Archive for the ‘corporate governance’ Tag

Corporate Governance in China

 

In a recent posting on this blog, I wrote about the Chinese government’s attempt to exert more control over state owned enterprises (SOEs).   That led to some questions about how SOEs were actually governed.  Since I am currently involved in an ongoing study of corporate governance in China with a Hong Kong colleague, Dr Gregg Li, a brief summary of the evolution of corporate governance ‘with a Chinese face’ may be of interest.

 

The People’s Republic of China (PRC) was established in 1949, by Mao Tse Tung, following the defeat of the Nationalist Army under Chiang Kai Shek and its retreat to Taiwan.   Mao founded the PRC and remained Chairman of the Chinese Communist Party from 1949 until his death in 1976.

 

Over that period, the state proclaimed ownership of the means of production, prohibited private property, and banned incorporated companies.  In 1958, Chairman Mao initiated the Great Leap Forward, relocating millions of farmers, peasants, and city workers. Massive economic dislocation and famine resulted. The Cultural Revolution began in 1966 and lasted a decade. Communes were reorganized and state-owned enterprises (SOEs) were created, most relying on state subsidies.

 

In the 1970s, Mao’s successor as paramount leader, Deng Xiao Ping, introduced a pragmatic form of market economy, whilst still maintaining an orientation towards a centralized communist state.  The industrial SOEs, which were large bureaucracies, continued to receive their production and distribution orders from state planners.  Employees of the SOEs received housing, medical care, and schooling for their children.  Deng stood down in 1989, and is now recognized as the initiator of the changes that led to the subsequent incredible economic growth up to the present day.

 

In 1988, the State Council of the PRC, advised by experts from the Organization for Economic Co-operation and Development (OECD), produced a set of corporate governance directives for SOE reform.  In September 1999, the Fourth Plenary Session of the 15th Chinese Communist Party’s Central Committee took a vital decision on enterprise reform, in what was termed a ‘strategic adjustment’ of the state sector, it was agreed that that ‘the state should be withdrawing from what should be withdrawn’.  Interestingly, corporate governance was recognized as being at the core of the modern enterprise system.

 

A new companies’ law was enacted in 1994, and revised in 2006. Two types of company were created:

  • a ‘limited liability company’ (LLC), with at least two and no more than 50 shareholders, somewhat similar to private companies in other jurisdictions
  • a ‘company limited by shares’, in other words a joint stock company (JSC) with some similarities to public companies in other jurisdictions.

Both types of company were defined as legal persons with shareholder liability for corporate debt limited, and with property rights as well as civil rights and duties.

 

Companies were given autonomy to run their businesses according to the market in order, as the Companies’ Act said: ‘to raise economic efficiency, improve labour productivity, and preserve and increase the value of assets.’  Companies were also called on by the new law ‘to conduct their business activities abiding by the law and by business ethics, strengthen the construction of socialist spiritual civilization and accept the supervision of the government and the public.’  Companies were allowed to invest in other companies and to create groups of companies with subsidiaries and branches.

 

China’s corporate governance rules were influenced by Western experience, including the advice from the OECD, drawing principally from practice, pioneered in countries including the USA, the UK, Germany, and South Africa.  Typically, these countries are democracies with independent judiciaries. In developing and emerging economies, including Russia, Latin American countries and India, corporate governance still tends to be emergent, with the state playing a more significant role, and corruption sometimes being endemic.

 

China stands out as a case on its own.  Government is an oligarchy, exercising considerable central control.  The PRC has developed an innovative corporate governance regime, and in the process became one of the worlds leading economies.

 

The SOEs include vast companies in the oil, telecoms, steel, finance, and other major sectors. In some cases, a minority of their shares are quoted on stock exchanges in Shanghai, Shenzen, or Hong Kong, with a few being floated in London or New York.

 

Although influenced by Western experience, the governance of SOEs is unique.  Separate boards of supervisors and boards of directors were formed, partly reflecting the German two-tier board system, but with independent directors on the board of directors, as in the USA and UK.

 

For decades governance was left to companies, under the overall supervision of the State-Owned Assets Supervision and Administration Commission (SASAC) and the China Securities Regulatory Commission (CSRC).   State involvement at a higher level tended to be distant.  Some felt that the Communist Party’s leadership had been undermined.  But central authorities have recently sought to reassert Party influence over the SOEs, as mentioned in a recent blog.

 

Although SOEs remain central to China’s economy, other types of enterprise evolved with diverse ownership structures and governance practices.  Many of these firms are family businesses but others are run as village or township entities.

