The conference considered whether corporate governance principles and practices around the world were converging.  Would a set of world-wide, generally-accepted corporate governance principles eventually emerge?  Or was differentiation between corporate governance practices inevitable because of fundamental differences in country cultures?  

Speaking at the conference the writer of this blog suggested that:

“A decade or so ago, it was widely thought that corporate governance practices around the world would gradually converge on the United States model.   After all, the US Securities and Exchange Commission had existed since 1934, sound corporate regulation and reporting practices had evolved, and American governance practices were being promulgated globally by institutional investors.  But that was before the collapse of Enron, Arthur Andersen, the sub-prime financial catastrophe, and the ongoing global economic crisis.  A decade ago it was also believed that the world would converge with US practices because the world needed access to American capital. That is no longer the case. So the convergence or differentiation question remains unanswered. 

Forces for convergence

“Consider first some forces that are leading corporate governance practices around the world to convergence.

Corporate governance codes of good practice around the world have a striking similarity, which is not surprising given the way they influence each other.  Though different in detail, all emphasise corporate transparency, accountability, reporting, and the independence of the governing body from management, and many now include strategic risk assessment and corporate social responsibility.  The codes published by international bodies, such as the World Bank, the Commonwealth of Nations, and OECD, clearly encourage convergence.  The corporate governance policies and practices of major corporations operating around the world also influence convergence.

Securities regulations for the world’s listed companies are certainly converging.  The International Organisation of Securities Commissions (IOSCO), which now has the bulk of the world’s securities regulatory bodies in membership, encourages convergence.  For example, its members have agreed to exchange information on unusual trades, thus making the activities of global insider trading more hazardous. 

International accounting standards are also leading towards convergence.  The International Accounting Standards Committee (IASC) and the International Auditing Practices Committee (IPAC) have close links with IOSCO and are further forces working towards international harmonization and standardization of financial reporting and auditing standards.   US General Accepted Accounting Principles (GAAP), though some way from harmonization, are clearly moving in that direction.

In 2007, The US Securities and Exchange Commission announced that US companies could adopt international accounting standards in lieu of US GAAPs.   However, American accountants and regulators are accustomed to a rule-based regime and international standards are principles-based requiring judgement rather than adherence to prescriptive regulations.

Global concentration of audit for major companies in just four firms, since the demise of Arthur Andersen, encourages convergence.  Major corporations in most countries, wanting to have the name of one of the four principal firms on their audit reports, are then inevitably locked into that firm’s world-wide audit, risk analysis and other governance practices.

Globalisation of companies is also, obviously, a force for convergence. Firms that are truly global in strategic outlook, with world-wide production, service provision, added-value chain, markets and customers, which call on international sources of finance, whose investors are located around the world, are moving towards common governance practices. 

Raising capital on overseas stock exchanges, also encourages convergence as listing companies are required to conform to the listing rules of that market. Although the governance requirements of stock exchanges around the world differ in detail, they are moving towards internationally accepted norms through IOSCO.

International institutional investors, such as CalPers, have explicitly demanded various corporate governance practices if they are to invest in a specific country or company. Institutional investors with an international portfolio have been an important force for convergence.  Of course, as developing and transitional countries grow, generate and plough back their own funds, the call for inward investment will decline, along with the influence of the overseas institutions.

Private equity funding is changing the investment scene.  Owners of significant private companies may decide not to list in the first place. Major investors in public companies may find an incentive to privatise. Overall the existence of private equity funds challenges boards of listed companies by sharpening the market for corporate control. 

Cross-border mergers of stock markets could also have an impact on country-centric investment dealing and could influence corporate governance expectations; as could the development of electronic trading in stocks by promoting international securities trading.

Research publications, international conferences and professional journals can also be significant contributors to the convergence of corporate governance thinking and practice.            

Forces for differentiation

“However, despite all these forces pushing towards convergence, consider others which, if not direct factors for divergence, at least cause differentiation between countries, jurisdictions and financial markets.

Legal differences in company law, contract law and bankruptcy law between jurisdictions affect corporate governance practices.  Differences between the case law traditions of the US, UK and Commonwealth countries and the codified law of Continental Europe, Japan, Latin America and China distinguish corporate governance outcomes.

Standards in legal processes, too, can differ.   Some countries have weak judicial systems. Their courts may have limited powers and be unreliable.  Not all judiciaries are independent of the legislature.  The state and political activities can be involved in jurisprudence. In some countries bringing a company law case can be difficult and, even with a favourable judgement, obtaining satisfaction may be well nigh impossible.                

Stock market differences in market capitalisation, liquidity, and markets for corporate control affect governance practices.  Obviously, financial markets vary significantly in their scale and sophistication, affecting their governance influence.

Ownership structures also vary between countries, with some countries having predominantly family-based firms, others have blocks of external investors who may act together, whilst some adopt complex networked, leveraged chains, or pyramid structures.

History, culture and ethnic groupings have produced different board structures and governance practices. Contrasts between corporate governance in Japan with her keiretsu, Continental European countries, with the two-tier board structures and worker co-determination, and the family domination of overseas Chinese, even in listed companies in countries throughout the Far East, emphasise such differences.  Views differ on ownership rights and the basis of shareholder power.

The concept of the company was Western, rooted in the notion of shareholder democracy, the stewardship of directors, and trust – the belief that directors recognise a fiduciary duty to their company.  But today’s corporate structures have outgrown that simple notion.  The corporate concept is now rooted in law, and the legitimacy of the corporate entity rests on regulation and litigation. The Western world has created the most expensive and litigious corporate regulatory regime the world has yet seen.  This is not the only approach; and certainly not necessarily the best.  The Asian reliance on relationships and trust in governing the enterprise may be closer to the original concept.   There is a need to rethink the underlying idea of the corporation, contingent with the reality of power that can (or could) be wielded.  Such a concept would need to be built on a pluralistic, rather than an ethnocentric, foundation if it is to be applicable to the corporate groups and strategic alliance networks that are now emerging as the basis of the business world of  the future. 

