Archive for the ‘Economic crisis’ Category
Twenty steps to better corporate governance
A new international corporate/company secretary organization was launched in March 2010 at the Headquarters of the Word Bank in Paris.
The Corporate Secretaries International Association (CSIA) is an international federation of professional bodies formed to promote good governance and corporate secretary-ship. Member organisations include national representative organisations from Australia, Hong Kong/China, India, Kenya, Malaysia, New Zealand, Singapore, South Africa, the United Kingdom, the United States and other jurisdictions representing some 70,000 governance professionals in more than 70 countries.
A research paper was presented at the launch of CSIA: Twenty Steps to Better Corporate Governance. Corporate governance experts from around the world, including the two authors of this blog site – Professor Chris Mallin and Professor Bob Tricker – were asked for their opinions on possible corporate governance implications arising from the recent global financial crisis and the ongoing economic hiatus.
The other contributors to the paper were (in alphabetical order):
- Sir Adrian Cadbury, widely known for his chairmanship of the UK Committee on the Financial Aspects of Corporate Governance and the seminal corporate governance code of best practice that bears his name,
- Dr John Carver, a corporate governance consultant, originator of the Policy Governance® model and author of Corporate Boards that Create Value, 2002, USA
- Professor Gabriel Donleavy, Professor of Accounting, University of Western Sydney, Australia,
- Professor William Judge, E.V. Williams Chair of Strategic Leadership, Old Dominion University and editor of Corporate Governance – an international review, USA,
- Dr Gregg Li, Head of Governance and Risk Management, Aon Global Risk Consulting, Hong Kong,
- Professor Jay W. Lorsch, Louis Kirstein Professor of Human Relations at the Harvard Business School, USA,
- James McRitchie, CEO, Corporate Governance Network, USA.
- Dr Shann Turnbull, Principal, International Institute for Self-governance, Australia.
To read more about the CSIA go to http://www.csiaorg.com.
The full paperTwenty Steps to Better Corporate Governance can be accessed at http://www.csiaorg.com/pdf/research_paper.pdf
Bob Tricker, 1 June 2010
The Financial Reporting Council (FRC) has issued an updated corporate governance code for UK companies. Formerly known as the Combined Code, the newly issued UK Corporate Governance Code is a response to the financial crisis which caused shock waves around the world.
The FRC traces the roots of the UK Corporate Governance Code to the Cadbury Committee Report (1992) http://www.ecgi.org/codes/documents/cadbury.pdf and its successor reports. They recognise that ‘The Code has been enduring, but it is not immutable. Its fitness for purpose in a permanently changing economic and social business environment requires its evaluation at appropriate intervals’.
The UK Corporate Governance Code (hereafter ‘the Code’) continues to have at its heart the ‘comply or explain’ approach which was introduced in the Cadbury Committee Report. Sir Adrian Cadbury in his seminal book ‘Corporate Governance and Chairmanship, A Personal View’(2002) stated ‘The most obvious consequences of the publication of the 1992 Code of Best Practice was that it put corporate governance on the board agenda. Boards were asked to state in their reports and accounts how far they complied with the Code and to identify and give reasons for areas of non-compliance’. The flexible approach provided by the ‘comply or explain’ approach is a great strength and has been adopted in many countries.
The Code has five sections being Section A: Leadership; Section B: Effectiveness; Section C: Accountability; Section D: Remuneration, and Section E: Relations with Shareholders. There is also currently a Schedule in the Code (Schedule C) ‘Engagement Principles for Institutional Shareholders’. This schedule contains three principles: dialogue with companies; evaluation of governance disclosures; and shareholder voting. However it will cease to apply when the Stewardship Code for institutional investors which is being developed by the FRC comes into effect.
Main changes to the Code
The FRC identifies six main changes http://www.frc.org.uk/press/pub2282.html as follows:
(i) ‘To improve risk management, the company‘s business model should be explained and the board should be responsible for determining the nature and extent of the significant risks it is willing to take.
