The basics of Corporate Governance

Summary

This script delves into the necessity and intricacies of corporate governance, highlighting the separation of ownership and control. It underscores the importance of aligning directors' actions with shareholders' interests, ensuring long-term wealth creation over short-term profits. The discussion covers various governance structures, with a focus on the unitary board system. It contrasts regulatory approaches, favoring the principles-based method over the rules-based one. The script outlines best practices, including a majority of non-executive directors, separate roles for the chair and CEO, and key subcommittees like audit, nomination, and remuneration. It also touches on international standards, emphasizing the OECD and ICGN frameworks, and concludes with practical advice for exams, suggesting that understanding shareholder concerns is key to grasping governance codes.

Takeaways

• 📈 Corporate governance is essential due to the separation of ownership and control in businesses, ensuring directors act in shareholders' best interests.
• 👔 Directors may have different objectives from shareholders, potentially leading to actions that benefit them personally but not the long-term health of the company.
• 🏢 The structure of corporate governance includes board composition, director roles, and internal controls, which are crucial for directing and controlling organizations.
• 🌐 Board structures can vary globally, with multi-tier systems featuring a supervisory board and a management board, or a more common unitary board with a mix of executive and non-executive directors.
• 📚 Corporate governance can be enforced through a rules-based approach, like the Sarbanes-Oxley Act in the USA, or a principles-based approach, which is more flexible and adaptable.
• 🔍 A principles-based approach requires companies to comply with best practice principles and disclose any deviations, allowing investors to make informed judgments.
• 🌟 Best practice in corporate governance often includes having at least half of the board composed of non-executive directors to ensure independent oversight.
• 🛠️ Key roles of non-executive directors include strategy development, scrutiny of executives, ensuring proper risk management, and overseeing human resources within the board.
• 🔑 It's a best practice for the roles of the chairperson and CEO to be separate to prevent concentration of power and to ensure clear division of responsibilities.
• 💼 Board subcommittees such as audit, nomination, and remuneration committees play vital roles in financial oversight, director appointments, and compensation, respectively.
• 🌱 The inclusion of a risk committee is becoming more common, focusing specifically on risk management and allowing for the involvement of executive directors.

Q & A

Why is corporate governance necessary?

Corporate governance is necessary due to the separation between ownership and control. It ensures that directors act in a manner that aligns with the objectives of the shareholders, preventing potential conflicts of interest that may arise from directors' personal objectives differing from those of the shareholders.

What is the primary role of non-executive directors (NEDs) in a unitary board structure?

Non-executive directors serve to represent the interests of shareholders without having operational responsibilities within the company. They are crucial in decision-making to prevent business decisions from being dominated by those with operational interests, thus ensuring a balance of power and oversight.

What are the four key roles of non-executive directors as outlined in the script?

The four key roles of non-executive directors are: Strategy (contributing to the company's strategic direction), Scrutiny (overseeing and challenging the decisions made by executive directors), Risk (ensuring proper risk management processes are in place), and People (assisting in board composition and director appointments).

Why should the roles of the chairperson and the CEO be separate in a corporate governance structure?

Separating the roles of the chairperson and the CEO prevents the concentration of power in one individual, which can be a concern for shareholders and the business. It allows for a clear division of responsibilities, with the chairperson focusing on running the board effectively and the CEO managing the business operations.

What is the significance of having a majority of independent non-executive directors on a board?

Having a majority of independent non-executive directors ensures that decisions are not dominated by those with operational responsibilities within the company. This helps maintain objectivity and focus on the long-term interests of the shareholders, rather than short-term operational gains.

What is the purpose of the audit committee in corporate governance?

The audit committee reviews the financial statements, oversees internal and external audits, and ensures there is an effective risk management process in place. It is typically composed of non-executive directors with financial expertise to provide independent oversight of the company's financial integrity.

What does the nomination committee in a corporate governance structure focus on?

The nomination committee is responsible for the board's composition, considering the structure, size, diversity, and the appointment of directors. It makes recommendations for the board's composition to ensure it has the right mix of skills and experience.

What is the remuneration committee's role in corporate governance?

The remuneration committee determines the compensation of directors, balancing fixed salaries with performance-related pay to motivate directors without encouraging excessive risk-taking. It ensures that the compensation structure aligns with the long-term goals of the shareholders.

Why is a risk committee sometimes established as a separate board subcommittee?

A risk committee can provide specific focus on risk management, separate from the audit committee, which typically consists of non-executive directors. This allows for the inclusion of executive directors in risk oversight, ensuring that risk management is given the necessary attention and is well-integrated within the business.

How does corporate governance relate to the principles-based approach versus the rules-based approach?

Corporate governance can follow a principles-based approach, which is more flexible and allows for the application of best practice principles in various circumstances. Alternatively, a rules-based approach, such as the Sarbanes-Oxley Act in the USA, mandates specific legal requirements with enforceable consequences, providing a more rigid structure.