Around the world, the Anglo-Saxon model is far from the norm. A truly global model of corporate governance would need to recognise alternative concepts including:

• the networks of influence in the Japanese keiretsu
• the governance of state-owned enterprises in China, where the China Securities and Regulatory Commission (CSRC) and the State-owned Assets Supervision and Administration Commission (SASAC) can override economic objectives, acting in the interests of the people, the party, and the state, to influence strategies, determine prices, and appoint chief executives
• the partnership between labour and capital in Germany’s co-determination rules
• the financially-leveraged chains of corporate ownership in Italy, Hong Kong and elsewhere
• the power of investment block-holders in some European countries
• the traditional powers of family-owned and state-owned companies in Brazil
• the domination of spheres of listed companies in Sweden, through successive generations of a family, preserved in power by dual-class shares
• the paternalistic familial leadership in companies created throughout Southeast Asia by successive Diaspora from mainland China
• the governance power of the dominant families in the South Korean chaebol, and
• the need to overcome the paralysis of corruption from shop floor, through boardroom, to government officials in the BRIC and other nations.

The forces for convergence in corporate governance are strong. At a high level of abstraction some fundamental concepts have already emerged, including the need to separate governance from management, the importance of accountability to legitimate stakeholders, and the responsibility to recognize strategic risk. These could be more widely promulgated and adopted. But a global convergence of corporate governance systems at any greater depth would need a convergence of cultures and that seems a long way away.

Bob Tricker

5.11.2011

Benefits and costs

The International Corporate Governance Network (ICGN) Securities Lending Code of Best Practice (2007) identifies the potential benefits but also the potential corporate governance implications of stock lending.  Benefits of stock lending include that it ‘improves market liquidity, reduces the risk of failed trades, and adds significantly to the incremental return of investors.’  However, there are potentially significant adverse effects on corporate governance in terms of shareholders’ voting rights. The ICGN state ‘Misconceptions as to its [stock lending] nature have led to loss of shareholder votes in important situations, as well as to cases of shares being voted by parties who have no equity capital at risk in the issuing company, and thus, no long-term interest in the company’s welfare. Lenders’ corporate governance policies may also be undermined through lack of coordination with lending activity. It is also imperative that there be as little risk as possible that a poll of the shareholders may be compromised through misuse of the borrowing process.’ The issues identified by the ICGN are very real ones which may have heightened importance in situations where investors are voting on contentious issues.  Resolutions which otherwise may have failed to be passed, may be passed because of the way in which votes secured through stock lending have been cast, and vice versa.

Pauline Skypala in her article ‘Securities lending – kept from view’ (FTfm, Page 6, 5^th September 2011) points out that last year the Pensions Regulator advised pension fund trustees and others managing schemes they should be aware of whether scheme assets could be lent and on what terms. In particular, they should know how much of the income earned was passed on to the scheme.

Ellen Kelleher in her article ‘Inquiries starting into “empty voting”’ (FTfm, Page 3, 26^th September 2011) gives the example of an activist hedge fund which might briefly borrow shares in a company purely to vote in favour of its takeover at the next general meeting.  This would be legitimate in most markets but can hardly be called best practice.

SCM Private, an actively managed passive investment firm, carried out research which revealed that UK retail fund managers controlling over £241 billion may lend out up to 100% funds but investors would be kept in the dark.  Furthermore, levels of disclosure, transparency and protection within current legislation are, SCM find, totally inadequate. http://www.scmprivate.com/content/file/pressreleases/press-release-scm-private-stock-lending-release-01-september-2011.pdf

Meanwhile the Investment Management Association (IMA) has defended stock lending pointing out that they are happy with the level of disclosure required.

ICGN basic tenets of best practice

Lenders and borrowers would do well to take note of the ICGN Securities Lending Code of Best Practice (2007) basic tenets of best practice:

1. All share lending activity should be based upon the realisation that lending inherently entails transfer of title from the lender to the borrower for the duration of the loan.

2. During the period of a stock loan, lenders may protect their rights only with the borrower, since they have no rights with the issuer of the shares which have been lent.

3. Institutional shareholders should have a clear policy with respect to lending, especially insofar as it involves voting.

4. Lending policy should be mandated by the ultimate beneficial owners of an institution’s shares.

5. Where lending activity may alter the risk characteristics of a portfolio, the policy should state the extent to which this is permitted.

6. The returns from lending should be disclosed separately from other investment returns when reporting to clients or beneficiaries. They should not be hidden under management and other costs.

7. It is bad practice to borrow shares for the purpose of voting. Lenders and their agents, therefore, should make best endeavours to discourage such practice.

Concluding comments

Stock lending has ramifications in a number of areas including fee income, portfolio risk, and voting rights. Lenders have a responsibility to be aware of the full implications of lending their shares and borrowers should not borrow shares with the intention of using the attached voting rights to circumvent corporate governance best practice.

 Chris Mallin 16^th October 2011

The News Corporation case
News Corporation (NewsCorp) is a media conglomerate, founded by Rupert Murdoch in Australia in 1979. In 2010, the company, now head-quartered in New York, had world-wide revenues of over $30 billion, profits of over $2.5 billion, and over 50,000 employees. The company’s main revenues come from cable networks, with the Fox News channel, and filmed entertainment. Publishing, including newspapers, accounted for less than 20%. NewsCorp shares are listed on NASDAQ and the Australian Securities Exchange.

Rupert Murdoch, born in 1931, has enjoyed unrivalled political influence around the world, being described by the Economist (23.7.11) as “a press baron, a manipulator of politicians, and a king maker.” The Murdoch family dominate the control of NewsCorp using dual-class shares. The ‘A’ shares, which account for 70% of the equity, have no voting rights, and consequently the holders of these shares have no say in board-level appointments. The B shares, which account for 30% of the equity, carry all the votes. The Murdoch family control about 39% of these voting shares, giving them unassailable control

News International Ltd. is the wholly-owned British subsidiary of NewsCorp, publishing the “The Times” newspaper, and the “News of the World”. The chairman of News International is James Murdoch, born in 1972, who is Rupert Murdoch’s son.

