Archive for the ‘Directors’ Category
BEIS Green Paper on Corporate Governance Reform
In November 2016, the Department for Business, Energy & Industrial Strategy (BEIS) issued a Green Paper on Corporate Governance Reform. The Green Paper states ‘The aim of this Green paper is to consider what changes might be appropriate in the corporate governance regime to help ensure that we have an economy that works for everyone’. It considers three specific areas of corporate governance which might be built on to enhance the UK’s current corporate governance framework. These areas are:
– executive pay
-strengthening the employee, customer, and supplier voice
– corporate governance in the UK’s largest privately-held businesses.
There are 14 Green Paper questions with six relating to executive pay, three to strengthening the employee, customer and wider stakeholder voice, and five relating to corporate governance in large, privately-held businesses. The consultation closed on 17th February 2017 and responses to the consultation will be made available by BEIS around May 2017. However, the responses will be made available in collated format and the anonymity of individual responses will be retained. Nonetheless those who have responded to the consultation are free to publish their own responses or make them more widely available.
An interesting article by Aime Williams and Madison Marriage ‘Investors back UK drive to curb executive pay levels’ (Financial Times, 18/19 February 2017, page 17,www.ft.com/Executive_Pay) reports that ‘some of the UK’s largest investors have revealed support for government proposals designed to curb high executive pay in the latest pushback against the widening wealth gap between bosses and workers’. The article cites the views of investors including Old Mutual Global Investors and Fidelity International; also the Pensions and Lifetime Savings Association (PLSA) which has a membership including over 1,300 pension schemes; and the Confederation of British Industry (CBI). The publication of pay ratios received broad support whilst other areas mentioned included more robust consequences for companies whose directors’ remuneration is not approved by shareholders and also implementing an annual binding vote on pay.
Turning now to the High Pay Centre, an independent non-party think tank focused on pay at the top of the income scale. It is interesting to note that the High Pay Centre joined forces with the Chartered Institute of Personnel and Development (CIPD) to submit a joint response to the Green paper consultation, marking the commencement of a formal relationship between the two bodies, to ‘advocate fairer and more ethical approaches to pay and reward’. Their recommendations include:
- All publicly listed companies should be required to publish the ratio between the pay of their CEO and median pay in their organisation.
- All publicly listed companies should be required to have at least one employee representative on their remuneration committee
- All publicly listed companies should be required to establish a standalone human capital development sub-committee chaired by the HR director with the same standing as all board sub-committees.
- The Government should set voluntary human capital (workforce) reporting standards to encourage all publicly listed organisations to provide better information on how they invest in, lead, and manage their workforce for the long-term.
The CIPD/High Pay Centre joint response is available at: http://highpaycentre.org/files/CIPD_and_HPC_response_to_BEIS_Green_Paper_on_Corporate_Governance_%281%29.pdf
Another High Pay Centre publication which is of particular interest in relation to pay ratios – which seem to be gaining increasing support from various quarters as we have seen earlier – is ‘Pay Ratios: Just Do It’ available at: http://highpaycentre.org/files/Pay_Ratios_-_Just_Do_it.pdf
Just a few responses have been mentioned in this blog in relation to executive pay but it seems as though overall the 14 questions posed in the Green Paper will have stimulated wide-ranging debate on key issues which will likely lead to significant reform of the UK’s corporate governance system in the not too distant future.
There has been much emphasis on the importance and value of board diversity. However the focus has generally tended to be on gender diversity, for example, in the UK the Davies Report (2011) recommended that representation of women on FTSE 100 boards be increased to at least 25% by 2015. By 2015 this 25% target had been exceeded with FTSE 100 boards having 26.1% of women on the board.
