WHAT IS CORPORATE GOVERNANCE?

- mechanisms, processes and relations by which corporations are controlled and directed
-about the distribution of different corporate parties for making decisions in corporate affairs.
If management is about running the business, corporate governance is about seeing that it is run
properly and accordingly. All companies need managing and governing.

WHY CORPORATE GOVERNANCE?

-

Improved company performance

Higher firm valuation and share performance
Reduced risk of corporate crisis and scandal

CORPORATE GOVERNANCE PARTIES

*Shareholders
*Directors
*Manager
*Creditors

CORPORATE GOVERNANCE PILLARS

Accountability
-

ensure that management is accountable to the board and board is accountable to

shareholders

Fairness
-

treat all shareholders equally

provide equal and effective consequences for violations

Transparency
-

ensure timely, accurate disclosure on all material matters

Independence
-

free from influence of others

CORPORATE GOVERNANCE ELEMENTS

Good board practices
*Clearly defined roles and authorities
*Duties & responsibilities are understood by Directors
*Board is well-structured
*Appropriate composition and mix of skills
*Board self-evaluation and training conducted

Control Environment
*Internal control procedures
*Risk management framework present
*Independent audit committee
*Management information systems established
*Independent external auditor conducts audit

Transparent disclosure
*Financial information disclosed
*Non-financial information disclosed
*In compliance with IFRS
*Companies registry filings are up to date
*High-quality annual report published

Well-defined shareholder rights

*Minority shareholder rights formalised
*Organised shareholder meetings conducted
*The board discuss corporate governance issues and created a governance committee
*The corporate governance improvement plan has been created and implemented

*Policies and procedures have been formalised and distributed to relevant staff

Price- earning ratio

*ratio used for valuing a company that measures its current share price relative to its per-shareearnings

Corporate Governance and Agency Theory

AGENCY THEORY -is the branch of financial economics that looks at conflicts of
interest between people with different interests in the same assets.

AGENCY THEORY DIAGRAM

Origins Of Agency Theory
During the 1960s & 1970s, economists explored risk sharing among individuals or groups. This
literature described the risk sharing problem as one that arises when co-operating parties have
different attitudes toward risks.
Agency Theory broadened this risk sharing literature to include the so called agency problem
that occurs when co-operating parties have different goals and division of labour. Specifically,
this theory is directed at the ubiquitous agency relationship in which one party delegates work to
another agent who performs that work.
CONFLICTS BETWEEN MANAGERS AND SHAREHOLDERS

SELF-INTERESTED BEHAVIOR-Agents have the ability to operate in their own selfinterest rather than in the best interests of the firm because of asymmetric information
and uncertainty.

COSTS OF SHAREHOLDER-MANAGEMENT CONFLICT

Agency costs are defined as those costs borne by shareholders to encourage managers to
maximize shareholder wealth rather than behave in their own self-interests.
-There are three major types of agency costs:
1

expenditures to monitor managerial activities, such as audit costs;

expenditures to structure the organization in a way that will limit undesirable managerial
behavior, such as appointing outside members to the board of directors or restructuring
the company's business units and management hierarchy; and

opportunity costs which are incurred when shareholder-imposed restrictions, such as

requirements for shareholder votes on specific issues, limit the ability of managers to take
actions that advance shareholder wealth.

STOCKHOLDERS VERSUS CREDITORS: A SECOND AGENCY CONFLICT

Shareholder-creditor agency conflicts can result in situations in which a firm's total value
declines but its stock price rises. This occurs if the value of the firm's outstanding debt falls by
more than the increase in the value of the firm's common stock.
AGENCY VERSUS CONTRACT
Although the notions of agency and contract are closely intertwined, some academics bristle at
the suggestion they are essentially the same. A conventional view holds that agency is a special
application of contract theory. However, some argue that the reverse is true: a contract is a
formalized, structured, and limited version of agency, but agency itself is not based on contracts
AGENCY AND ETHICS
Since agency relationships are usually more complex and ambiguous than contractual
relationships, agency carries with it special ethical issues and problems, concerning both agents
and principals.

STEWARDSHIP THEORY

Is a theory that managers, left on their own, will indeed act as responsible stewards of the
assets they control.
Is an alternative view of agency theory in which managers are assumed to act in their
own self-interests at the expense of shareholders.
Managers are viewed as loyal to the company and interested in achieving high
performance.
Ownership doesnt really own a company, its merely holding it in trust.

EXAMPLE

Environmental concerns- operating with the littlest possible impact on Earth

EFFECT ON BUSINESS

A company committed to a higher purpose will draw clients who share that same
purpose.

EFFECT ON EMPLOYEES

Employees who hold on to the same vision tend to stick around and work hard to achieve
the companys goals even if the compensation is not as much as they can get elsewhere.

EFFECT ON CLIENTS

Customers also like to feel like they are part of something, and may stay with a
stewardship-driven business even if its price for goods or services is higher.