The seventeen directors of NewsCorp include nine who are nominally independent, but whose length of service and connections would make that definition doubtful in some corporate governance codes. They are:
Rupert Murdoch, Chairman and Chief Executive Officer, NewsCorp
José María Aznar, independent director. Former President of Spain. President,
Foundation for Social Studies and Analysis
Natalie Bancroft, 34, independent director, member of the family that controlled
Dow Jones and Wall Street Journal prior to their disputed take-over
by NewsCorp
Peter Barnes, independent director, Chairman of Ansell Limited a US-based and
Australian-registered maker of industrial gloves
Chase Carey, Deputy Chairman, President and Chief Operating Officer, NewsCorp
Kenneth E. Cowley, independent director, Chairman, R.M. Williams Holdings Pty.
Limited
David F. DeVoe, Chief Financial Officer, NewsCorp
Viet Dinh, 43, independent director and chairman NewsCorp Nominating and
Corporate Governance Committee. Professor of Law, Georgetown
University. Having fled war torn Vietnam, he served as assistant attorney general under President George Bush
Rod Eddington, independent director appointed in 1999. Chairman for Australia and New Zealand, J.P. Morgan. Former chief executive of British Airways
and of Australia’s Ansett Airlines. Said to have been mentor to Rupert
Murdoch’s son Lachlan, who is also a NewsCorp director
Joel Klein, Executive Vice President, CEO, Education Division, NewsCorp
Andrew S.B. Knight, independent director. Chairman, J. Rothschild Capital
Management Limited
James Murdoch, Deputy Chief Operating Officer, NewsCorp
Chairman and CEO, International News Corporation
Lachlan Murdoch, Executive Chairman, Illyria Pty Ltd
Thomas J. Perkins, independent director. Partner, Kleiner, Perkins, Caufield & Byers
Arthur M. Siskind, Senior Advisor to the Chairman, NewsCorp
John L. Thornton, independent director appointed in 2004. Professor and Director of
Global Leadership, Tsinghua University of Beijing. Formerly Chief Operating Officer of Goldman Sachs and an independent director of HSBC involved in power struggles at board level.
Stanley S. Shuman (Director Emeritus), Managing Director, Allen & Company LLC
Source: www.newscorp.com/corp_gov/bod.html

The matter of succession has been raised by some analysts. The possibility of a dynasty passing from father to son was questioned, and the suggestion made that Rupert Murdoch move to non-executive chairman and a new appointment made as CEO. The name of Chase Carey, currently COO NewsCorp, was often mentioned.

Details of the board committees can be found at: www.newscorp.com/corp_gov/bc.html, which also provides access to the charters of those committees, including the Nomination and Corporate Governance Committee. The News Corporation Statement of Corporate Governance is at www.newscorp.com/corp_gov/socg.html

NewsCorp publish the group’s standards of business conduct, which can be accessed at www.newscorp.com/corp_gov/subc.hrml
The concern for ethical conduct is reflected in a letter from Rupert Murdoch, Chairman and Chief Executive Officer:

Dear Colleagues:
For more than a half century, News Corporation has shaped global media by ensuring the public’s needs are met and that our offerings are of the highest caliber. Today, hundreds of millions of people around the world trust us for the best quality and choice in news, sports and entertainment.
This public trust is our Company’s most valuable asset: one earned every day through our scrupulous adherence to the principles of integrity and fair dealing.
We have revised this Standards of Business Conduct to make it easier to read and use, and to clearly outline what we should all expect of ourselves as colleagues. Each of us has the power to influence the way our Company is viewed, simply through the judgments and decisions we each make in the course of an ordinary day.
It’s an important responsibility and I’m honored to share it with you.
Rupert Murdoch
Source: www.newscorp.com/corp_gov/sobc_letter.html

Disaster strikes NewsCorp and its subsidiary News International
In July 2011 the best-selling British Sunday newspaper, the “News of the World”, was closed after 168 successful years. For some years, the company had faced damaging allegations of telephone hacking to obtain stories, but had claimed that this was the work of a single rogue, free-lance investigator, who went to jail. But subsequently it emerged that the practice was widespread and known to senior executives. The public were not too concerned when they believed that the hacked telephones belonged to entertainment and sports stars, and other celebrities. But when it emerged that the journalists had intercepted voice messages of a missing 13 year-old school girl, Milly Dowler, who was subsequently found murdered, the public mood changed. Worse, it was discovered that journalists had deleted messages from her cell phone to make more space for subsequent material, leading her parents to believe she was still alive. Evidence emerged that telephone hacking to obtain stories was widespread and ran to thousands, including families of soldiers killed in Iraq and Afghanistan and people killed in the terrorist bombings in London. It was then alleged that large sums had been paid to celebrities, who had discovered that their voice mails had been listened to by the “News of the World”, to settle actions for breach of privacy. On 19 July 2011, Rupert and James Murdoch were summoned before a committee of the British House of Commons to answer questions. Rupert Murdoch said that “this is the most humble day of my career”

Worse was to come, when it appeared that payments had been made to police for information. This raised the possibility of prosecution for bribery under the American Foreign Corrupt Practices Act. Some senior police officers resigned.

The BSkyB deal fails
News International owned 39% of the company BSkyB, which ran the successful British satellite Sky TV station. James Murdoch was chairman of BSkyB. In early 2011, New International bid for the remaining shares. Expectations were high that the bid would be approved by the UK broadcasting and competition authorities, and accepted by the shareholders. However, the saga over telephone hacking and payments to police caused the government to block the bid, which was abandoned on 14 July 2011. News Corp shares plunged 7%, wiping $3bn. off its market value. Nevertheless, on 29 July 2011, the BSkyB board of directors unanimously voted for James Murdoch to remain as chairman.

Some questions inevitably arise
1. How can the disreputable behaviour have occurred at the News of the World when the Group had such a clear commitment to high standards of conduct?
2. As the top executives of the subsidiary and the holding companies respectively, should either James or Rupert Murdoch be held responsible, for the bad behaviour in a relatively small and not very significant part of the Group?
3. Is the use of dual class shares to maintain a family’s domination over a public company really desirable? Is it right that the ‘A’ shares, which account for 70% of the equity, have no voting rights and therefore no say in board-level appointments?

