Lesson 10

Corporate Governance Defined &

Model of Corporate Governance
Corporate Governance Defined

Topics:
• Definitions of CG
• The scope of CG
• The significance of constitutions for corporate entities
• The difference between governance & management
• The performance & conformance aspects of governance
• Alternative board structures
All corporate entities need a
governing body

• Profit-orientated companies, public & private

• Not-for-profit organisations
• voluntary & community organisations / charities
• academic institutions
• governmental corporate entities
• Management is responsible for running. Governing body
ensures that it is running in the right direction & being run
well
• Directors - set the org direction, formulate strategy &
policy. The board is also responsible for supervising
management & being accountable.
Corporate Governance Defined

Definitions of Corporate Governance

Definitions vary according to the perspectives:

• operational
• relationship
• stakeholder
• financial economics
• societal
Corporate Governance Defined

Defining corporate governance – Operational

Corporate governance is the process by

which companies are directed & controlled
- Cadbury Report 1992 & OECD 1999
Corporate Governance Defined
Defining corporate governance – Relationship
The relationship among various participants in determining the
direction & performance of corporations. The primary
participants are the shareholders, the management & the
board of directors - Monks & Minow 2001

The CG structure specifies the distribution of

rights & responsibilities among the different participants in the
organisation – such as the board, managers, shareholders &
other stakeholders – and lays down the rules & procedures
for decision-making - OECD 2002
Corporate Governance Defined

Defining corporate governance - Stakeholder

Corporate governance is the process by which

corporations are made responsive to the rights &
wishes of stakeholders
- Demb & Neubauer, 1992
Corporate Governance Defined

Defining corporate governance

– Financial economics perspective

Corporate governance deals with the way suppliers of

finance assure themselves of getting a return on their
investment - Shleifer & Vishny, 1997
Corporate Governance Defined

Defining corporate governance - Societal

The whole set of legal, cultural, & institutional
arrangements that determine what (public) corporations
can do, who controls them. How that control is exercised, &
how the risks & return from the activities they undertake
are allocated - Blair, 1995

Corporate governance is concerned with holding the

balance between economic & social goals & between
individual & communal goals - Cadbury, 2000
Corporate Governance Defined

Defining corporate governance – Overall

Corporate governance is the exercise of power over a

corporate entities - Tom Clarke, 2004
The spheres of Corporate Governance

Other sources of
finance Institutional investors
Stock
CG activists
Markets
Societal Market
influences and Investment
analysts intermediaries
other Providers of
stakeholders debt capital
Shareholders
i.e. members
Government Governing
and other body -
corporate board of
regulators directors External
Contractual auditors
stakeholders:
Suppliers, Management
Customers
bankers

Law courts Investigative

Media
Every corporate entity needs a constitution
The essence of Governance

The members

Governing body

Corporate
entity
Management
Management involves an
organisational hierarchy
Governance is different from
management

governance

management
Corporate Governance Defined

The difference between Governance & Management:

• Management runs the business
• The board ensures that the business is well run
& running in the right direction
 INED
Board Structure

ED

Co. Secretary
Investment (Compliance
Manager Officer)

General
Manager
Corporate Governance Defined

The basic board processes

Outward looking
Accountability Strategy formulation

Supervising
executive activities Policy making
Inward looking

Past & present focused Future focused

Corporate Governance Defined

Outward
looking Providing Strategy
Accountability Formulation

Approve & work with the

CEO

Monitoring and Policy

Inward Making
Supervising
looking

Past and Future

present focused focused
Corporate Governance Defined

The conformance & performance roles of the unitary board

Conformance Performance

Accountability Strategy formulation

Supervising
executive activities Policy making
Corporate Governance Defined

• All executive board

• Majority executive board
• Majority non-executive board
Alternative board structures
• All non-executive board

• Two-tier board
Supervisory board
Management board
Corporate Governance Defined

The all-executive board

O
O O
O O
O = executive
directors
Corporate Governance Defined

The majority-executive board

N N
O
O executive directors O
N non-executive directors O O O
Corporate Governance Defined

The majority non-executive board Compliance mode

N
N N
N N
O

N non-executive directors O O
O executive directors Critique of too much
power CEO
Corporate Governance Defined

The all non-executive board

N N N
N
N N N

N non-executive
directors
Directors & board architecture

Two-tier board Supervisory N

board N N
N N
All non-executive
directors
N N
N non-executive directors N N
O executive directors
O
Management O O
board
O
Comparison of CG board structures
Board Diversity

• Diversity for business effectiveness

• balance of experience, knowledge & skills.
• It is more about functional abilities
• Stakeholder diversity
• representatives that links to company, i.e. customer,
suppliers…
• Societal diversity
• balance decisions with interest of society
• representative by age, gender, nationality, political
interest & environmental concerns
 Models of Corporate Governance

Topics:

• How context & culture affect CG

• American rule-based model
• UK/Commonwealth principles-based model
• Continental European two-tier model
• Japanese business network model
• Asian family based model
• CG: convergence or differentiation?
• Institutions necessary for successful CG
Models of Corporate Governance

How Context & Culture affect CG?

