Corporate Governance

Geetha A/P A. Rubasundram

Financial Reporting

Dias Serikbayev

TP020865

 

What is corporate governance?

A.C. Fernando says that a recent academic survey of corporate governance defined it as follows: “Corporate governance deals with the ways in which suppliers of finance to corporation assure themselves of getting a return on their investment. How do suppliers of finance get managers to return some of the profits to them? How do they make sure that managers do not steal the capital they supply or invest it in bad projects? How do suppliers of finance control managers?”

 From this point of view, corporate governance tends to focus on a simple model:

1. Shareholders elect directors who represent them.
2. Directors vote on key matters and adopt the majority decision.
3. Decisions are made in a transparent manner so that shareholders and other can hold directors accountable.
4. The company adopts accounting standards to generate the information necessary for directors, investors and other stakeholders to make decisions,
5. The company’s policies and practices adhere to applicable national, state and local laws.

(A.C. Fernando, 2006, Corporate Governance: Principles, Policies and Practices, Dorling Kindersley, page 10)

In other words, the corporate governance is interaction system between shareholders and the company management (joint stock company, corporation), including its board of directors, and also with other interested persons by means of which the rights of shareholders are realized; complex of the mechanisms allowing shareholders to supervise activity of heads of the company and to resolve arising problems with other groups of influence.

Also corporate governance has no direct bearing on operational and tactical management of the company, but recently joins in strategic management. Subject of corporate governance is control of commission of corporate actions.

Need of corporate governance is caused by that business as the property belongs to principals (to owners, investors), and the rights of management are delegated by this property to agents —  board of directors and management that generates asymmetry of information and the related agency expenses which are expressing itself in actions of management, the interests of owners not directed on satisfaction of their interests.

In the course of development of rules of corporate governance a business community of the countries acting mainly as investors, relies on active support of the governments and the international organizations where these countries play a dominating role. So, for example, in 1998 the World Bank initiated the global program on improvement of a condition of the corporate governance, aimed at significant improvement of national corporate management systems and disclosure of information on activity of the companies in the various countries. In May, 1999 Council of the Organization for Economic Co-operation and Development (OECD) accepted the Principles of corporate governance under which members of the governments of all member countries of OECD put the signatures. This document contains very detailed explanations concerning what specific problems have to regulate national standards of corporate governance and how to provide substantial increase of a role of investors (shareholders) in management of the companies in which they invest. Malaysia is involved in the Co-operation of OECD, but not the member of it.

QUESTION 2

Code of the best practice

In formation of the general approaches and the principles of corporate governance actively participates not only governmental bodies of a large number of the countries, but also non-state (public, enterprise and so forth) organizations and groups. If efforts of government bodies are directed first of all on legislation improvement for the purpose of obligation fixing of certain standards of information disclosure on companies' activities, protection of the shareholders rights and providing the equal relation to them, the accounting of interests of other interested parties, activity of a business community and other non-state structures and groups is directed on formation of rules and procedures of corporate governance which would be voluntary accepted by most business community, would correspond is international to the recognized principles and at the same time considered national features.

The result of appearance in different countries of codes of corporate governance is the set of voluntary accepted standards and the internal norms establishing and regulating an order of the corporate relations. It is possible to carry to their number such, as Cadbury Code which was prepared in 1991 in Great Britain by Adrian Cadbury Committee which was created by Council of financial information, the London stock exchange and labor union of accounting employees; The Code of the best practice for the German corporate governance, prepared by the German group of corporate governance in January, 2000. The code of corporate governance prepared in 1999 by the financial committee of Malaysia.

Legal status of the code of corporate governance or the code of best practice is not identical in the various countries. In one country it is a part of the general package of indispensable conditions which the companies need to follow in order that its securities passed listing at the exchange. Thus the essence of requirements to the issue of securities consists not in obligatory following of the code under the threat of an exception of listing but in a duty publicly to inform on the reasons of non-compliance with the rules recommended by the code.

For example, the American institutional investors actively push all American companies to follow the principles of corporate governance stated in the document, accepted by "General Motors". In Brazil and Mexico codes of corporate governance are completely voluntary for following. In India and Thailand similar codes also are voluntary and their requirements are not included in requirements for listing of corporate papers at the exchanges of these countries. However in Malaysia, Hong Kong and in the Republic of South Africa the main requirements stated in codes of corporate governance, are included in requirements for obligatory disclosure of information.