(ii) Performance-related pay should be aligned to the long-term interests of the company and its risk policy and systems.
(iii) To increase accountability, all directors of FTSE 350 companies should be put forward for re-election every year.
(iv) To promote proper debate in the boardroom, there are new principles on the leadership of the chairman, the responsibility of the non-executive directors to provide constructive challenge, and the time commitment expected of all directors.
(v) To encourage boards to be well balanced and avoid “group think” there are new principles on the composition and selection of the board, including the need to appoint members on merit, against objective criteria, and with due regard for the benefits of diversity, including gender diversity.
(vi) To help enhance the board’s performance and awareness of its strengths and weaknesses, the chairman should hold regular development reviews with each director and FTSE 350 companies should have externally facilitated board effectiveness reviews at least every three years.’
The changes that seem most likely to be contentious and attract most debate relate to the annual re-election of directors and the move to encourage boards to consider diversity, including gender, in board appointments.
Annual re-election of directors
According to Rachel Sanderson and Kate Burgess, in their article ‘Directors must be re-elected annually’ (FT, page 17, 28th May 2010), the annual re-election of directors in FTSE 350 companies is the most controversial aspect of the Code. They state ‘Critics, including the Institute of Directors, have said it will encourage short-termism and be disruptive. Those in favour have said it will make boards more accountable to shareholders’.
The widespread concern about the underperformance of some UK board directors prior to, and during, the recent financial crisis no doubt led to increased support for the idea of the annual re-election of directors.
Another potentially contentious change is the fact that boards are now encouraged to consider the benefits of diversity, including gender, to try to ensure a well-balanced board and avoid ‘group think’. Similar provisions may be seen in the German Corporate Governance Code (2009) ‘The Supervisory Board appoints and dismisses the members of the Management Board. When appointing the Management Board, the Supervisory Board shall also respect diversity’ (5.1.2) and the Dutch Code of Corporate Governance (2008) ‘The supervisory board shall aim for a diverse composition in terms of such factors as gender and age (111.3).
The UK has not gone as far as Norway which has, since 2008, enforced a quota of 40% female directors on boards of all publicly listed companies. Similarly Spain introduced an equality law in 2007 requiring companies with 250+ employees to develop gender equality plans which clearly has implications for female appointments to the board.
Whilst it is fair to say that the number of females with experience at board level in large UK companies is relatively limited, non-executive directors can be drawn from a much wider pool including the public sector and voluntary organisations. Their experience can bring new insights to the board, maybe challenging long-accepted views and hence adding value.
As mentioned above, the Code currently contains Schedule C ‘Engagement Principles for Institutional Shareholders’ but this will be withdrawn when the Stewardship Code becomes operational. The Stewardship Code is being developed separately by the FRC and will set out standards of good governance for institutional investors, the FRC hopes to publish it by the end of June 2010.
Andrew Hill in the FT Lombard column (FT, page 18, 28th May 2010) ‘New code sets the high-water mark for governance’ discussed the new Code. He points out that ‘Now it is up to shareholders, encouraged by their own forthcoming stewardship code, to rise to the challenge……the FRC has set a new high watermark for post-crisis governance standards. The test will be whether investors use it responsibly and maintain sensible pressure on boards, as recession turns to recovery and chief executives’ and directors’ risk aversion dissipates’.
The FRC has produced a robust UK Corporate Governance Code, building on the earlier Codes and retaining the flexibility of the ‘comply or explain’ approach. Future success will be measured by companies following the substance, or spirit of the Code, and not just its form and by institutional shareholders and boards engaging more fully.
The new edition of the Code will apply to financial years beginning on or after 29 June 2010. The Code, and a report explaining the main changes, can be found at: http://www.frc.org.uk/corporate/ukcgcode.cfm
Chris Mallin 28th May 2010
One of the main areas in corporate governance that has caught the headlines recently is risk management. There is a widely held perception that in recent years many boards have not managed the risks associated with their businesses well – whether that was because they did not identify the risks fully or whether because having identified the risks, they did not take appropriate action to manage them.