 

Although Hong Kong is now part of the PRC, the governance of companies there reflects a quite different story.  Since the mid-nineteenth century, Hong Kong had been a British Protectorate under a lease from Mainland China.  That lease ended In 1997 and Britain transferred its rights over Hong Kong to the PRC, which deemed it a Special Administrative Region of China.

 

Under the British influence, Hong Kong developed its own legislature, an independent judiciary based on UK-style common law, and its own currency linked to the US$.  The Hong Kong Stock Exchange began life in 1891, and now oversees the Hong Kong Corporate Governance Code.  Institutions for company registration and regulation were created, and strong professions were formed – legal, audit, accountancy, finance, and company secretarial.

 

This infrastructure and these institutions remained after the 1997 handover; as the Joint Agreement between the PR: and the UK put it – ‘one country two systems.’ But as the business worlds of China and Hong Kong grow together, some Hong Kong institutions are coming under China’s influence.

 

To reach its present economic and political significance in the world, China has travelled a unique road.  This historical and cultural context means that corporate governance in China has developed a distinct ‘Chinese face,’ unlike anywhere else in the world.  Exploring and understanding the special features of Chinese corporate governance and the challenges they might present in the future is an ongoing project

 

Bob Tricker

May 2017

Corporate governance is not management

For many years, I have said that the major focus of business throughout the 20th century was professional management – new management theories, management schools, management consultants, and management gurus – whereas the focus for the 21st century would be governance.   I think we can safely say that this has happened.

Unfortunately, in the process some people are now conflating the two quite different concepts: ‘management’ and ‘governance.’  There is talk about ‘the importance of governance in the NHS’ when the issue is mainly management.  Even the UK government’s consultation on the green paper on the review of corporate governance (see Chris Mallin’s most recent blog) writes: ‘The purpose of corporate governance is to facilitate effective, entrepreneurial, and prudent management that can deliver the long-term success of a company.’

If ‘management’ and ‘governance.’  are used interchangeably, the fundamental distinction between the two  is lost.  The notion of management as a hierarchy is commonplace: the classical management pyramid showing a chief executive officer, or managing director, with overall managerial responsibility and the reporting relationships of the managers down the management hierarchy.  Authority and responsibility are delegated downwards, with matching accountability expected upwards.

The board of directors seldom appears- because the board is not part of the management structure; nor is it a hierarchy.  Each director has equal responsibility and similar duties and powers under the law. There is no executive ‘boss’ of a board.  In a unitary board, that is a board with both executive and non-executive outside directors, the executive directors hold managerial roles in addition to their responsibilities as directors.   As executives, they are employees of the company and employment laws apply.  Directors, as such, are not employees and company laws apply.  Executive directors, of course, wear two hats: and are subject to both company law and employment law.

In the two-tier board structure, the executive board consists entirely of executives and is responsible for management.  The supervisory board consists entirely of outside members and is responsible for governance, including the hiring and firing of management.

In other words, management is responsible for running the business.  The board is responsible for its governance, ensuring that the corporate strategy is appropriate and being achieved, that corporate policies are in place, overseeing management’s performance, and being accountable to investors and other legitimate stakeholders.   Briefly, management runs the business; the board ensures that it is being well run and achieving is objectives. The concepts and the responsibilities of management and governance are quite different.  To conflate the two invites confusion.

-Bob Tricker, 2017

Culture and corporate governance [1]

 

Commentators frequently mention the importance of culture in corporate governance.  They recognize that the ‘comply or explain’ regime of adherence to corporate governance codes does not capture the reality of corporate behaviour,   But there seems to be some confusion about what is meant by culture  and why it is really relevant to corporate governance.

What is culture?

Culture can be thought of as the beliefs, expectations and values that people share.  Like the skins of an onion, culture has many layers – national cultures, regional cultures, the culture of a company, and the culture in a board room.

The culture of a country is influenced by its social, economic and political heritage, its geography, and its religion.  Culture is moulded by situations that affect relations between individuals, institutions, and states.   Culture is influenced by law, is reflected in the language, and is passed on by experience in families, schools, and organizations.  It is culture that determines what is thought of as acceptable, important, and right or wrong.  Culture affects how people think and act.  It is fundamental to understanding corporate governance.

In the late twentieth century, when ideas about corporate governance began to be discussed, much of the thinking and practice was influenced by countries that shared Anglo-American cultures – a belief in the rule of law; the importance of the rights of individuals to personal freedom and the ownership of property, in the context of accountable, democratic institutions, including an independent judiciary.

In the United States, corporate governance practices stemmed from the rule of company law laid down by state jurisdictions and at the Federal level by regulation from the US Securities and Exchange Commission.

In the UK, and subsequently in most Commonwealth countries associated with the UK, the governance of companies was determined by Companies Acts and, for listed companies, by corporate governance codes, reinforced by Stock Exchange rules, which required companies to report compliance with the code or explain why they had not.