Bob Tricker 8 September 2011

Recent trends

The latest Manifest and MM&K Total Remuneration Survey 2011 finds little link between remuneration, performance and shareholder value, reporting that the median FTSE100 CEO remuneration increased by 32% to £3.5million in 2010 compared to 2009, whilst the FTSE100 index only rose 9% over the same period.  Moreover over a 12 year time horizon, CEO remuneration has quadrupled whilst share prices have been flat.

In the US, the BDO 600: 2011 Survey of Board Compensation Practices of 600 Mid-Market Public Companies reported that ‘director pay in the middle market is up seven percent, reflecting the increased responsibilities, time commitment, and regulatory issues – such as the Dodd-Frank Act – that boards face today’. The report states that these factors, coupled with a rebounding stock market, have allowed companies to increase director pay to $110,155, up from $102,809 in 2009, and that much of this increase can be attributed to a greater use of full-value equity vehicles, which are up 22% from last year, indicating that the recovering stock market is adding to compensation growth overall.

Issues of concern

Concern has been expressed at a number of companies where shareholders have thought that executive directors would receive remuneration in excess of what they deserved in relation to their performance or in relation to the company’s performance.  For example, Andrew Parker in his articles (FT, Page 17, 29^th June 2011 ‘Strategy and pay fuel anger at C&WW’ and FT, Page 15, 5^th July 2011 ‘Amber-top alert over C&W pay’) highlighted that the Association of British Insurers (ABI) issued an ‘amber top’ to alert shareholders about a number of issues at C&W including aspects of the planned new pay scheme at C&W Worldwide.  The ABI was concerned that ‘given C&W Worldwide’s depressed stock price, the chief executive and finance director could be awarded too many performance shares’.

Robert Wright in his article (FT, Page 4, 24^th June 2011) ‘Ex-rail chief defends £1m payoff’ stated that that Mr Coucher, the former CEO of Network Rail, had defended the £1.07m payout that he received on leaving the company saying that it represented a payment in lieu of his notice period and the bonuses he would have received if he had been allowed to work his notice period after resigning. 

In some companies chief executives have forfeited their bonus if the company has not performed to expected standards.  In his article (FT, Page 16, 28^th June 2011) ‘TalkTalk struggles see chief’s bonus cut’, Andrew Parker pointed out that Dido Harding, chief executive of TalkTalk, had secured only 20% of her maximum potential bonus in 2010/11 as there were ‘acute customer service problems’.  Justin King, the CEO of J. Sainsbury, saw his salary and bonus fall significantly because the company did not achieve key profit targets, reported Andrea Felsted (FT, Page 19, 8^th June 2011) ‘Sainsbury chief’s pay drops sharply after missed targets’.

Elsewhere Vodafone has decided to place more emphasis on profit improvement in its executive pay plan.  Andrew Parker in his article (FT, page 20, 2^nd June 2011) ‘Vodafone refocuses executive pay plan’, reported that greater account would be taken in future of profit-based targets by reducing the relative importance of revenue-based targets.

Banking and insurance sector

In the banking and insurance sector, some banks have slashed cash bonuses, for example, Michiyo Nakamoto reported in his article (FT, Page 15, 4-5 June 2011) ‘Nomura slashes cash bonuses’  that Japan’s largest investment bank, Nomura, had slashed the cash bonuses paid to its top executives and directors by 95% after suffering a decline in profits and its share price.  As a result only 6 out of 23 directors/executives received a cash bonus in the year to March 2011.  Patrick Jenkins reported in his article (FT, page 19, 1^st July 2011) ‘Europe’s banks and insurers lead in withholding bonuses’, that nearly three-quarters of banks and insurers in Europe have introduced a system to withhold bonuses from staff if their performance does not match up to expectations.  One of the contributors to the financial crisis was thought to be overly generous short-term bonuses, and many banks have decided to put in place a system of deferred payments. There are also malus or clawback arrangements which may be used, for example, for a breach of code of conduct.

Increased use of ‘say on pay’

The use of ‘say on pay’, whereby shareholders have an advisory vote on executive pay proposals (remuneration committee report), has been utilised much more in recent months.  Tim Bradshaw and Kate Burgess (FT, page 20, 3^rd June 2011) in their article ‘WPP suffers shareholder revolt over pay’ highlighted that WPP had a large shareholder revolt when over 40% of shareholders voted against the WPP pay policies. They report that one large fund manager stated ‘Investors are increasingly concerned by salary creep.  It is a topical issue at the moment.  Some companies seem to think after a couple of years of restraint that they can claw back the pay rises they would have got’.  Roger Blitz (FT, Page 19, 14^th June 2011) ‘William Hill expects fallout over chief’s pay deal’ points out that some 38% of votes cast either opposed or did not endorse the group’s remuneration report, with Ralph Topping, the Chief Executive, receiving a salary increase of 11% and shares worth £1.2m by way of a ‘golden handcuffs’ retention payment. 

In the US, the say on pay has also been used frequently in recent weeks, as Dan McCrum finds in his article (FT, Page 17, 6^th July 2011) ‘Shareholders quick to put ‘say on pay’ powers to work’. He reports that Hewlett-Packard and Jacobs Engineering saw their pay packages rejected outright whilst Monsanto and Northern Trust faced stiff shareholder protest votes, during this, the first year that large public companies have been required to have an advisory vote on executive compensation as part of the Dodd Frank legislation.

It may be that, with the advent of a more widespread use of say on pay in a number of markets, the days of golden executive remuneration packages are numbered.

Chris Mallin 13^th July 2011

The TEPCO case study
In an unlikely outburst, Naoto Kan, the Japanese prime minister, shouted “What the hell is going on?” to executives of the Tokyo Electric Power Company (TEPCO) following Japan’s worst nuclear crisis at the Fukushima Daiichi nuclear power plant, after the tsunami and earthquake on 11 March 2011. Were the directors or the corporate governance systems and procedures at fault?