Review of UK’s Combined Code
The Financial Reporting Council (FRC)’s Review of the UK’s Combined Code published in December 2009 http://www.frc.org.uk/corporate/reviewCombined.cfm states that ‘One of the strongest themes to emerge from the review was the need for boards to take responsibility for assessing the major risks facing the company, agreeing the company’s risk profile and tolerance of risk, and overseeing the risk management systems. There was a view that not all boards had carried out this role adequately and in discussion with the
chairmen of listed companies many agreed that the financial crisis had led their boards to devote more time to consideration of the major risks facing the company.’ The FRC therefore proposes to make the board’s responsibility for risk more explicit in the Code through a new principle and provision. Moreover it also intends to carry out a limited review of the Turnbull Guidance on internal control during 2010.
Many companies, and especially those in the financial sector, have already established risk committees whilst other companies especially smaller companies, may combine the consideration of risk with the role and responsibilities of the audit committee.
Alternative investment market
The UK’s Alternative Investment Market (AIM) expanded rapidly during the 12 years following its inception in 1995. Then from 2007 onwards it went into decline. David Blackwell, in his article ‘Signs of recovery seen after years of famine’ (FT, page 23, 16th December 2009) states that ‘Hundreds of companies have left the market, the number of flotations has collapsed and fines for Regal Petroleum and others – albeit for regulatory infringements dating back years – have once again sullied the market’s reputation’. Nonetheless he points out that 2009 saw an improvement with the AIM index rising by 62 per cent over the year compared to a rise of 22 per cent in the FTSE 100.
The lighter regulatory touch on AIM has both attractions and drawbacks. On the one hand, companies find it easier to gain a London listing (albeit on AIM rather than the main market); on the other hand, this may bring concomitant risks for investors as they will be investing in companies which may well be riskier than their main market counterparts.
Family firms are the dominant form of business in many countries around the world and range from very small businesses to multinational corporations. Richard Milne in his article ‘Blood ties serve business well during the crisis’ (FT, Page 19, 28th December 2009) points out that the attributes of a typical family business will have stood it in good stead during the recent financial crisis: ‘Long-term thinking, conservative, risk-averse: the very characteristics of the typical family business seem to be the ones needed in the economic crisis of the past two years’. Given that they tend to be more conservative, family firms will take less risks, for example, by not over extending themselves with their gearing (leverage).
Banks and financial institutions
Many banks and financial institutions were widely criticised because of the perceived overly generous bonuses paid to some executive directors and senior management at a time when the world is suffering the consequences of a global financial crisis precipitated by bankers who did not seem to fully appreciate the risks involved with some of the products they were trading in. And yet already we see banks again paying out enormous bonuses. Megan Murphy in her article ‘Tycoon attacks return of bankers’ bonuses’ (FT, Page 3, 28th December 2009) quotes Guy Hands, the private equity tycoon, who is highly critical of these big bonuses and speaks of bankers ‘taking home “wheelbarrows of money” on the back of taxpayers’ support’. Moreover he is quoted as saying ‘It cannot be right to continue with a system that allows risk to be taken in the knowledge that, if things go right, bankers will take on average 60-80 per cent of the profits generated through compensation and, if they go wrong, shareholders and ultimately the government will pick up the costs’.
Managing risk is, of course, relevant to all parties in the business and financial world as the article by Sophia Grene ‘Managing risk is the main task ahead’ (FTfm, Pg 1, 4thJanuary 2010) illustrates. In her article, Sophia points out that ‘many financial models failed in the past two years as markets demonstrated they did not behave according to conventional assumptions’ and that ‘the main challenge for asset managers in the coming decade is understanding, managing and communicating risk’.
Managing risk and managing it well is an important consideration for boards of directors, whether in main market firms, second tier markets, or family firms. Firms, and especially those in the banking and financial sector, need to pay particular attention to executive director remuneration packages which should not encourage adverse decision-making in terms of the impact on risk, that is, remuneration packages should be designed so that they do not lead to unacceptable risk-taking which may be to the detriment of the long-term sustainability of the company and potentially, as we have already seen, the wider economy.