Various corporate governance codes and guidelines have stated that firms should have a ‘balanced board’. In 2014, when updating the UK Corporate Governance Code, the Financial Reporting Council pointed out that constructive and challenging debate on the board can be encouraged ‘through having sufficient diversity on the board. This includes, but is not limited to, gender and race. Diverse board composition in these respects is not on its own a guarantee. Diversity is as much about differences of approach and experience, and it is very important in ensuring effective engagement with key stakeholders and in order to deliver the business strategy’.
‘A Report into the Ethnic Diversity of UK Boards: Beyond One by ’21’
Earlier this month The Parker Review Committee, chaired by Sir John Parker, issued ‘A Report into the Ethnic Diversity of UK Boards: Beyond One by ’21’.
Starting from the premise that UK boardrooms, including those of leading public companies, do not reflect the UK’s ethnic diversity nor the stakeholders that companies engage with (customers, employees, etc.), the Parker Report states that ‘ethnic minority representation in the Boardrooms across the FTSE 100 is disproportionately low, especially when looking at the number of UK citizen directors of colour’. For example, the Report highlights that of 1087 director positions in the FTSE 100, UK citizen directors of colour represent only about 1.5% of the total director population with 90 individual directors of colour (four hold two Board positions) whilst total directors of colour represent about 8% of the total (compared to 14% of the UK population). Some 53 FTSE 100 companies do not have any directors of colour. Seven companies account for over 40% of the directors of colour, interestingly five out of the seven companies have headquarters historically located outside the UK. In terms of the key board roles of Chair and CEO, only nine people of colour hold the position of Chair or CEO.
The Parker Report’s recommendations can be found at http://www.ey.com/Publication/vwLUAssets/A_Report_into_the_Ethnic_Diversity_of_UK_Boards/$FILE/Beyond%20One%20by%2021%20PDF%20Report.pdf and are as follows:
- Increase the Ethnic Diversity of UK Boards
1.1. Each FTSE 100 Board should have at least one director of colour by 2021; and each FTSE 250 Board should have at least one director of colour by 2024.
1.2. Nomination committees of all FTSE 100 and FTSE 250 companies should require their internal human resources teams or search firms (as applicable) to identify and present qualified people of colour to be considered for Board appointment when vacancies occur.
1.3. Given the impact of the ‘Standard Voluntary Code of Conduct’ for executive search firms in the context of gender-based recruitment, we recommend that the relevant principles of that code be extended on a similar basis to apply to the recruitment of minority ethnic candidates as Board directors of FTSE 100 and FTSE 250 companies.
- Develop Candidates for the Pipeline & Plan for Succession
2.1. Members of the FTSE 100 and FTSE 250 should develop mechanisms to identify, develop and promote people of colour within their organisations in order to ensure over time that there is a pipeline of Board capable candidates and their managerial and executive ranks appropriately reflect the importance of diversity to their organisation.
2.2. Led by Board Chairs, existing Board directors of the FTSE 100 and FTSE 250 should mentor and/or sponsor people of colour within their own companies to ensure their readiness to assume senior managerial or executive positions internally, or non-executive Board positions externally.
2.3. Companies should encourage and support candidates drawn from diverse backgrounds, including people of colour, to take on Board roles internally (e.g., subsidiaries) where appropriate, as well as Board and trustee roles with external organisations (e.g., educational trusts, charities and other not-for-profit roles). These opportunities will give experience and develop oversight, leadership and stewardship skills.
- Enhance Transparency & Disclosure
3.1. A description of the Board’s policy on diversity be set out in a company’s annual report, and this should include a description of the company’s efforts to increase, amongst other things, ethnic diversity within its organisation, including at Board level.
3.2. Companies that do not meet Board composition recommendations by the relevant date should disclose in their annual report why they have not been able to achieve compliance.
At the UK’s Conservative Party conference, in early October 2016, the Prime Minister, Mrs. Theresa May, raised some significant corporate governance issues:
‘So if you’re a boss who earns a fortune but doesn’t look after your staff, an international company that treats the tax laws as an optional extra…a director who takes out massive dividends while knowing that the company pension scheme is about to go bust, I’m putting you on warning…’
Each of these issues has been discussed in recent blogs. But she also suggested that workers should be appointed to boards of directors. As could be predicted, this suggestion was welcomed by the Trades Union Council but raised alarm in some British boardrooms.