The influence of religion on corporate governance 

Religious beliefs are part of the culture of every country and affect personal values, relationships, and attitudes to authority.  They influence morality, ethical standards, and what business behaviour is considered acceptable.  Under-pinning beliefs are reflected in the way business decisions are made, corporate entities operate, and corporate governance practices develop in different countries.

The United States was founded by Puritans seeking religious freedom.  The founding fathers, the majority of whom were lawyers, placed great emphasis on their constitution, the rule of law, and democratic rights.   Those same traits are reflected in the governance of American companies to this day.  Legal contracts, litigation, and shareholder rights are still at the forefront of business issues.

In the United Kingdom, on the other hand, the approach to corporate governance was more flexible, less rule-based and litigious, reflecting the broader traditions of Britain’s religious inheritance.  The Church of England, rejecting control from Rome, established a freedom of expression and tolerated other non-conformist religious traditions, which became embedded in British culture. The voluntary approach to corporate governance – ‘conform or explain why not’ – reflects this more flexible, voluntary approach.

Other countries influenced by Britain during the days of the British Empire (including Australia, Canada, South Africa, other countries in Africa and the West Indies, as well as Hong Kong and Singapore, shared these corporate governance influences.

In Germany, the teachings of Martin Luther, 500 years ago, shaped the country’s language and changed its way of life.  Luther influenced belief in the moral imperative to seek principle and order, to be prudent with money, and to avoid debt.  Southern European nations, on the other hand, influenced by Roman Catholicism, took a less austere approach: a distinction that is still being played out among the nations that adopted the Euro as their national currency.

Northern European nations were also affected by the teaching of John Calvin, which emphasized the importance of working for the community, not just for their families and themselves.  Germany’s co-determination laws view companies as partnerships between labour and capital. In the two-tier board governance structure, the supervisory board contains representatives of workers as well as investors.

The influence of religion on corporate governance practices can be seen strikingly in Japan.  Buddhism and Shinto, the national religion, have been dominant religious influences.  Even though relatively few Japanese now identify with either religion, belief in spirits is widespread.  Shrines to spirit deities are commonplace.  Social cohesion is a dominant feature of Japanese business life, with high levels of unity throughout the organization, non-adversarial relationships, lifetime employment, enterprise unions, personnel policies emphasizing 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.

The Japanese Keiretsu networks connect groups of Japanese companies through cross-holdings and interlocking directorships, Chairmen and senior directors of companies in the keiretsu have close, informal relationships.   Although the paternalistic relationship between company and lifetime ‘salary-man’ is under economic pressure, boards still tend to be decision-ratifying bodies rather than Western style decision-making forums.

Although there have been recent efforts to require independent non-executive directors, as in the Western corporate governance model, Japanese top management remains rather sceptical.  Many Japanese do not see the need for such intervention ‘from the outside’.  Indeed, they have difficulty in understanding how outside directors function. ‘How can outsiders possibly know enough about the company to make a contribution,’ they wonder, when they themselves have spent their lives working for it?  How can an outsider be sensitive to the ingrained corporate culture?

Of course, the cultural significance of religion does not mean that religion or religious organizations played a part in the development of corporate governance norms.  Indeed in some countries, the UK, China, and Japan for example, many people no longer claim any religious affiliation.  But the religious culture provided the ethical context, the moral influence in creating law, running business, and influencing approaches to corporate governance.

Culture and the future of corporate governance

When corporate governance norms were first discussed in the 1980s, many thought that corporate governance in countries around the world would gradually converge with Western practices.  They believed that because these countries needed to raise capital, trade in securities, and do business globally they would adopt Western practices.   Institutions such as the World Bank and the OECD[2] put considerable effort into advising developing countries about modern corporate governance practice.

Globalization became a dominant feature in world trade because some countries offered significantly lower costs to developed markets.  Some thought that globalization of the movement of goods, services, money, people, ideas  and information, would inevitably lead to a convergence of intellectual insights, politics, and ideology.  Such arguments are seldom heard these days. Capital can be raised in the East as well as the West.   Securities can be traded on many stock exchanges.[3]   The notion, which might be termed ‘globalism,’ seems unlikely to survive.  Attempts by countries to protect their own industry and labour markets, control the flow of people, money, and information across their borders challenge the onrush of globalization.

Now, as the 21st century moves forward, discussion about corporate governance increasingly recognizes the significance of culture – national, regional, corporate, and board-level – to successful corporate governance.. The governance of companies within a country needs to be consistent with that country’s culture.