Please refer to the newly published third edition of my book ‘Corporate Governance’ for updates to various national and international corporate governance codes and guidelines; board committees including risk and ethics committees; the Alternative Investment Market (AIM); family firms; remuneration packages, and the global financial crisis.
In addition, new material on many other areas including: private equity and sovereign wealth funds; governance in NGOs, public sector/non-profit organisations, and charities; and board diversity. Many examples, mini case studies and clippings from the Financial Times are included to illustrate the application of corporate governance in the real world.
Chris Mallin 7th January 2010
Widespread concern at the high levels of executive director remuneration has led to calls for wider adoption of a ‘say on pay’ in the US. Investors in the UK and Australia have, for many years, had the right to vote on the remuneration committee report of the companies in which they invest. The vote on the remuneration committee report is an advisory one meaning that it is not binding on the company. However in practice institutional investors have tended not to vote against the remuneration committee reports and on the -until recently – relatively rare occasions on which the remuneration committee report was voted against, it was seen as a strong signal of disapproval about some aspect of executive remuneration and one which the directors would be unwise to ignore.
Royal Bank of Scotland
It was no surprise to anyone that the Royal Bank of Scotland shareholders overwhelmingly rejected the banks remuneration committee report at the companies Annual General Meeting on 3rd April. Jane Croft and Andrew Bolger (FT, Page 12, 4/5th April 09) in their article ‘Thumbs down for RBS pay report’ stated that some 90.42% of votes cast rejected the report. UK Financial Investments Ltd (UKFI) the Government owned company which manages the taxpayers’ shareholding in RBS, and controls 58% of the RBS shares, voted against the report. Manifest, the proxy voting agency, stated that ‘the resolution on the remuneration report at Royal Bank of Scotland Group plc represents the highest ever “Total Dissent” vote on the remuneration report since the introduction of the requirement for the report to be put forward to a non-binding vote’.
Remuneration (compensation) committees
Remuneration committees have previously been criticised for having a ratcheting effect on executive directors’ remuneration. The composition of such committees is usually independent non-executive (outside) directors but nonetheless this has not stopped the increasing levels of executive remuneration. This is probably in part attributable to the fact that remuneration committees would tend to recommend remuneration for executive directors in the upper quartile of their peer group hence the ratcheting effect over time. The Corporate Library points out that, in the US, chief executives pay rose 24 percent in 2007 giving a median remuneration of $8.8 million.
Trade Unions Involvement
An interesting development is for trade unions calling for more worker involvement in setting top executive pay. Brian Groom (FT, Page 3, 6th April 09) in his article ‘TUC leader urges staff input over chiefs’ pay’ highlights that Brendan Barber, General Secretary of the Trade Union Congress (TUC), stated ‘there was “massive anger” among workers at paying the price for a recession made in the boardroom, not on the shop floor’. The directors of FTSE 100 companies came in for criticism as well as the directors of banks, with Mr Barber arguing for ‘workforce representation involved in remuneration committees of major companies’. The idea of representation of the workforce on the board or board committees has traditionally not been given much consideration by UK boards but maybe that might change in the future.
Another are where we may see change is in relation to shareholder proposals or resolutions. Although it is possible in the UK for shareholders to put forward shareholder proposals or resolutions, it is not that easy to do and hence dialogue has been the most frequently used tool of corporate governance with shareholder proposals maybe numbering just five or six a year.
In the US it is much easier to put forward a shareholder proposal and so we can see 800 or 900 of these each year in US companies. It is likely that in the future more of these shareholder proposals will be relating to executive remuneration and that they will achieve strong support from institutional investors who are increasingly being criticised for not having taken more action to help limit executive remuneration. Francesco Guerrera and Deborah Brewster in their article (FT, Page 21, 6th April 09) ‘Mutual funds helped to drive up executive pay’ highlight that mutual funds have tended to vote in favour of companies compensation plans and this has effectively sanctioned these spiralling executive remuneration packages. Kristin Gribben (FTfm, Page 5, 6th April 09) in ‘Pay proposals to dominate proxy season’ puts forward the view that, in future, mutual funds in the US will be more likely to support remuneration (compensation) related resolutions filed by shareholders.