But we have been here before. Extracts from Corporate Governance: Principles, Policies, and Practices (3rd ed., 2015, pages 12 and 85) explain why:
‘In the 1970s, the European Economic Community (EEC), now the European Union, issued a series of draft directives on the harmonization of company law throughout the member states. The Draft Fifth Directive (1972) proposed that all large companies in the EEC should adopt the two-tier board form of governance, with both executive and supervisory boards. In other words, the two-tier board form of governance practised in Germany and Holland, would replace the British model of the unitary board, in which both executive and outside directors oversee management and are responsible for seeing that the business is being well run and run in the right direction.
In the two-tier form of governance, companies have two distinct boards, with no common membership. The upper, supervisory board monitors and oversees the work of the executive or management board, which runs the business. The supervisory board has the power to hire and fire the members of the executive board.
Moreover, in addition to the separation of powers, the draft directive included employee representatives on the supervisory board. In the German supervisory board, one half of the members represent the shareholders. The other half are chosen under the co-determination laws through the employees’ trades’ union processes. This reflects the German belief in co-determination, in which companies are seen as social partnerships between capital and labour.
The UK’s response was a Committee chaired by Sir Alan Bullock (later Lord Bullock), the renowned historian and Master of Saint Catherine’s College, Oxford. His report – Industrial Democracy (1977) – and its research papers (1976) were the first serious corporate governance study in Britain, although the phrase ‘corporate governance’ was not then in use. The Committee proposed that the British unitary board be maintained, but that some employee directors be added to the board to represent worker interests.
The Bullock proposals were not well received in Britain’s boardrooms. The unitary board was seen, at least by directors, as a viable system of corporate governance. Workers had no place in the boardroom, they felt. A gradual move towards industrial democracy through participation below board level was preferable.
Neither the EEC’s proposal for supervisory boards nor worker directors became law in the UK. Since then, the company law harmonization process in the EU has been overtaken by social legislation, including the requirement that all major firms should have a works council through which employees can participate in significant strategic developments and changes in corporate policy.’
Proponents of industrial democracy still argue that governing a major company requires an informal partnership between labour and capital, so employees should participate in corporate governance. Maybe an extension of the Shareholder Senate idea, suggested in a recent blog, called a Stakeholder Senate could provide another forum to inform, liaise with, and influence the board.
Bob Tricker October 2016
Serious study of corporate governance is relatively new. Early books on the work of directors and boards date back no more than forty years and the subject only acquired its title in the mid 1980s. Throughout the 20th century, the focus of attention was not on corporate governance but on management. Marketing, production, finance, operations research, and management information systems were at the forefront of interest. Organizational studies forged ahead, but the board of directors seldom appeared on the organization chart.
Now corporate governance has become the focus for the 21st. century. True, the US Securities and Exchange Commission had existed since 1934, promoting sound corporate regulation and reporting practices. But that was before the collapse of Enron, the world-wide implosion of Arthur Andersen, and the sub-prime financial catastrophe. Corporate scandal and collapse in the 1980s led to the first corporate governance code: the UK’s Cadbury Report. This seminal work soon led to codes in other countries around the world.
These codes, however, tended to concentrate on form rather than function, emphasizing the importance of independent outside directors, the need for audit, remuneration, and nomination committees of the board, and the separation of the role of the board chairman from the CEO. More recently, enterprise risk assessment, and corporate social responsibility have been added to the lexicon. Corporate governance reports were required confirming that public companies had complied with the code or, if not, explaining why. With the emphasis on structure, little concern was shown for the process of corporate governance: what actual goes on inside the board room, the leadership style of the chairman, internal political manoeuvres, and directors’ inter-personal behaviour when strong personalities meet.