The activity of the Board of Directors

Mission of Board of Directors

It is recommended that each company had the document describing the purposes, tasks, powers and responsibility of the board of directors, including the description of mission of council and containing the following basic provisions:

• Mission of board of directors consists in the maximum increase in cost of a contribution of shareholders. In the activity the board of directors has to be guided by the purposes and interests of shareholders.
• Fundamental obligation of board of directors is elaboration of strategy of development of the company; ensuring disclosure of information on the company for shareholders and the market; creation of internal control mechanisms; ensuring observance with the company of current laws and rules; regular evaluation of the work of management.
• Board bears responsibility for how management of the company carries out the duties on realization of strategy of owners of the company

 

Description of the content of activity of board and procedures

The main recommendations containing on this aspect of activity of board in codes of corporate governance ("code of best practice") consist in the following:

• Duties and the sphere of powers of board have to be accurately recorded in writing form to avoid the conflicts in relationship with management.
• Board has to have the right of access to any information on company activity.
• Board has to carry out functions of an assessment of a business management of the company, identification of the main risks and creation of the risk control system , determination of powers of management and control of their performance, planning of appointment, movement, replacement and training of the senior administrative personnel, evaluation of the work of management (including the general manager), implementation of the development program of the relations with investors and other interested parties, the analysis of adequacy and efficiency of internal control mechanisms, ensuring company's observance with the current legislation.
• Board has to define duties of the members and watch their observance. These duties include the following:

2. Not to use on company resources for own targets; to visit council meetings regularly (some codes recommend to record the minimum number of the visits, for example not less than 70% of meetings);
3. To observe full confidentiality concerning information which disclosure can negatively affect company activity, and also concerning the questions which are being discussed at meetings of council;
4. To fulfill the duties honestly and in a complex;
5. To prevent of violations of the rights of minority shareholders.

• Board is responsible for preparation of the financial information disclosed on by the company.

• Board provides observance by the company of ethical standards of business.
• Independent directors have to have opportunity for carrying out independent meetings (that is without participation of other directors and managers) for discussion of activity of the company.

Criteria of membership in the board and assessment of activity of directors

 

The main contents of the recommendations containing on this aspect of board activities in codes of the countries with emerging markets, consist in the following:

• Board has to develop and regularly update a set of criteria — personal characteristics which members of board have to correspond. Shareholders have to be informed on these selection criteria of candidates for member structure of the board.
• Each member of board has to possess the corresponding personal characteristics such as:

1. Appropriate level of preparation;
2. Existence of sufficient experience and knowledge;
3. Lack of the conflict of interests concerning the company;
4. Existence of sufficient time for implementation of the duties;
5. Ability to formulate and defend independent judgments

• Board has to develop and officially formulate criteria and effective procedures of an assessment of board activity as a whole, and each of directors separately by which has to be guided in practice of regular carrying out such assessment. In process of evaluation of the work of each member of board the special attention is paid to visit of their meetings of board and its committees. A number of codes recommend to establish the minimum percent of number of meetings which the director (usually - not less than 75%) has to visit, and to suggest the general election of shareholders not to re-elect in board structure for new term of the director who has visited in a year number of meetings of less established level.

• Board has to stimulate the reduction of membership of the same director in boards of directors of the various companies.

Maintaining need of updating of structure of board and inclusion in its structure of the new members, who is capable to bring new experience and the knowledge, which is necessary for the companies in changing conditions, codes at the same time are very careful concerning the offer of any fixed terms of membership in council and in obligation of replacement of old members by new ones and norms of updating.

 

Selection, invitation and introduction in a course of business of new members of board

The main contents of the recommendations containing on this aspect of activity of board in codes of the countries with emerging markets, consist in the following:

• Board has to have accurately certain procedure of introduction in a course of business and training of new members of council by which has to be guided in  activity. Such procedure usually provides acquaintance of new directors to the description of their duties and tasks of members of council, the last annual reports of the company, protocols of meetings of shareholders and council, position of the company in its sector of business, the main competitors, suppliers, clients and so forth.

Besides this general recommendation, various codes contain the following specific recommendations in different countries.

In Malaysia, key element of successful corporate governance is that the board of directors has the procedure of evaluation of the work of directors, selection, promotion, appointment and introduction in duties of new board members. On the basis of observance of this formal procedure the committee on appointments in board of directors has to take out the recommendations to council... We believe that the board of directors has to appoint new members, and shareholders have to approve the appointment. Re-election of board members on a regular basis allows not only to maintain efficiency of council, but gives the chance to shareholders to estimate activity of the board members and if necessary to replace them.

Division of positions of the chairman of the board and general manager

The general recommendation is that the companies have to encourage that the positions of the chairman and the general manager were occupied by different people. However degree of a category of this recommendation strongly differs. In the codes adopted in the USA, the recommendation is the smallest. In the codes adopted in the European countries and in particular in the countries with emerging markets this recommendation sounds much stronger.

Thus some codes contain specific recommendations about this problem.

The number of Board of Directors

On this matter the codes adopted in the various countries, contain strongly different recommendations (some codes does not contain concrete recommendations about this aspect). For example, in Malaysia each Board of Directors has to choose how many of the members should be in it for efficiency of company activities.

Proportion between executive and external directors members of board

The vast majority of codes contain the recommendation about that the majority of board members was made mostly of external and often only independent directors. The recommendations concerning a share of non-executive directors in total number of Board and classification of various categories of these directors are different in each country.