There is concern that some companies may seek to remuneration executive directors via the ‘back-door’ if, for example, bonus schemes do not pay out. Pauline Skypala (FTfm, Page 2, 6th April 09) in ‘Warning over “back-door” pay’ highlights that this is a concern to some investors including Co-operative Asset Management whose corporate governance manager, Paul Wade, states ‘If a company fails to create value for its shareholders, it is totally inappropriate to grant rewards to management that are disproportionate to shareholder returns’.
With the continuing focus on executive directors’ remuneration packages, the forthcoming AGMs promise to give rise to many interesting debates, much emotive discussion, more shareholder proposals, and many more instances where ‘say on pay’ will result in an emphatic ‘no’ to excessive remuneration or remuneration which does not have appropriately stretching performance links.
Chris Mallin 6th April 2009.
Corporate governance has been gaining more predominance around the world over the last decade. However the last year or so which has brought the financial crisis and the ‘credit crunch’ has seen an unprecedented interest in some of the areas that are central to corporate governance: executive remuneration; boards of directors, independent non-executive directors; internal controls and risk management; the role of shareholders.
However the focus on these areas has brought into sharp relief some of the failings of the present system whether these have been brought about by greed, naivity, or a lack of real appreciation of the risk exposures of banks.
Whilst many would agree that bankers have received huge payouts, often for a seeming failing company, bonuses appear likely to be cut, possibly by around 40% or more. Peter Thal Larsen and Adrian Cox (FT, Page 13, 07/08 Feb 09) in their article ‘Barclays bankers braced for bonus cut’ highlight that even much reduced bonuses are likely to be controversial given that feelings are running high amongst the public and politicians alike.
The generous remuneration packages of executive directors of some of the UK’s largest banks have caught the headlines day after day in recent weeks. In their article ‘Former executives face bonus grilling’ (FT Page 2, 9th Feb 09), George Parker and Daniel Thomas mention an interesting historical fact ‘in the early 18th century, after the bursting of the South Sea bubble, a parliamentary resolution proposed that bankers be tied up in sacks filled with snakes and thrown into the River Thames’! No doubt there are those who wish the same might happen today although a grilling before the Commons Treasury Committee may prove to be almost as unpleasant an experience!
Adrian Cox’s article ‘Barclays executives must wait longer for bonuses’ (FT, page 2, 11th Feb 09) highlights that Barclays is trying to design a pay structure that retains staff whilst rewarding long-term performance at a time when banks have been urged to show ‘moral responsibility’ in their remuneration structures. The pay restructuring will affect not just directors but also senior employees, and other banks including UBS, Credit Suisse, RBS and Lloyds are in a similar position.
‘Former HBOS chiefs accused over risk controls as bankers apologise’ was the striking head of the article by Jane Croft, Peter Thal Larsen and George Parker (FT, page 1, 11th Feb 09). Under questioning from the Commons Treasury Committee, Lord Stevenson, Andy Hornby, Sir Tom McKillop and Sir Fred Goodwin all apologised for what had happened at RBS. Part of the questioning brought to light that a former employee had warned the board of potential risks associated with the bank’s rapid expansion.
Risk management is an area that is bound to gain a higher profile given the extent of the impact of the use of toxic assets which many feel were not well understood.
Where were the institutional shareholders?
Lord Myners, the City minister, has urged shareholders to challenge banks ‘Myners calls on shareholders to challenge reward cultures’ by Adrian Cox and Kate Burgess (FT page 3, 10th Feb 09). Lord Myners, they state, said that’ institutional investors should look at the content of remuneration reports and ask questions if the data are complex or opaque’.