Corporate governance is about the way power is exercised over corporate entities.
It involves the behaviour of boards and their directors, the interaction between the governing body and management, the company’s links with its shareholders and other players in the stock market, and the relations between the company and its many stakeholders. It involves strategy formulation and policy making on the one hand, and executive supervision and accountability on the other.
Corporate governance codes have been incorporated into the rules of many stock exchanges and compliance has become a requirement for listing. They have developed and reinforced good governance structures. But have they changed corporate behaviour?
Have the codes worked?
The corporate governance codes have certainly been a force for improving governance structures, procedures, and reporting. But the codes have not changed perceptions of corporate behaviour. Consider a few cases.
- BP, the oil company, published policies on corporate social responsibility and sustainability, yet lost over half its share value following the Deepwater Horizon oil-rig debacle in the Gulf of Mexico.
- Companies claiming to be good corporate citizens have been criticized for ‘aggressive’ tax avoidance by moving their profits, legally but questionably, through offshore tax havens.
Despite companies’ declared commitment to corporate social responsibility, publishing ethics codes and compliance reports, concerns about business ethics are widespread and serious. Around the world, the behaviour of companies, the attitudes of their directors and the actions of key executives have come under the public spotlight. Fraudulent management in Australia’s HIH Insurance, the world-wide collapse of auditors Arthur Andersen, corruption in Italy’s Parmalat, allegations of bribery against BAE Systems in Europe, the rigging of Libor interest rates by British banks and, of course, excessive risk taking by financial institutions around the world that sparked the global economic crisis, provide just a few examples.
Critics of business behaviour point to fraud, bribery and corruption. They allege price-rigging, pollution, and counterfeiting. They see arrogance, greed, and abuse of power by those at the top of companies. Some are cynical about business behaviour. How can you trust these people, they ask? Protestors challenge the basis of capitalism. For them, business ethics has become an oxymoron, citing corporate avarice, disparity of wealth, and excessive director remuneration that does not reflect corporate performance.
Yet business exists by satisfying customers, creating employment, and generating wealth. Business provides the taxes that society needs to function. Many companies accept a social responsibility to be sound corporate citizens. They recognize that they have a duty to respect the interest of all the stakeholders who might be affected by their actions. Many also seek a sustainable, environmentally friendly approach to their operations. To those who doubt whether modern business can be trusted, they point out that business dealings and the very concept of the limited-liability company are based on trust. Not everyone is convinced.
Since the 19th century, the underpinning of corporate governance has been company law, with ownership as the basis of power. Shareholder members of the company appoint directors, approve the directors’ reports and financial accounts, receive the report of the auditors, and approve dividends. The fiduciary duty of the directors is to be stewards for their shareholders’ interests. The reality, as we all know, is very different, particularly in large, international, listed companies. It is the directors, not the shareholders, who wield the power over the corporate entity, despite valiant attempts by institutional investors to regain the initiative.
Meanwhile, interest in business ethics seems to be at an all time high. The subject of business ethics has grown significantly, with interest focusing on corporate citizenship, companies’ social responsibilities, and their relations with stakeholders. More recently, green credentials and sustainability have been added to the agenda. But business ethics is not just about corporate citizenship: business ethics are basic to running successful business.
Ethics and the corporate governance codes
Ethics are hardly mentioned in the corporate governance codes, yet the examples just cited all raise ethical issues. They concern the way those companies were governed, how power was exercised over them, and the way business risks were taken. In other words, business ethics are inherently part of corporate governance. They are not an optional exercise in corporate citizenship.
Ethics involve behaviour. Business ethics concern behaviour in business and the behaviour of business. Decisions at every level in a company have ethical implications – strategically in the board room, managerially throughout the organization, and operationally in each of its activities. Ethical risks abound, whether decisions are at the strategic, managerial, or operational level.