Bob Tricker

March 2017

[1]  The material in this blog has been adapted from:  Corporate Governance in Modern China – principles, practices, and challenges; Bob Tricker and Gregg Li, to be published next year

[2] the Organisation for Economic Co-operation and Development

[3]  The stock exchanges of Singapore and Hong Kong now rank third and fourth in significance after London and New York

UK Corporate Governance Reform 2017

 

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.

Executive remuneration

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

Pay ratios

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

Going forward

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.

Chris Mallin

February 2017

Developing a shareholder strategy

A survey of shareholder communications in more than 400 companies listed on the Hong Kong Stock Exchange (HKSE) was published recently by the Hong Kong Institute of Chartered Secretaries (HKICS).   Since the HKSE ranks third equal with the Singapore Stock Exchange in world rankings (behind London and New York), it is likely that the findings have a wider significance.

The report, which I drafted, suggested that effective shareholder communications rest on an understanding of the shareholder base and their information needs. A key conclusion was that whilst some listed companies recognize that shareholder communications are vital, the majority do not and have some way to go to be effective.

Some of the key findings in the study were that:

  • A sizeable proportion of listed companies did not know much about their shareholders – the survey results showed that a third of respondent companies did not know who their shareholders were. They did not regularly or routinely monitor their shareholder base.
  • Some listed companies were not even bothered to find out – 5% of respondents said that they felt that they should be routinely monitoring who their shareholders were but did not: and a further 15.5% said they should be monitoring them on an ad hoc basis but did not.
  • The majority of listed companies lack a shareholder communication strategy

–  58.3% of respondents recognized that their communications with their shareholders were inadequate or ‘somewhat inadequate’.  Most saw the need for improvement.  But 8.6%, although they recognized that their communications were inadequate, saw no need for change. Only 33.1%% thought that their shareholder communications were adequate.

  • The vast majority did not think that all shareholders should be treated equally – Whilst respondents strongly believed that shareholders should be engaged more effectively, only a few (92) felt that all shareholders should be involved, whilst the majority (269) felt that engagement should only be with institutional investors and long-term shareholders. However, respondents believed that these investors had a stewardship role to proactively engage with the company.
  • There is little accountability for shareholder communications at the CEO or board levels – Many companies (172) report information on their shareholder profile to senior management, the board, or board committees. But more companies (241) did not report the data or did not know how it was used.
  • The company secretary is a source of help on investor relations profiling the shareholder base in 52.5% of the companies responding, followed by the Head of Investor Relations (21.0%). Companies reported devoting more resources to investor relations activities including shareholder communication and engagement, with increasing significance for an investor relations function.

Five ‘imperatives’ were developed to give practical and effective guidance to the board of directors and senior management to enhance shareholder communications and investor relations for listed companies, namely to:

  1. Develop an investor relations strategy within the corporate strategy
  2. Know and regularly review the shareholder base
  3. Formulate and regularly review shareholder communication policies
  4. Formulate and regularly review shareholder engagement policies
  5. Review the responsibility and accountability for investor relations

‘The full report can be read at: https://www.hkics.org.hk/index.php?_room=10&_action=detail&_page=3

(Click for the English or Chinese versions)

-Bob Tricker, 2017

 

A new idea in corporate governance – Shareholder Senates

Around twenty years ago I wrote that while the twentieth century had been the era of management, with its new management schools, management consultants, and management gurus, the twenty-first century would be the era of corporate governance.   Corporate governance has certainly now moved centre stage. Google has 52 million references to the phrase.

Interest in corporate governance has flourished. The late Sir Adrian Cadbury wrote the first corporate governance code – the UK’s Financial Aspects of Corporate Governance (1992).  He always emphasized that his report was not a comprehensive approach to corporate governance, but focused on the financial aspects. Nevertheless, he made proposals that are still pertinent ̶ the creation of board level audit committees, remuneration committees, and nomination committees, with independent outside directors; the separation of the board chairman from the CEO; and public reporting that the company had complied with the code or explaining why it had not.

Since then, corporate governance codes, often as stock exchange requirements, cover almost all listed companies around the world. But despite countless amendments, revisions, and rewrites most corporate governance development has been piecemeal. There has been relatively little original thinking. Most codes still adopt Cadbury’s voluntary ‘comply or explain’ approach. The principle exception is in the United States, where regulation and legislation are used to oversee the governance of corporations.

The development of corporate governance practice has almost always been in response to corporate failure or economic malaise. In the United States, the Securities and Exchange Commission (SEC) was set up in 1932–3, after the stock market crash of 1929 and the great depression that followed. The Cadbury report responded to concerns about corruption found in UK Government inspectors’ reports on failed companies including the collapse of Robert Maxwell’s’ corporate empire.

