16.02 0.62 1 Share 46.97 78.57 7.14 16.10 0.57 0.11 1 Disc 60.36 94.29 30.00 10.93 0.44 0.05 0.06 1
  60. 60. Findings & Evidences <ul><li>There is positive and significant relationship between CGI and Tobin’s Q </li></ul><ul><li>The CGI remains positive but significance level reduces with adding more explanatory variables </li></ul>
  61. 61. Findings & Evidences <ul><li>The results based on sub-indices reveal importance of Board composition, ownership and shareholdings with firm performance. However investors are not willing to pay a premium for companies that are engaged in open and full disclosure. </li></ul>
  62. 62. Findings & Evidences <ul><li>The results of firm performance including control variables are also consistent with prior research </li></ul><ul><ul><li>The coefficient of size is positive and significant in most of the cases </li></ul></ul><ul><ul><li>The coefficient of growth is significant and positive </li></ul></ul><ul><ul><li>The coefficient of leverage is positive and significant </li></ul></ul>
  63. 63. Conclusion <ul><li>Results show that Corporate Governance Code potentially improves the governance and decision making process of firms listed at KSE. Large shareholders still have a tight grip of companies. However we point out that adequate firm-level governance standards can not replace the solidity of the firm. The low production and bad management practices can not be covered with transparent disclosures and transparency standards. </li></ul>