Corporate entities, though granted many of the legal powers of human beings, have no moral sense. The board has to provide the corporate conscience. Directors set the standards for their organization, provide its moral compass. British-based Barclays bank was fined £290 million by US and UK regulators for colluding with other banks to rig the interest rates set for loans between them. Misstating the rate improved the financial standing of the bank and increased traders’ bonuses. The British regulator said that “the misconduct was serious, widespread and extended over a number of years…There was a cultural tendency to always be pushing the limits… a culture of gaming, and gaming us. The problem came from the tone at the top.” Every organization’s culture is fashioned by its board and top management.
Ultimately, the board of directors and top management are responsible for the ethical behaviour of their enterprise. The board of directors with top management are responsible for establishing their company’s risk profile, determining the acceptable level of risk. Some companies accept higher levels of risk than others. Determining the acceptable exposure to ethical risk needs to be part of every organization’s strategy formulation, policy making, and enterprise risk management.
With moral dilemmas in business it is often not a matter of right or wrong, but what’s best for all concerned, both in the company and among all those affected by its actions. Boards have to recognize issues and make choices. This is a function of corporate governance, which needs to be built on the bedrock of business ethics. It seems likely that future codes of corporate governance will find their foundations in ethics.
The disquiet over excessive executive remuneration packages and a lack of appropriate links with relevant performance measures has been a matter of concern in recent years. After the financial crisis, there is even more of a focus on this aspect with shareholders becoming increasingly frustrated with both the amount and the design of executive remuneration packages.
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, 29th June 2011 ‘Strategy and pay fuel anger at C&WW’ and FT, Page 15, 5th 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, 24th 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, 28th 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, 8th 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, 2nd 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, 1st 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, 3rd 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, 14th 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, 6th 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 13th July 2011
A great deal has been written about the cause and effect of the nuclear power station disaster at Fukushima Daiichi, which followed the Japanese tsunami and earthquake. No doubt more will be said in the future. But relatively little attention has been paid to the governance of the company behind the Fukushima plant. This case and commentary look at some aspects of the governance of the Tokyo Electric Power Company (TEPCO). The material comes from the second edition of Corporate Governance – principles, policies and practices due in 2012.
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.
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
In late February, Lord Davies’ report on ‘Women on Boards’ was published http://www.bis.gov.uk/assets/biscore/business-law/docs/w/11-745-women-on-boards.pdf
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, 21st 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, 19th/20th 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, 16th 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, 21st 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 1st March 2011
The New York Stock Exchange Commission on Corporate Governance has reported.
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
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
Corporate governance codes and guidelines have long recognised the important role that institutional investors have to play in corporate governance. As well as being influential in their home countries, institutional investors have increasingly become a more significant force in other countries through their cross-border holdings. Recent corporate governance reforms motivated by the global financial crisis have placed even more emphasis on the role of institutional investors.
Role of Institutional Investors
Back in 1992, the Cadbury Report recognised the role played by institutional investors stating that ‘we look to the institutions in particular ‘ to use their influence as owners to ensure that the companies in which they have invested comply with the Code’. Various codes since then have emphasised the importance of the role. The Financial Reporting Council (FRC) publishes the UK’s Combined Code on Corporate Governance (commonly known as the Combined Code). The Combined Code (2008), in Section E, identifies three main principles. Firstly it states that ‘institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives’; secondly ‘when evaluating companies’ governance arrangements, particularly those relating to board structure and composition, institutional shareholders should give due weight to all relevant factors drawn to their attention’; thirdly, ‘institutional shareholders have a responsibility to make considered use of their votes http://www.frc.org.uk/corporate/combinedcode.cfm The first and third principles relate to two of the tools of governance being dialogue and voting. All three principles essentially require institutional investors to behave in a responsible and conscientious way, taking all relevant factors into account and making considered decisions.