The US Sarbanes-Oxley Act (SOX 2002), was a response to the failure of Enron, Waste Management, and other companies, followed by the folding of the ‘Big Five’ accounting firm, Arthur Andersen, reducing the big five to the even bigger four. Unfortunately, SOX did not prevent the global financial crisis, starting around 2008, in which US companies such as Lehman Brothers failed and American International Group, Fannie Mae, Freddie Mac, and others were bailed-out by the US government. The result was further federal legislation. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, called by some SOX 2, attempted to improve American financial regulation and the governance of the US financial services industry.

As yet, no over-arching theory of corporate governance has emerged. New thinking and new ideas are badly needed in the governance of organizations. A fundamental governance question for the modern public company, for example, is: What role should the shareholders play in corporate governance?

In the original mid-nineteenth model of the joint-stock limited liability company, the shareholders were mostly individuals–aristocrats and members of the newly forming affluent middle class. These shareholders appointed the directors who reported to them on their stewardship of the company. The directors may have known their shareholders personally. Shareholder meetings and votes were the way boards of directors were held to account. Indeed, in the original model accounts were audited by an audit committee, elected from among the shareholders themselves.

But today, individuals running their own portfolios form only a small part of the shareholder base. These ‘retail shareholders’ typically have relatively small holdings and little influence. They might also include directors, executives, and other employees of the company.

Significant shareholders are more likely to be:

  • active institutional investors, such as mutual funds, pension funds, and financial institutions, closely interested in the company’s affairs who may be actively involved in corporate governance matters; and
  • passive institutional investors, such as index-tracking funds required by their constitutions to invest in a given range of securities, using computer algorithms to make investment decisions, with little interest in corporate governance issues. The shareholder base could also include:
        • hedge funds gambling against the market and selling short, with real short-term interests in the business, but not in longer-term corporate governance;
        • private equity investors seeking short term strategic opportunities;
        • dominant investors, perhaps the company’s founders or their family trusts, who are closely interested in, and possibly actively involved in company affairs. Though they might hold only a minority of the voting equity, in some jurisdictions they can maintain ownership power through dual-class shares;
        • state-owned corporations, perhaps with a minority of their shares traded publically, and possibly influenced by state economic and political interests; and
        • sovereign funds, using state capital to invest, possibly with political or economic implications as well as financial interests.Concerns over corporate behaviour, such as allegedly excessive director remuneration, unclear or over-ambitious corporate strategies, or the lack of board diversity have led some politicians and other commentators to call for shareholders to exercise their duty to oversee board behaviour more fully. This has led to the emergence of proxy advisers; firms that study issues facing companies and advise institutional investors on voting decisions.

But votes in shareholder meetings are advisory; exhortatory at best. Shareholders’ votes do not bind the board. Directors do not have to follow them. Energetic efforts by some institutional investors, including grouping together, have not changed the underlying power structure.

Bob Monks, in his book Corpocracy (New York: Wiley, 2007), showed how power had moved over the years from owners to directors. Concerned by what he saw as an abuse of power, he co-founded Institutional Shareholder Services (ISS) in 1985 to wage proxy warfare on companies. These proxy battles continue to this day. However, the fundamental question remains: In the modern public company what should the role of shareholders be?

Is it, on the one hand, to preserve the nineteenth-century legal concept of the corporation–that the shareholders own the company and are expected to play a basic role in its governance by electing the directors and holding them to account. Or is it, on the other hand, for the shareholders to accept a corporate stakeholder role providing finance, just as suppliers provide goods and services, customers produce sales revenues, and the employees provide the work force?

I have just completed a study on shareholder communication for the Hong Kong Institute of Chartered Secretaries, which will be published shortly and duly noted in this blog. In a survey Hong Kong’s listed companies gave overwhelming support for the idea that shareholders should exercise a stewardship role in the governance of listed companies. In this they are in line with the opinions of many authorities around the world–regulators, legislators, and corporate governance commentators.

Had the alternative view been taken, that shareholders are just one of the various stakeholders in a corporation, appropriate governance models could be developed. The German supervisory level two-tier board could provide a start; members are nominated to represent both labour and capital (the employees and the investors). Representatives of other stakeholders could be added.

Such a development would reflect a change in the UK Companies’ law in 2006. Prior to that company law in the UK required directors to act in the best interests of the company, which effectively meant in the interest of the shareholders, in other words, by attempting to maximize shareholder value in the long term. But the Companies Act 2006 specifically spelled out a statutory duty to recognize the effect of board decisions on a wider public. For the first time in UK company law, corporate social responsibility (CSR) responsibilities were included among the formal duties of company directors:

‘A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard to:

(a) the likely consequences of any decision in the long term

(b) the interests of the company’s employees

(c) the need to foster the company’s business relations with suppliers, customers, and others

(d) the impact of the company’s operations on the community and the environment

(e) the desirability of the company maintaining a reputation for high standards of business conduct, and

(f) the need to act fairly as between members of the company.’