The company appeared to have a commitment to sound corporate governance. As it stated on its web site:
“At TEPCO, we have developed corporate governance policies and practices as one of the primary management issues for ensuring sustainable growth in our business and long-term shareholder value. We believe in strengthening mutual trust through interactive communication with our valued stakeholders, including shareholders and investors, customers, local communities, suppliers, employees and the public, so we can move forward toward solid future growth and development. Therefore, TEPCO considers enhancing corporate governance a critical task for management and is working to develop organizational structures and policies for legal and ethical compliance, appropriate and prompt decision making, effective and efficient business practices, and auditing and supervisory functions.”

The TEPCO web site explains the company’s corporate governance processes:
“The Board of Directors currently comprises 20 directors, including 2 outside directors. Also, TEPCO has seven auditors, including four outside auditors. The Board of Directors generally meets once a month and holds additional special meetings as necessary. Based on interactive discussion with objective outside directors, the Board establishes and promotes TEPCO’s business and oversees its directors’ performance. TEPCO has also established the Board of Managing Directors, which meets once a week in principle, and other formal bodies to implement efficient corporate management through appropriate and rapid decision making on key management issues, including those deliberated by the Board of Directors. In particular, we have established internal committees to deliberate, adjust and plan the direction of the whole Company across a range of key management concerns, including internal control, CSR and system security, as well as stable electricity supply.”

“For more appropriate and quicker decision making, TEPCO also has the Managing Directors Meeting generally held once a week and other formal bodies to efficiently implement key corporate management issues, including those to be discussed by the Board of Directors. In particular, the Board has inter-organizational committees such as the Internal Control Committee, CSR Committee, System Security Measures Committee and Supply and Demand Measures Conference to intensively discuss directions of key management issues across the entire company.”

But behind the reassuring corporate governance explanations on the TEPCO web site lay a different reality. The company’s opaque handling of the situation at the stricken plant was widely criticized. The extent of the danger was minimized and the full extent of the damage only gradually became apparent, as the risk severity level was gradually increased to rank alongside Chernobyl as a most severe nuclear accident.

The effects in Japan included damaged to fishing and agriculture through radio-activity in sea and soil, disruption in manufacturing as power supplies were rationed, and longer-term strategic concerns about the future of nuclear power generation. Around the world, the effects included slow-downs in production as supplies of parts from Japan dried up, concerns about the safety of Japanese produce, and serious questioning about the safety and strategic future of nuclear power.

TEPCO’s handling of the incident exposed failings in its risk management systems. The company had a history of safety violations: in 2002, it falsified safety test records and in 2007, following an earthquake, its Niigata nuclear plant had a fire and a leak of radioactive water, which were concealed.

In fact the board was dominated by inside directors, qualified by their seniority within the company. Out of the 20 directors, 18 were insiders, whilst of the two nominally outside directors one of them, Tomijirou Morita, was chairman of Dai-Ichi Life Insurance, which was connected financially with TEPCO. In 2008, Tsunehisa Katsumata, the company president at the time of the 2007 problem, was elevated to chairman, being replaced by Masataka Shimizu, another career-long TEPCO employee. TEPCO had never appointed a head from outside the company.

TEPCO commentary
At first glance, the web site seems to reflect a company strongly committed to sound corporate governance: ‘corporate governance policies and practices a primary issue’, ‘interactive communication with our valued stakeholders’, ‘corporate governance a critical task’. So how to account for the discrepancies between the company’s alleged concern for corporate governance and the catastrophic failure of its Fukushima reactors?

Some clues can be found in the web site explanation of the company’s corporate governance. Notice the emphasis on ‘management’: ‘corporate governance is a primary management issue,’ ‘corporate governance (is) a critical task for management.’ The directors seem to make no distinction between management and governance. Nor is that surprising, because they are the same people. 18 of the directors are executives at the top of the management hierarchy, and one of the two alleged outside directors is not independent.

The classical model of Japanese corporations and their keiretsu groups reflects the social cohesion within Japanese society, emphasising unity throughout the organization, non-adversarial relationships, lifetime employment, enterprise unions, personnel policies encouraging commitment, initiation into the corporate family, decision-making by consensus, cross-functional training, and with promotion based on loyalty and social compatibility as well as performance.

In the classical Japanese model, boards of directors tend to be large and are, in effect, the top layers of the management pyramid. People speak of being ‘promoted to the board’. The tendency for managers to progress through an organization on tenure rather than performance means that the mediocre can reach board level. A few of the directors might have served with associated companies, others might have been appointed to the company’s ranks on retirement, or even from amongst the industry’s government regulators (known as a amakaduri or “descent from heaven”).

But independent non-executive directors, in the Western sense, would be unusual, although the proportion is increasing. Many Japanese do not see the need for such intervention “from the outside.” Indeed, they have difficulty in understanding how outside directors operate. “How can outsiders possibly know enough about the company to make a contribution,” they question, “when the other directors have spent their lives working for the company? How can an outsider be sensitive to the corporate culture? They might even damage the harmony of the group.” A study by the Japanese Independent Directors Network, in November 2010, showed that of all the companies on the Nikkei 500 index, outside directors made up 13.5% of the board, women 0.9% and non- Japanese 0.17%.

TEPCO fits this model perfectly.

However, the classical model of Japanese corporate governance is coming under pressure. With the Japanese economy facing stagnation in the 1990s, traditional approaches to corporate governance were questioned. A corporate governance debate developed and the stakeholder, rather than shareholder, orientated corporate governance model came under scrutiny. Globalisation of markets and finance put further pressure on some companies. The paternalistic relationship between company and lifetime ‘salary-man’ slowly began to crumble.

Some companies came under pressure from institutional investors abroad. Company laws were redrafted to permit a more US style of corporate governance. But few firms have yet embraced them. Signs of movement included calls in 2008 by eight international investment funds for greater shareholder democracy, and a report from the Japanese Council for Economic and Fiscal Policy to the prime minister proposing that anti-take over defences be discouraged and the take-over of Japanese firms be made easier.