Corporate Governance Reform
The UK Treasury commissioned the Walker Review of Corporate Governance of UK Banking Industry which reported in November 2009. The Walker Review recommends ‘strengthening the role of non-executives and giving them new responsibilities to monitor risk and remuneration; it also recommends a stewardship duty on institutional shareholders to play a more active role as owners of businesses.’ http://www.hm-treasury.gov.uk/walker_review_information.htm Kate Burgess and Brooke Masters in their article ‘Institutions urged to adopt tougher stance’ (FT, Pg 21, 26th November 2009) states ‘Institutional investors are being urged to be tougher on company boards by Sir David Walker, as the City grandee adds his weight to pressure for them to take their responsibilities more seriously.’
The FRC’s statement welcoming the Walker Report can be found at: http://www.frc.org.uk/press/pub2174.html. The FRC has agreed to implement those recommendations that it considers should apply to all listed companies. In addition the FRC has agreed to consult on adoption of a Stewardship Code for institutional investors as recommended by Sir David.
A recent review of the Combined Code http://www.frc.org.uk/corporate/reviewCombined.cfm has however recommended that Section E of the Code (addressed to institutional shareholders) be removed, ‘subject to sufficient progress being made on the Stewardship Code for institutional investors and its associated governance arrangements.’ The Stewardship Code for institutional investors as was proposed by Sir David Walker, and is an area on which the Financial Reporting Council (FRC) will be consulting separately http://www.frc.org.uk/corporate/walker.cfm
The final report on the review of the Combined Code (2008) makes various recommendations which include, inter alia, annual re-election of the chairman or the whole board; new principles for the roles of the chairman and non-executive directors. Kate Burgess in her article ‘Sir Christopher misses out on succession planning’ (Pg 21, FT, 2nd December 2009) highlights that more emphasis should have been put on succession planning in companies as this tends to be a weakness in many firms. Moreover it would be beneficial to investors in their stewardship role to have more knowledge of the process in place for succession planning.
The Institutional Shareholders’ Committee (ISC) membership comprises the Association of British Insurers, the Association of Investment Trust Companies, the National Association of Pension Funds, and the Investment Management Association. The ISC has previously published guidance on the responsibilities of institutional investors in 2002, 2005 and 2007. In November 2009, the ISC published its Code on the Responsibilities of Institutional Investors which is included as an Annex in the Walker Review and which is widely viewed as the basis for the Stewardship Code which will be monitored for the adherence of institutional investors on a ‘comply or explain’ basis. The ISC states 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.’ http://www.institutionalshareholderscommittee.org.uk/ The Code discusses the stewardship responsibilities of institutional investors which include effective monitoring of investee companies and voting of all shares held.
Of course in order to carry out their responsibilities as shareholders, institutional investors need to be able to exercise their rights effectively – if they cannot, then they may be tempted to exit, i.e. to sell their shares. An article in the Financial Times, ‘Shareholder rights’ (FT, page 12, 30th November 2009) points out that ‘if selling the shares is a blunt instrument, then removing board members is the sharpest. More than nine in 10 international investors say the ability to nominate, appoint and remove directors is the most valuable shareholder right. It is wrong that efforts to boost this power in the US have been delayed by the business lobby.’ Clearly it is in the interests of effective stewardship for institutional investors to be able to exercise their rights. This will enable them to take action on prominent topical issues such as having a ‘say on pay’ in relation to directors’ remuneration, and removing underperforming directors from the board.
However another dimension to consider is that of free riders. Ruth Sullivan in her article ‘Walker plan points finger at freeriders’ (FTfm Pg 3, 30th November 2009) points out that some institutional investors will not engage more with their investee companies and be active owners, rather they will save their time and money and free ride on the efforts of other institutional investors.
The recent reforms mooted by the Walker Review and the Review of the Combined Code have made recommendations which will help to strengthen corporate governance in the UK. The role of institutional investors is seen an important one and institutional investors are being encouraged to engage more fully in their role as owners and adhere to the ISC Code of Responsibility for Investors.
Chris Mallin 2nd December 2009