Context:
• Differences in ownership patterns
• highly dispersed with no dominant owner
• concentrated with single or block holders dominant
• Markets for corporate control
• Financing

Culture influences CG
Models of Corporate Governance

Listed Company Ownership

Models of Corporate Governance

Markets for corporate control

• In finance markets that are large, liquid, & with
high turnover, listed companies face
• chances of hostile take-over bids
• consequential loss of board control
• widespread merger & acquisition activity

• In finance markets that are small, illiquid with low

turnover, the market for corporate control will be
weaker, & merger & acquisition activity infrequent
Models of Corporate Governance

5 broad systems of CG:

• the American rule-based mode
• the UK/Commonwealth principles-based model
• the Continental European two-tier model
• the Japanese stakeholder-orientated network model
• the Asian family-based model
Models of Corporate Governance

The American rule-based model

• companies incorporated by states
• Investor protection federal by SEC
• company law based on common law
• governance regulated by law & mandatory rules, which
are inherently inflexible
• high levels of litigation
• GAAP rule-based
• unitary boards with executive
& non-executive directors
• roles of board chairman
& CEO often combined
Models of Corporate Governance

The UK/Commonwealth principles-based model

• companies incorporated at country level
• company law based on common law
• governance principles-based
• corporate governance codes - follow or explain why not
• international accounting standards
• unitary boards with executive & non-executive
directors
• roles of board chairman & CEO separated
Models of Corporate Governance

The Continental European two-tier model

• companies incorporated at country level
• company law based on rule-based civil law
• governance rooted in the law
• international accounting standards
• supervisory board - all non-executive
• executive board - all executive
• no common membership between the two boards
• co-determination with employee & shareholder
appointed directors on supervisory board
 Models of Corporate Governance

The Japanese business network model

• Keiretsu networks of companies connected through cross-holdings,
interlocking directorships & extensive inter-trading
• classical model of the keiretsu reflects the social cohesion within
Japanese society
• unity throughout the organisation
• non-adversarial relationships
• lifetime employment
• enterprise unions
• personnel policies encouraging commitment
• decision-making by consensus
• promotion based on loyalty & social compatibility as well as
performance
This model is currently under pressure to change but survives
Models of Corporate Governance

The Japanese business network model

• boards of directors tend to be large
• all executive - the top layers of the management
pyramid
• 'promotion to the board‘
• independent outside directors not acceptable
• how can they understand the company?
• how can they appreciate the corporate culture?
• potential to disrupt the harmony
• Meetings of the whole board formal, ceremonial
• Governance power lies with chairman & senior
directors/executives
 Models of Corporate Governance

The Asian family-based model

Overseas Chinese firms are:
• family centric with close family control
• controlled through an equity stake kept within the family
• entrepreneurial often with a dominant entrepreneur
• decision making centralised
• close personal links emphasizing trust & control
• paternalistic in management style
• social fabric dependent on relationships & social harmony
• strategically intuitive with business seen as more of a succession
of contracts or ventures, rather than strategic plans, brand-
creation or quantitative analysis
 Models of Corporate Governance

CG – convergence or differentiation?
Forces for convergence
• CG codes of good practice around the world
• securities regulators
• international accounting standards
• global concentration of audit practices
• globalisation of companies
• raising capital on overseas exchanges
• international institutional investors
• private equity funding
• cross-border merger of stock exchanges
• research publications, conferences & professional journals
Models of Corporate Governance

CG – convergence or differentiation?
Forces for differentiation
• legal differences in company law, contract law &
bankruptcy law
• different standards in legal processes
• stock market differences – capitalisation, liquidity
• differences in the market for control
• differences in ownership structures
• historical differences & expectations
• cultural differences
Models of Corporate Governance

Institutions necessary for successful CG:

• a reliable legal system with an independent judiciary

• courts that are bias & corruption free
• judgements that are enforceable, free of political pressures
• a stock market with liquidity, international standing financial
institutions, regulatory authorities including securities & futures
market regulators
• a companies registry that facilitates comprehensive disclosure
• accounting & legal professions that are internationally respected
• auditing firms that are professional, reliable, & independent of
their clients
• professional organisations educational institutions with relevant
qualifications
• consulting organisations able to advise companies & directors
• financial & corporate governance training
• CG research reported in sound journals