Thus UK company law now requires companies to consider employees, suppliers, customers, and other business partners, as well as the community and the environment, in their decisions.

However, if shareholders are to continue to be a responsible part of the corporate governance mechanism, how might that be achieved? If shareholders are really to affect corporate governance in the companies in which they invest, they need more power. New corporate governance models will have to be devised. One idea might be a Shareholder Senate.

Shareholder Senates

A Shareholder Senate would be a new governance body set mid-way between the company and the body of shareholders. Members of the Senate would be nominated by long-term institutional investors and elected by all the shareholders.

The Senate would meet formally with the board’s remuneration committee, its nomination committee, and its audit committee with the auditors. Periodically, it would have discussions with the Chairman and the entire board. It would also meet independently to formulate reports and make recommendations to shareholders.

The overall responsibility for the company and its management would remain with the board of directors. The Senate would have the authority to question, to advise, and to influence the company on its strategies, operational performance, and financial matters. For example, a Senate could question and challenge levels and methods of executive remuneration, the adequacy of risk assessment systems, the balance of skills, experience, and adequacy of the directors, and confirm that succession plans existed for all senior executives.

The Senate would not have the power to block the board’s decisions, nor could it hire and fire directors (as the German supervisory board can). But it would have the responsibility to liaise with the shareholders, and the power to recommend how they vote on specific motions. It could also introduce motions for shareholder meetings. Over time, Shareholder Senates would supplement and probably replace the work of proxy advisers.

Shareholder Senates would become a fundamental component of companies’ corporate governance structures and processes. Accordingly, members of the Senate would have fees and expenses reimbursed by the company, just as non-executive, outside directors have. The company would be responsible for publishing Senate reports and other communications with investors, just as it publishes other corporate reports.

Concern might be expressed that members of Shareholder Senates would receive unfair insider information. But Senate members could be placed in a similar position to directors who may not trade shares prior to the announcement of results. In fact, Senate members would be in a less exposed position than a nominee director elected by a major shareholder, because they would not attend board deliberations.

In fact, it would not be difficult to introduce a requirement for shareholder senates into companies’ legislation or to include them in corporate governance codes, operating on the ‘comply or explain’ principle.

The proposal for Shareholder Senates will not be welcomed by most directors and their boards, because they would inevitably mean a shift of power away from the boardroom back to the owners. However, there was plenty of antagonism in British board rooms to the original Cadbury Report proposals: many thought independent outside directors were an unnecessary imposition and an infringement of executive directors’ right to run their own companies.

There is little doubt that Shareholder Senates will not be achieved without legislation and regulation. Such developments could be prompted by the ongoing dissatisfaction with the governance of the modern corporation. The newly appointed British prime minster, Theresa May, following the UK’s referendum vote to leave the European Union, mentioned problems with the governance of British companies in her inaugural statement.

Corporate governance evolves. Dissatisfaction exists over the present corporate governance model. Some boards readily accept a responsibility to engage with their shareholders. Others do not. Some companies are run for the benefit of their owners. Others are not. Criticisms multiply of board-level excess, particularly over board-level remuneration. Shareholder Senates would provide an opportunity to re-establish owners’ rights. They would give investors a more effective say in the governance of their companies. Power would no longer be abdicated by the owners to the directors.

 

Bob Tricker
September 2016

How the phrase ‘corporate governance’ arose

My experiences during a decade as Director of the Oxford Management Centre in the 1970s made me realize that there was an underlying contradiction in the way that the Centre was run. Oxford colleges are run by their Fellows and the Head of the House (by whatever name the Head is known – Master, Warden, Principal) reflecting the governance of the monastic institutions from which the colleges derived.

The Management Centre, on the other hand, was run like a company, which it was. But the academic standards set for the Fellows were those of an Oxford college, as Sir Norman Chester, Warden of Nuffield College and Chairman of the Management Centre’s board of directors (its Council), was frequently at pains to point out. Power over the Centre’s strategy lay with the Chairman and that Council, not with the Centre’s Director or the Fellows. The Chairman and his Council wielded power over the finances, and the hiring and firing of academic staff.

The Council was made up of senior Oxford academics and influential businessmen, and had more members than the teaching staff. The problem was that the Chairman and the other board members, both the businessmen and the Oxford academics alike, had no experience of management education. They did not know the subject, they were unaware of the market, and ignorant of the competition: whereas the Director and Fellows, who did know, were subject to the whims of that governing body. Moreover, I came to realize that members of the Council often acted personally and politically in Council meetings, sometimes with prejudice and personal passion. This was not the analytical and rational management decision making we were teaching at the Management Centre.