Perhaps the TEPCO experience will encourage further moves towards enhanced corporate governance.

Bob Tricker 20 April 2011

 The report was awaited with much speculation especially as to whether he would recommend quotas whereby listed companies would have to have a certain proportion of female  board members (see the blog post below ‘Diversity in the Boardroom’ which highlighted some of the issues).  Brian Groom (FT, page 4, 21^st February 2011) ‘Drive for 20% women on boards’ reported that Lord Davies, had rejected quotas and that ‘only 11 per cent of submissions were in favour of quotas and the vast majority of women were vehemently opposed’ to quotas.  The report stated that ‘we have chosen not to recommend quotas because we believe that board appointments should be made on the basis of business needs, skills and ability’.

 From their consultation, the report identified that ‘the informal networks influential in board appointments, the lack of transparency around selection criteria and the way in which executive search firms operate, were together considered to make up a significant barrier to women reaching boards.’ Aiming to improve the situation and increase the number of women on boards, the report has made ten recommendations including, inter alia, that FTSE 100 companies should aim for a minimum of 25% female representation by 2015 and that all Chairman of FTSE 350 companies should set out the percentage of women they aim to have on their boards in 2013 and 2015; quoted companies should be required to disclose each year the proportion of women on the board, women in senior executive positions and female employees in the whole organisation; the Financial Reporting Council (FRC) should amend the UK Corporate Governance Code to require listed companies to establish a policy concerning boardroom diversity, including measurable objectives for implementing the policy, and disclose annually a summary of the policy and the progress made in achieving the objectives; investors to pay attention to the report’s recommendations as part of their central role in engaging with companies; and executive search firms should draw up a Voluntary Code of Conduct addressing gender diversity and best practice which covers the relevant search criteria and processes relating to FTSE 350 board level appointments. Moreover this steering board led by Lord Davies will meet every six months to consider progress against these measures and will report annually with an assessment of whether sufficient progress is being made. 

Companies themselves can provide support and encouragement through mentoring schemes.  Executive recruiters (or ‘headhunters’) also have a role to play as Gill Plimmer and Alison Smith (FT, page 4, 19^th/20^th February 2011) report in their article ‘Agencies to help break glass ceiling’.  The pressure is on for headhunters to put forward more women candidates to companies for consideration for board positions.  

Internationally, some countries have quotas, others do not.  As Joe Leahy (FT, page 10, 16^th February 2011) ‘Gender gap narrows in Brazil’ reports, women executives may find it easier to climb up the corporate promotions ladder in Brazil but getting to the top rung can still be very difficult. For example, in Brazil the percentage of women board directors is only 8%, and to be appointed to the CEO position is even more difficult. In the European context, Daniel Schäfer and Peggy Hollinger (FT, page 21, 21^st February 2011) ‘German groups brush off quota threat’ point out that in 2010 only 2.2 per cent of executive board members at Germany’s 30 blue-chip DAX companies were women. They also highlight that in Germany ‘until 1977 a husband was legally allowed to terminate his wife’s labour contract’! 

It remains to be seen whether the European Commission will impose quotas for the proportion of women on the boards of large listed companies in Europe.  For now there is no Europe wide quota system in place although this may change in future.  However there is much to be said for the view expressed in the Davies report ‘we believe that board appointments should be made on the basis of business needs, skills and ability’.

 Chris Mallin 1^st March 2011

Others argue that, in addition to the gender balance aspect, female directors bring their own strengths to the boardroom in terms of their life experience, their mode of thinking and their ways of dealing with both people and situations.  Some argue that there are positive financial benefits to have more women on the board, whereas others state that the benefits are more to do with the way that the board operates with women more inclined to discuss matters in depth and to try to reach a consensual solution.

The UK Corporate Governance Code (2010) http://www.frc.org.uk/corporate/ukcgcode.cfm encourages the board to consider the benefits of diversity, including gender, to try to ensure a well-balanced board and avoid ‘group think’.  Similarly the German Corporate Governance Code (2009) states ‘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) advocates ‘The supervisory board shall aim for a diverse composition in terms of such factors as gender and age (111.3).

An early exponent of women’s representation in the boardroom was Norway which, since 2008, has 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 with clear implications for female appointments to the board. Moreover in 2015, legislation will become effective in Spain which requires Spanish companies to ensure that 40 per cent of board members are female.

However as Emiliya Mychasuk (FT page 12, 8^th Dec 2010) ‘The quandary of quotas’ points out, there are doubts over the effectiveness of quotas in helping women climb the corporate ladder as whilst the number of women on the board may increase over time , there is not a corresponding improvement in the number of women in senior line management positions.

In the UK, Brian Groom (FT, Page 4, 2^nd December 2010) ‘Drive for more women on the board levels off’ points out that ‘the proportion of women on FTSE100 boards seems to have plateaued at 12.5%, prompting demands for a “wind of change” to prevent the UK from falling behind other countries in which the female share of top jobs is rising”.

Nonetheless there are some encouraging signs and, as Cherie Blair, (FT Weekend Magazine ‘Women of the Decade’, portrait by Richard Nicholson, Page 28, 11^th/12^th Dec 2010) states ‘The glass ceiling absolutely still exists, but it’s splintering each year’.

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.  In this regard headhunters and recruitment agencies have a role to play by widening the pool of potential candidates which they look at and thereby, hopefully, increasing the number of women candidates put forward to companies.  Companies themselves can have a fundamental impact by advocating and supporting appropriate mentoring schemes.

Diversity should not be for diversity’s sake, it should be for the benefit of the company, its shareholders and other stakeholders.  Women can bring new insights to the board, looking at things from a different point of view and maybe challenging long-accepted opinions, and potentially adding value.

Chris Mallin 5^th January 2011

In autumn 2009, the New York Stock Exchange (NYSE) formed an independent commission to examine core governance principles in the light of changes that had occurred in governance over the past decade, and to make recommendations which could be widely supported by listed companies, directors and investors. Chaired by Larry W. Sonsini, Chairman of Wilson Sonsini Goodrich & Rosat, a US law firm specializing in business and securities law, the commission members represented investors, listed companies, broker-dealers, and governance experts. On 23 September, 2010 the NYSE Euronext (NYX) published the Commission’s final report which identified 10 core principles of corporate governance covering the scope of the board’s authority, management’s responsibility for governance and the relationship between shareholders’ trading activities, voting decisions and governance.