In Malaysia, The board of directors has to represent balance of executive and non-executive directors (including independent non-executive directors) and none of its members or group of members doesn’t have the dominating impact on decision-making.  Independent non-executive directors have to be not less than 1/3 board members. When the company has the major shareholder, in addition to the above condition (about 1/3 independent directors), the board of directors has to include a certain number of directors who sufficiently reflect investments into the companies of other shareholders. In this context "major shareholder" is the shareholder who can have a majority of votes when electing board members. In cases when the major shareholder has fewer majorities of votes, but is the largest shareholder in comparison with all others, the board of directors has to make the decision on number of the members who will represent interests of other shareholders.

Definition of the concept "independent" (director)

 

The majority of codes consider necessary to give concept of the independent director and requirements corresponding to it. As a rule, as the independent director the member of board conforming to following main requirements admits:

• Do not have the working place for this time and throughout a certain period in the past,  which is before appointment to the board structure (in some codes concrete term is specified, usually from 3 to 5 years), in this particular company or its subsidiaries at a management position.
• Not to be the paid consultant or the adviser of the company or its subsidiary (it is frequent - not to have contracts with the organization which is the consultant of this particular company or its subsidiary).
• Not to be the considerable client or a supplier and not to be connected with the considerable client or the supplier of the company or their subsidiaries.
• Not to have contracts with the organizations (funds, universities and so forth), receiving the help from this particular company.
• Not to be the relative with any of members of management of this particular company.

In codes of some countries it is specified that remuneration for participation in structure of board can be the only remuneration for the position of independent director and it is banned to possess of the shares of the company. In codes of other countries such restriction is absent or even the direct recommendation that all board members have to be the owners of common stocks of this company contains.

A number of codes differ the concepts "independent" and "non-executive", specifying that the non-executive director have the option of being independent or not.

In Malaysia, each company which has passed listing, has to have independent directors, who are not connected with its employees, do not represent the concentrated or family possession of equity stakes, represent public shareholders and are free from any communications which could affect independence of their judgments... From the practical point of view it does not make sense to formulate more exact criteria of independence. The board of directors has to make itself the decision on, whether its specific member is independent in the above sense or not. The concept "independent" has two main aspects — independence of management and independence of the major shareholder.

 Quantity, structure and independence of committees of council

The general contents of recommendations about this aspect of board of directors activity is underlining of need to have a number of committees on key problems which carry out permanent job on the basis of accurately recorded rules and the procedures providing independence and responsibility of decisions made by them as a member of board. Usually committees which have to be surely created within board are called as which have to be surely created within board, committees on audit, appointments and remunerations.

A number of codes consider necessary the creation of committees on an assessment of activity of board, according to activity of the general manager and managers. Practically all codes recommend that independent directors are the majority or very considerable part of members of committees (some codes even recommend that the audit committee have to be consisted only of independent directors) and members of committees have to have the opportunity to receive all necessary information on a problem and also could resort to services of the independent experts paid from the company funds. For example the concrete recommendations containing in code in Malaysia:

The board of directors of each company has to appoint that the committee of directors consists only of non-executive directors where majority are independent directors who will have the right to offer the candidate for election to the board of directors and to estimate activity of board members on a constant basis. The decision whether it is necessary to appoint the candidate offered by committee as the board member is accepted by full structure of council. At the same time with creation of such committee the board of directors has to formulate its powers, in particular definition, whether committee has the right to work on behalf of board or has the right to analyze only this or that question and to address to board with recommendations. The board of directors has to appoint committee on remunerations which consists completely or mainly of non-executive directors. This committee will make recommendations to the board on amount of remuneration of executive directors in any form, addressing by preparation of such recommendations for external experts. Executive directors should not play any role in the solution of questions on the amount of their remuneration. Names of members of the committee on remunerations have to be included in the board report... The board of directors has to create audit committee; including not less than three non-executive directors where majority are independent directors, to formulate in writing tasks of this committee, power and a duty. The chairman of audit committee has to be independent non-executive director.

Regularity of meetings of committees of council, their agenda

The main recommendation concerning this aspect of activity of board of directors is directed on ensuring efficiency of activity of committee on audit which is considered as the main division of council. It is offered to reach this goal by the following:

• Development and administrative authorization by board the provision on auditor committee, clearly and accurately formulating its tasks and powers (the analysis of efficiency of system activity of internal audit, the analysis of policy of accounting used in the company, interaction with the external auditor).
• Providing members of the committee with all financial information necessary for them about the company activity.
• Members of the committee are only or mainly independent directors.

In Malaysia, Obligations of audit committee consist in the following:

 

1. To consider appointment of the external auditor, to determine the amount of its remuneration, and also refusal of services of former auditor and search of the new auditor;
2. To discuss with the external auditor prior to audit implementation the volume and nature of work done;
3. To consider semi-annual and annual financial statements with special attention to such aspects, as changes in policy and practice of accounting, the considerable specifications brought by the results of audit, compliance to auditor standards and other precepts of rights;
4. To consider the problems of intermediate and final audit (if necessary, to discuss such questions without presence of representatives of management of the company);
5. To consider correspondence of the external auditor and company management;
6. To consider any transactions with the related parties which can take place in the company or group to which it belongs;
7. To consider results of the investigations made in the company and the answers of management to them:
8. To consider other questions at the request of board.