Eventually, Chester was replaced as Chairman by a businessman, who had also been the benefactor of the Centre. He did not agree with my strategy of focusing the Centre’s work on top management and fired me. ‘Every man has his price,’ he said. Mine was a five year research fellowship at Nuffield College to research whatever I wanted, with a tiny teaching commitment and no administration – an opportunity seldom available at the professorial level.

Governance is not management – the Corporate Policy Group

It occurred to me that the experience of board level activities at the Management Centre was probably the case at the top in many organizations. What went on in boardrooms was not management. It involved the exercise of power. It was a personal and political process. This activity, which could be called governance, was different from management. Governance involved formulating strategy, setting policy, supervising management, and being accountable overall. Management runs the enterprise, but the governing body ensures that it is being run well and in the right direction. This awareness was reinforced by a study[1] on audit committees for British boards that I had already done for accountancy firm Deloitte, Haskins and Sells.

My Research Fellowship provided the perfect opportunity to explore board level processes in depth. I formed a trust, called the Corporate Policy Group, as a focus for the project. In retrospect, I should have called it the Corporate Governance Group, but the phrase ‘corporate governance’ was not then in use and the concept was not understood. When I contributed the management topics to Alan Bullock’s Dictionary of Modern Thought in 1977, there was an entry for ‘corporate strategy’ but not for ‘corporate governance.’ It would be different today.

The Corporate Policy Group was based at Nuffield College and ran for the five years of my Research Fellowship from 1979 to 1983. In the explanatory literature of the Corporate Policy Group I suggested that ‘Many ideas are currently being discussed around the world – improving strategic decision-making, alternative board structures and committees, new roles for outside non-executive directors, audit committees, supervisory boards, regulation, accountability, industrial democracy, wider disclosure, accounting standards, and so on. Yet we know remarkably little about the reality of board level behaviour. There is no generally agreed frame of reference, little except anecdotal evidence, a paucity of serious analysis and thought, inadequate development and training for board membership; concern but few answers on improving board level performance. Companies today can be complex, concentrated, and large, their operations multi-product and international. Inevitably they are enmeshed with governments. They exist in a world of changed expectations – of managers, employees and their unions, consumers and throughout society. Yet we continue with essentially nineteenth century assumptions, based on entrepreneurial capitalism and the (supposed) power of shareholders in annual meeting. There is a variety of ideas but a paucity of thought. There is discussion without data, decisions without grasping the totality of matters involved. The Corporate Policy Group has been created to provide rigorous analysis, careful discussion, thoughtful review, and dissemination of the results.’

 High-flying aims, but remember it was written in 1979.

The Group had no researchers, other than me, but quickly became a network of scholars, company chairmen, CEOs and directors, auditors, lawyers, and others interested in the field. The main focus of our interest was on board structures and processes, the roles of executive and non-executive directors, the reality of strategy formulation, as well as corporate regulation and accountability. Such matters are commonplace today, but then corporate governance codes, compliance reports, and the other paraphernalia of modern corporate governance did not exist.

The initial approach I adopted involved the exploration of the frontiers of knowledge on the topics, discussions with board chairmen and other directors, round-table discussions with directors from different companies, and seminars and conferences. We invited Harold Williams, the Chairman of the Securities and Exchange Commission from Washington, who gave an American perspective on corporate regulation. Another conference, run with the Anglo-German Foundation, looked at the control of the corporation from the perspective of various stakeholders, outlining the German experience of supervisory boards and worker directors.

As the project progressed, I developed two research exercises about the structure and style of boards, and about management and governance relationships between subsidiary and holding companies, which provided the basis for a book – Corporate Governance – the first to use that title. The main findings were, firstly, that there were many opportunities to improve performance and effectiveness. Secondly, the way many business entities operate in society no longer reflected the underlying nineteenth-century legal model of the corporation, and consequently there was a need to rethink the underlying conceptual framework.

The Trustees of the Corporate Policy Group suggested that the findings published in Corporate Governance should be developed into another book of practical insights for directors. Unfortunately, one of my findings had been that practicing directors had little time for reading books, so the material formed the basis of short courses for the Institute of Directors in London and other programmes I ran in Australia, Singapore, and Malaysia.

On the phrase ‘corporate governance’

One evening at dinner at Nuffield high table, a guest sitting opposite asked what I did. I said I had just written a book. Silly really, because so had everyone else at that table.

‘Really, what is it about?’ he asked politely.

‘Corporate governance,’ I said.

‘You mean corporate government?’