The Commission argued that a board’s fundamental objective is to build long-term sustainable growth in shareholder value, so corporate policies that encourage excessive risk-taking for the sake of short-term increases in stock price are inconsistent with sound corporate governance. Corporate management has a critical role in corporate governance, the Commission concluded, as management has the primary responsibility for creating an environment in which a culture of performance with integrity can flourish.
Consistent with business opinion in many other parts of the world, the Commission felt that while legislation and agency rule-making are important to establish the basic tenets of corporate governance, over-reliance on legislation may not be in the best interests of shareholders, companies or society. The Commission, therefore, called for market-based governance solutions whenever possible.

The 10 core principles outlined by the Commission on Governance were:
1. The Board’s fundamental objective should be to build long-term sustainable growth in shareholder value for the corporation
2. Successful corporate governance depends upon successful management of the company, as management has the primary responsibility for creating a culture of performance with integrity and ethical behaviour
3. Good corporate governance should be integrated with the company’s business strategy and not viewed as simply a compliance obligation
4. Shareholders have a responsibility and long-term economic interest to vote their shares in a reasoned and responsible manner, and should engage in a dialogue with companies thoughtful manner
5. While legislation and agency rule-making are important to establish the basic tenets of corporate governance, corporate governance issues are generally best solved through collaboration and market-based reforms
6. A critical component of good governance is transparency, as well governed companies should ensure that they have appropriate disclosure policies and practices and investors should also be held to appropriate levels of transparency, including disclosure of derivative or other security ownership on a timely basis
7. The Commission supports the NYSE’s listing requirements generally providing for a majority of independent directors, but also believes that companies can have additional non-independent directors so that there is an appropriate range and mix of expertise, diversity and knowledge on the board
8. The Commission recognizes the influence that proxy advisory firms have on the markets, and believes that it is important that such firms be held to appropriate standards of transparency and accountability
9. The SEC should work with exchanges to ease the burden of proxy voting while encouraging greater participation by individual investors in the proxy voting process
10. The SEC and/or the NYSE should periodically assess the impact of major governance reforms to determine if these reforms are achieving their goals, and in light of the many reforms adopted over the last decade the SEC should consider the expanded use of “pilot” programs, including the use of “sunset provisions” to help identify any implementation problems before a program is fully rolled out

Principle #7 has raised some eyebrows in the United States. “While independence is an important attribute for board members”, the Commission said, “boards should seek an appropriate balance between independent and non-independent directors to ensure an appropriate mix of expertise, diversity and knowledge. The NYSE’s Listing Standards do not limit a board to just one non-independent director.”

The US-based Corporate Governance Alliance Digest, December 1, 2010, asked “Is this a good idea? Including more non-independent members on an issuer’s board may be a very hard sell to investors, given the fact that in all markets investors rank board independence as the most important governance topic. Is adding non-independent members an irritant worth creating?”

On the unitary board of a listed company, directors are responsible for both the performance of the enterprise and its conformance. In other words, the board is expected to be involved in strategy formulation and policy making, whilst also supervising management performance and ensuring appropriate accountability and compliance with regulations. It has been suggested that this means the unitary board is effectively trying to mark its own examination papers. Of course, the two-tier board structure avoids this problem by having the executive board responsible for performance and the supervisory board for conformance, with no common membership allowed between the two boards.

Typically, corporate governance codes and stock exchange listing rules call for independent outside (non-executive) directors to play a vital role in the unitary board. Independence is precisely defined to ensure that these directors have no interest in the company that could adversely affect genuine independent and objective judgement. The number or percentage of independent board members on listed company board is usually specified. Audit, remuneration and nomination committees of the board must be mainly or wholly comprised of these independent, outside directors.

The definition of independence in most corporate governance codes is exhaustive. To be considered independent a director must have no relationship with any firm in the up-stream or down-stream added-value chains, must not have previously been an employee of the company, nor be a nominee for a shareholder or any other supplier of finance to the company. Indeed, the definition of independence is so strict that an independent director who has served on the board for a long period is often assumed to have become close to the company and is no longer considered independent.

Herein lays a dilemma. The more independent directors are, the less they are likely to know about the company, its business and its industry. Conversely, the more directors know about the company’s business, organization, strategies, markets, competitors, and technologies, the less independent they become. Yet such people are exactly what top management needs to contribute to its strategy, policy making and enterprise risk assessment.

This argument looks set to run a long way.

Bob Tricker 6 December 2010

During the twentieth century the work of boards of directors was seldom mentioned, the focus was on management. But within a couple of decades the phrase ‘corporate governance’ has become commonplace. The challenges of corporate governance are discussed in the popular press as readily as in business journals and the academic literature. Moreover, interest in the subject is world-wide.

Research into corporate governance began during the 1980s. The research journal Corporate Governance – an International Review was founded in 1992, the year in which Sir Adrian Cadbury published his seminal UK corporate governance report. Much of the early research in corporate governance originated in the United States, but as Denis and McConnell (3) have reported “the first generation of international corporate governance research typically examined governance mechanisms such as board composition and equity ownership in individual countries, mirroring the U.S. research that had preceded it. The second generation of international corporate governance research, however, recognized the impact of differing legal systems on the structure and effectiveness of corporate governance and compared systems across countries.”

Why has the subject of corporate governance grown so fast and the concept become so widespread? Some suggest it has been a response to company collapses, fueled by board-level corruption and the abuse of power. Others see a growing societal dissatisfaction with corporate behaviour. Dawkins (1998) has another idea (4). He suggested that culturally-determined ideas are transmitted from person to person. The development of ideas is analogous to the natural selection, replication, and mutation of physical genes, he suggests, coining the word ‘memes’ to cover such transferrable ideas. In other words, successful ideas propagate and spread, poor ones become extinct. So it may be with corporate governance.