My view is that it is an ongoing debate as to what extent institutional shareholders should intervene in the affairs of the companies in which they invest (investee companies). It is widely recognised that engagement and dialogue are useful and necessary for an institutional investor to monitor the activities of investee companies. However there is a line to be drawn between what it is feasible – and desirable – for the institutional shareholders to do, and what might be seen as undesirable and restrictive.
Sophia Grene article ‘Funds say they did all they could to warn banks’ (FT, page 9, 8th Feb 09) highlights the view of the UK’s Investment Management Association that ‘fund managers did all they could to prevent banks hurtling to their doom, but under the current system, shareholders cannot shout loud enough to be heard’ The IMA also indicated a possible way forward for the future ‘investors can only do so much…..maybe we need to take a closer look at how investors and non-executive directors interact. They’re privy to much more information than the investors’.
Walker Review of the Corporate Governance of the Banking Industry
Sir David Walker has been appointed to lead a review of the corporate governance of the banking industry which will look into remuneration and bonuses, risk management and board composition. The terms of reference can be found at:
In the US, President Obama has brought in reforms to limit the remuneration of executives to $500,000 at banks which have had a bail out. Shares could also be given under incentive plans but would only vest once government support had been repaid, ‘Obama gets tough on pay for executives’, Alan Beattie and Edward Luce (FT page 1, 5th Feb 09).
An unprecedented economic crisis now dominates the world economy. Comparisons with previous recessions or the great depression of the 1930s miss the point. The world economy has never been in a situation like this before. Global companies are larger, more complex and interdependent than ever before, financial markets are vast and interrelated in a way previously unknown, and questions of corporate governance – the way power is exercised over all types of corporate entity – are being asked as never before. Consider a few:
- Where were the directors of the failed financial institutions?
- Why did their independent outside directors not provide the check on over-enthusiastic executive directors, that they are supposed to?
- Did the directors really understand the strategic business models and sophisticated securitised instruments involved?
- Did they appreciate the risk inherent in their companies’ strategic profile?
- Where were the auditors?
- In approving the accounts of client financial institutions did they fully appreciate and ensure the reporting of exposures to risk? Expect some major legal actions as client companies fail. Hopefully, we shall not see another Arthur Andersen – there are only four global accounting firms left!
- Did the credit agencies contribute to the problem by awarding high credit ratings to companies exposed to significant risk? Expect some major changes here.
- Government bailouts of failing banks have produced near nationalised conditions in some cases. That turns governments into major institutional investors. (The Chinese government is the world’s largest institutional investor: maybe there are some insight there – see chapter 8)
- Government bailouts also raise the ethical issue of so-called moral hazard; by protecting bankers from their past reckless decisions, would others be encouraged to take excessive risks in the future?
- Will the experts who designed the sophisticated loan securitisation vehicles and other financial engineering systems be held to account? Are their ideas and enthusiasms now under control? This key issue has not yet been addressed.
- Where were the banking regulators? Although the extent of the crisis is unprecedented, the regulators seem to have been beguiled into complacency. There is some evidence that they might have been taken-over by the industry they were there to regulate. New rules are inevitable. But remember, the US Sarbanes and Oxley Act, drafted hurriedly in response to the Enron collapse and the loss of confidence in the market, has proved far more expensive than expected and has not been entirely successful, as we are now seeing.
- Were any of the financial institutions’ activities illegal? Compare the situation with Enron, where some top executives continued to believe that nothing they had done was wrong, even as they approached jail. No doubt there are investigators pursuing this question right now.
- Finally, did excessive bonuses and share options encourage short-term and unrealistic risk-taking with shareholders funds? Predictably, this has been a major focus of the tabloids. In the future, some control is likely on performance related remuneration. The news that some bankers had lost their fortunes as share prices collapsed was cold comfort to mortgagees who lost their homes, shareholders who lost their savings and employees who lost their livelihoods.
It is fascinating to see that the subject of corporate governance, though not always mentioned as such, has become central to political, social and economic thought.