‘No, I checked the meaning – it’s about corporate governance.’

‘Good Lord,’ he responded, ‘that word hasn’t been used since the time of Chaucer.’

Turned out he was a visiting Professor of English. Although he was not entirely correct: Harold Wilson, British Prime Minister (1916–1995) had written a book in 1977 with the title ‘The Governance of Britain’ [2]. But that was about the governance of a country, not a company: corporate governance was new. The visiting professor was right about Chaucer, however. Turns out Chaucer did coin the word governance, although he couldn’t quite decide how to spell it (gouernance, or governaunce).

 

This note has been adapted from the recently published book Oxford Circus – the story of Oxford University and Management Education, Bob Tricker (2015) available from Amazon or through www.BobTricker.com

 

[1] Tricker, R. I (1978), The Independent Director, London: Tolley

[2] Wilson, Harold (1977), The Governance of Britain, New York: Harper Collins

 

Bob Tricker, December 2015

UK Stewardship Code – Compliance

As reported in an earlier blog post (5th July 2010), the Financial Reporting Council (FRC) issued the UK Stewardship Code in the summer of 2010 with the aim of enhancing ‘the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities’.

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.

 To what extent have asset managers, asset owners and service providers complied with the recommendations of the Stewardship Code?  Several reports have been produced which detail the level of compliance.

Level of compliance

The FairPensions (2010) survey analysed 29 of the largest asset managers and found that 24 of these had published a formal statement/response with respect to the Stewardship Code. An additional four (Insight, Invesco, Morgan Stanley and State Street) had posted short statements on their website referring to the Code. FairPensions reviewed the 24 compliance statements to assess the quality of disclosures made with respect to the Code.

They were disappointed as they felt that the investors’ statements often gave ‘tick-box’ responses to the Stewardship Code principles whereas it was an opportunity to “tell their story” as to how they monitor companies and incorporate stewardship activity into their wider investment process. http://www.fairpensions.org.uk/sites/default/files/uploaded_files/whatwedo/StewardshipintheSpotlightReport.pdf

The Investment Management Association (IMA) (2011) survey of adherence to the Stewardship Code analysed the questionnaire responses from 41 asset managers, seven asset owners and two service providers. The questionnaire was developed with the oversight of a Steering Group chaired by the FRC’s Chief Executive.  The IMA (2011) survey covered the period to 30 September 2010 and showed widespread adherence by 50 UK institutional investors to the best practice set out in the FRC’s Stewardship Code. The IMA reported:

“Over 90% of major institutional investors now vote all or the great majority of their shares in UK companies; nearly two thirds now publish their voting records.

At the time the survey was conducted, 43 out of 50 respondents had published a statement on adherence to the Code, and another six did so subsequently.

Over 1,300 people focusing on stewardship activities are employed by 43 of the respondents to the survey.”

http://www.investmentfunds.org.uk/research/stewardship-survey

The FRC (2011) published Developments in Corporate Governance 2011, The Impact and Implementation of the UK Corporate Governance and Stewardship Codes, FRC, London.

http://www.frc.org.uk/images/uploaded/documents/Developments%20in%20Corporate%20Governance%2020117.pdf

They reported that, as of December 2011 the Stewardship Code had attracted 234 signatories, including 175 asset managers, 48 asset owners and 12 service providers23. This level of take-up indicates that the concept of stewardship is being taken seriously.  Importantly there has been a wide base of support for the Stewardship Code including from both large and small institutional investors.

There seems to be rather mixed evidence as to whether institutional shareholders are engaging more with their investee companies since the Stewardship Code was introduced. However over time it is to be expected that overall there will be a higher level of engagement.

Reasons for non-compliance

Organisations not complying with the Stewardship Code tend to fall into two groups: (i) those not signing based on their specific investment strategy, and (ii) those who do not commit to codes in individual jurisdictions.

Future developments

The FRC proposes to make limited revisions to both the UK Corporate Governance Code and the Stewardship Code which, subject to consultation, will take effect from 1st October 2012. As far as the Stewardship Code is concerned, they FRC state that it is ‘not currently envisaged that new principles will be introduced but it may be helpful to clarify the language in certain places, for example on the different role of asset managers and asset owners.’

Areas where the FRC might consider strengthening the language include conflicts of interest, collective engagement, and the use of proxy voting agencies, and possibly a recommendation that investors disclose their policy on stock lending.

Finally a Stewardship Working Party has been formed consisting of Aviva Investors, BlackRock, Governance for Owners, Railpen Investments, Ram Trust and USS together with Tomorrow’s Company.  They will determine whether it is possible to devise a “scale of stewardship” which would enable institutions to differentiate themselves.

 Chris Mallin 8th March 2012