Improving the Substance of Corporate Governance

1
Improving the Substance of Corporate Governance

• Mak Yuen Teen

SIAS Corporate Governance Conference, 8 October
2008
2
Redefining Corporate Governance?

• Corporate governance refers to having the right
  people, structure and processes to direct and
  manage the company, in order to enhance its
  long-term value, through enhancing performance,
  accountability and risk management. It is about
  empowering management, while ensuring that there
  is adequate oversight and accountability.

3
Redefining Corporate Governance?

• Having the right people is as (more?) important
  as structure and processes
• Robust risk management is critical to good
  corporate governance (and may be undermined by
  design of pay for performance schemes)
• The board should not micro-manage

4
Keys to Improving Substance

• To improve substance, the board must
• believe in accountability
• take responsibility for governance
• seek continuous improvements
• incorporate good governance principles into
  everything it does

5
1. Setting the Tone at the Top

• Hold directors and senior management to the
  highest ethical standards
• having a code of conduct or ethics for directors
  and senior management is a good start
• enforcing ethical standards on directors and
  senior management is critical

6
2. Building an Effective Board

• Rigorous processes should be followed in
• recruiting the right directors, which involves
  assessing current mix of skills and backgrounds
  of directors against the desired mix, and having
  a robust process for identifying and selecting
  candidates
• diversity in competencies and backgrounds is
  valuable provided its not tokenism (e.g.,
  specialists/generalists, CEOs/non-CEOs,
  local/foreign directors, gender, races,
  private/public/non-profit, etc.)

7
Foreign Directors Pros and Cons

• Pros
• knowledge of overseas market in which company has
  a listing or significant business
• not part of old boys network so better able to
  express dissenting views
• influence the board to adopt international good
  practices
• Cons
• lack of knowledge of local laws and practices
• difficulty in actively contributing to board and
  committee work
• difficulty in paying them adequate fees or may
  lead to fee escalation for entire board if no
  policy on differential fees for foreign directors

8
2. Building an Effective Board

• Rigorous processes should be followed in
• inducting and developing directors
• assessing independence of independent directors
  to ensure that they are independent in substance,
  continue to be so, and likely to be perceived to
  be so
• assessing board and director performance to
  ensure that the board and individual directors
  are in fact adding value

9
Induction of Directors

• In the UK, the Institute of Chartered Secretaries
  and Administrators (ICSA) has published a
  guidance note on Induction of Directors
  (http//www.icsa.org.uk), divided into
• essential information to be provided immediately
  (directors duties, companys business, board
  issues)
• additional material to be provided within the
  first few months
• additional information which the company
  secretary might consider making the director
  aware of

10
Assessing Director Independence

• Principles-based approach to assessment of
  independence by the NC
• determines whether the director is caught by one
  of the 4 relationships in guideline 2.1
• considers whether there is any other relationship
  or factor which may influence the directors
  ability to act independently (e.g., long tenure,
  interlocks)
• considers the directors actual behaviour
• carefully explains why director is deemed
  independent where threats to independence exist

11
Assessing Board and Director Performance

• A typical board assessment questionnaire may
  cover
• board structure, roles and responsibilities
• board meeting processes
• board culture and relationships
• boards access to information and management
• boards involvement in strategy and planning
• boards involvement in monitoring
• Committee performance should also be assessed

12
Assessing Board and Director Performance

• Some key issues
• Feedback from management
• Feedback from key shareholders
• Use of external party
• Simple annual, plus more comprehensive less
  regular, evaluations
• Quantitative vs qualitative
• Benchmarking to other boards
• Using the results of assessment

13
3. Board-Management Relationship

• Board and management must have a good working
  relationship but without becoming too close
• Board and management must have clear
  understanding of their respective roles and
  responsibilities
• Board should delegate clearly, have clear
  reserved powers and supervise its delegation

14
3. Board-Management Relationship

• Supervising delegation requires the board to be
  pro-active in asking questions and seeking
  information
• Certain reserved powers can be delegated to board
  committees but this should be explicit
• Beware of board committees over-reaching into
  management

15
Examples of Reserved Powers of the Board

• Approval of vision, mission, values statement,
  code of ethics and strategic plan
• Recommendation to appoint/change auditors
• Recommendation on the remuneration of auditors
• Approval of auditors engagement letter
• Review of auditors recommendations and
  observations
• Approval of all circulars and other documents,
  including those required by the stock exchange to
  be sent to shareholders
• Approval of press releases on matters decided by
  the Board
• Approval/review of interested party transactions

16
Examples of Reserved Powers of the Board

• Approval of interim and final accounts and
  reports
• Approval of interim dividends and recommendation
  of a final dividend
• Approval of all significant changes in accounting
  policies and practices
• Approval of budget
• Approval of all changes to the organisation of
  senior management
• Approval of CEO remuneration and policy
• Approval of individual items of expenditure in
  excess of a stated amount

17
4. Internal Control and Risk Management

• An internal control system should include at
  least the following
• explicit assignment of responsibilities for
  internal control
• procedures for assessing the effectiveness of
  internal controls
• reporting of significant risk and internal
  control matters to the Board and CEO
• whistleblowing arrangements

18
4. Internal Control and Risk Management

• According to the ASX recommendations, a sound
  risk management system should include
• policies on risk oversight and management, which
  clearly describe roles and accountabilities
• policies which cover oversight risk profile
  risk management compliance and control and
  assessment of effectiveness
• the boards oversight of establishment and
  implementation of the risk management system, and
  review of its effectiveness at least annually

19
4. Internal Control and Risk Management

• risk profile should cover material financial and
  non-financial risks, and should be regularly
  reviewed and updated
• managements responsibility for establishing and
  implementing a system for identifying, assessing,
  monitoring and managing material risk throughout
  the organisation
• means of analysing the effectiveness of its risk
  management system and effectiveness of
  implementation

20
5. Executive and Director Pay

• There is often an over-reliance on cash bonuses
  based on annual profits and stock options to pay
  for performance
• Such pay for performance schemes encourage
  senior executives to take on more risk without
  bearing the full consequences (they have
  asymmetric payoffs)
• Relative TSR also does not properly account for
  risk

21
Annual Cash Bonuses
22
5. Executive and Director Pay

• Is it time for risk-adjusted measures to be used
  for rewarding CEOs? (but CEOs have considerable
  power in influencing pay level and policy)
• Different pay for performance schemes may be
  appropriate for different types of companies and
  for different senior executives within the
  company
• Stock options are generally inappropriate for
  NEDs

23
5. Executive and Director Pay

• May need to consider raising premiums for
  chairmen relative to NEDs in Singapore
• NED fees are too low for some companies but may
  be reaching competitive levels for larger
  companies
• Attendance fees may be starting to create
  dysfunctional incentives in some companies

24
Questions? Slides can be downloaded from
www.cgfrc.nus.edu.sg email yuenteen.mak_at_watsonwy
att.com bizmakyt_at_nus.edu.sg