(1) Tricker, R I, 1984, Corporate Governance – practices, procedures and powers in British companies and their boards of directors, Gower Publishing Aldershot UK, and The Corporate Policy Group, Nuffield College, Oxford.

(2) Cochran, Philip L and Steven L. Wartick, 1988, Corporate Governance – a review of the literature, Morristown, Financial Executives Research Foundation

(3) Denis, Diane K. and John J. McConnell, 2001, International Corporate Governance, Journal of Financial and Quantitative Analysis, 38: 1-36

(4) Dawkins, Richard, 1998 (2nd edition) The Selfish Gene, Oxford, The Oxford University Press, page 192

The UK Corporate Governance Code has traditionally emphasised the value of a constructive dialogue between institutional shareholders and companies based on a ‘mutual understanding of objectives’.  Now, in the Stewardship Code, the FRC sets out the good practice on engagement with investee companies which it believes institutional shareholders should aspire to.

Kate Burgess and Miles Johnson in their article ‘FRC’s blueprint for investor engagement’ (FT, page 18, 2^nd July 2010) describe the Stewardship Code as ‘the first of its type in the world and designed to sit side by side with the UK’s code on corporate governance recently reworked by the FRC’.

Background to the UK Stewardship Code 

The Institutional Shareholders’ Committee (ISC) is a forum which allows the UK’s institutional shareholding community to exchange views and, on occasion, coordinate their activities in support of the interests of UK investors. Its constituent members are: The Association of British Insurers (ABI), the Association of Investment Companies (AIC), the Investment Management Association (IMA) and the National Association of Pension Funds (NAPF) http://www.institutionalshareholderscommittee.org.uk/

In November 2009, the ISC issued the ‘Code on the Responsibilities of Institutional Investors’.  The ISC stated that ‘the Code aims to enhance the quality of the dialogue of institutional investors with companies to help improve long-term returns to shareholders, reduce the risk of catastrophic outcomes due to bad strategic decisions, and help with the efficient exercise of governance responsibilities’ and ‘the Code sets out best practice for institutional investors that choose to engage with the companies in which they invest. The Code does not constitute an obligation to micro-manage the affairs of investee companies or preclude a decision to sell a holding, where this is considered the most effective response to concerns’.

Further detail is available at: http://institutionalshareholderscommittee.org.uk/sitebuildercontent/sitebuilderfiles/ISCCode161109.pdf

UK Stewardship Code Principles

Following a consultation earlier this year, the FRC assumed responsibility for the oversight of the Stewardship Code. The ISC Code discussed above contained seven principles which now form the basis for the Stewardship Code and indeed the Principles were adopted with only minor amendments.  The minor amendments relate to Principle 3 about the monitoring of companies. In the Stewardship Code, institutional investors are encouraged to meet the chairman of investee companies, and other board members as appropriate, as part of the ongoing monitoring, and not only when they have concerns; attend, where appropriate and practicable, the general meetings of companies in which they have a major holding; and give careful consideration the any explanations given by investee companies for departures from the UK Corporate Governance Code, advising the company where they do not accept its stance.

The principles of the UK Stewardship Code are:

Principle 1: Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.

Principle 2: Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed. 

Principle 3: Institutional investors should monitor their investee companies.

Principle 4: Institutional investors should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.

Principle 5: Institutional investors should be willing to act collectively with other investors where appropriate.

Principle 6: Institutional investors should have a clear policy on voting and disclosure of voting activity.

Principle 7: Institutional investors should report periodically on their stewardship and voting activities.

Who the UK Stewardship Code applies to

The Stewardship Code is to be applied on a ‘comply or explain’ basis.  The UK Stewardship Code is ‘addressed in the first instance to firms who manage assets on behalf of institutional shareholders such as pension funds, insurance companies, investment trusts, and other collective vehicles’.  The FRC expects such firms to disclose on their websites how they have applied the Stewardship Code or to explain why it has not been complied with.

However it has been pointed out that it is not the responsibility of fund managers alone to monitor company performance ‘as pension fund trustees and other owners can also do so either directly or indirectly through the mandates given to fund managers’.  Therefore the FRC encourages all institutional investors to report whether, and how, they have complied with the Stewardship Code.

The FRC plans to list on its website all investors who have published a statement indicating the extent to which they have complied with the Stewardship Code.  This list will be made available from October 2010.

Monitoring and review of the application of the Stewardship Code will be in two phases.  As an interim measure, the Investment Management Association (IMA), will carry out its regular engagement survey which will also cover adherence to the Stewardship Code in 2010. The first full monitoring exercise will then take place in the second half of 2011.

Other issues

The FRC points out that there are a number of significant issues which were raised during the consultation phase which are not addressed in the UK Stewardship Code.  These include disclosure by institutional investors of their policies in relation to stock lending; arrangements for voting pooled funds; and the information to be disclosed in relation to voting records.  The FRC will undertake additional work in relation to these areas prior to the monitoring exercise in 2011.

A recent EU Green Paper ‘Corporate governance in financial institutions and remuneration policies’ (June 2010) may also have ramifications for the UK Stewardship Code as in section 5.5, the Green Paper mentions that the Commission intends to carry out a review centred around, inter alia, ‘institutional investors adherence to ‘stewardship codes’ of best practice’. http://ec.europa.eu/internal_market/company/docs/modern/com2010_284_en.pdf

Concluding comments

It is apposite to conclude with a comment from Bob Campion in his article ‘Managers on alert to comply or explain’ (FTfm Page 5, 5^th July 2010) ‘The new code is a timely opportunity for pension trustees to finally get to grips with their role as institutional shareholders.  If they do, it will be up to fund managers to demonstrate their own expertise in this area or risk losing business’.

The UK Stewardship Code, together with a report on its implementation, can be found at:

http://www.frc.org.uk/images/uploaded/documents/UK%20Stewardship%20Code%20July%2020103.pdf

http://www.frc.org.uk/images/uploaded/documents/Implementation%20of%20Stewardship%20Code%20July%2020103.pdf

Chris Mallin 5^th July 2010