STAKEHOLDER

THEORY

In the traditional view of the firm, the shareholder view, the shareholders or stockholders
are the owners of the company, and the firm has a binding financial obligation to put their needs
first, to increase value for them. However, stakeholder theory argues that there are other parties
involved, including governmental bodies, political groups, trade associations, trade unions,
communities, financiers, suppliers, employees, and customers. Sometimes even competitors are
counted as stakeholderstheir status being derived from their capacity to affect the firm and its
other stakeholders. There have been many definitions of stakeholders.

What is a stakeholder?

It is defined as any person/ group which can affect or be affected by the actions of the
business

Any group or individual who can affect or is affected by the achievement of the

organization's objectives
Those groups "on which the organization is dependent for its continued survival".
Stanford Research Institute (1963)

What kind of entity can be a stakeholder?

Persons, groups, neighborhoods, organizations, institutions, societies, and even the

natural environment are generally thought to qualify as actual or potential stakeholders.

The basis of the stake can be unidirectional or bidirectional- "can affect or is affected by"
- and there is no implication or necessity of reciprocal impact, as definitions involving

relationships, transactions, or contracts require.

Excluded from having a stake are only those who cannot affect the firm (have no power)

and are not affected by it (have no claim or relationship).

It includes employees, customers, suppliers, creditors and even the wider community and
competitors.

What is Stakeholder Theory?

It looks at the relationships between an organization and others in its internal and external
environment. It also looks at how these connections influence how the business conducts

its activities.
It is a theory that states that a company owes a responsibility to a wider group of

stakeholders, other than just shareholders.

The stakeholder concept was originally defined as including those groups without whose

support the organization would cease to exist.

Organizations that manage their stakeholder relationships effectively will survive longer

and perform better than organizations that dont.

It attempts to articulate a fundamental question in a systematic way: which groups are
stakeholders deserving or requiring management attention, and which are not?

R. Edward Freeman

The original proposer of the stakeholder theory, Strategic Management: A Stakeholder

Approach (1984)
Recognized it as an important element of Corporate Social Responsibility (CSR), a

concept which recognizes the responsibilities of corporations in the world today.

The core idea of the stakeholder theory is that organizations that manage their stakeholder
relationships effectively will survive longer and perform better than organizations that
dont.

Freeman suggests that organizations should develop certain stakeholder competencies. These
include:

Making a commitment to monitor stakeholder interests

Developing strategies to effectively deal with stakeholders and their concerns

Dividing and categorizing interests into manageable segments

Ensuring that organizational functions address the needs of stakeholders

What is CSR or Corporate Social Responsibility?

Defined by Jones as "the notion that corporations have an obligation to constituent groups
in society other than stockholders and beyond that prescribed by law or union contract,
indicating that a stake may go beyond mere ownership"

The term generally applies to efforts that go beyond what may be required by regulators or
environmental

protection

groups.

Additional Fact:
Recent controversies surrounding the tax affairs of well-known companies such as Starbucks,
Google and Facebook in the UK have brought stakeholder theory into the spotlight. Whilst the
measures adopted by the companies are legal, they are widely seen as unethical as they are
utilizing loopholes in the British tax system to pay less corporation tax in the UK. The public

reaction to Starbucks tax dealings has led them to pledge 10m in taxes in each of the next two
years in an attempt to win back customers.
Business Application
Stakeholder theory suggests that the purpose of a business is to create as much value as possible
for stakeholders. In order to succeed and be sustainable over time, executives must keep the
interests of customers, suppliers, employees, communities and shareholders aligned and going in
the same direction.
A stakeholder approach can assist managers by promoting analysis of how the company fits into
its larger environment, how its standard operating procedures affect stakeholders within the
company (employees, managers, stockholders) and immediately beyond the company
(customers,
Generic

suppliers,financiers).
Stakeholder

Map

with

specific

stakeholders

Freeman suggests, for example, that each firm should fill in a "generic stakeholder map" with
specific stakeholders. General categories such as owners, financial community, activist groups,
suppliers, government, political groups, customers, unions, employees, trade associations, and
competitors would be filled in with more specific stakeholders. In turn, the rational manager
would not make major decisions for the organization without considering the impact on each of
these specific stakeholders. As the organization changes over time, and as the issues for decision
change, the specific stakeholder map will vary.

If the corporate manager looks only to maximize stockholder wealth, other corporate
constituencies (stakeholders) can easily be overlooked. In a normative sense, stakeholder theory
strongly suggests that overlooking these other stakeholders is (a) unwise or imprudent and/or (b)
ethically unjustified. To this extent, stakeholder theory participates in a broader debate about
business and ethics: will an ethical company be more profitable in the long run than a company
that looks only to the "bottom line" in any given quarter or year? Those who claim that corporate
managers are imprudent or unwise in ignoring various non-stockholder constituencies would

answer "yes." Others would claim that overlooking these other constituencies is not ethically
justified, regardless of either the short-term or long-term results for the corporation.
Inevitably, fundamental questions are raised, such as "What is a corporation, and what is the
purpose of a corporation?" Many stakeholder theorists visualize the corporation not as a truly
separate entity, but as part of a much larger social enterprise. The corporation is not so much a
"natural" individual, in this view, but is rather constructed legally and politically as an entity that
creates social goods. Robert Reich has noted that for many years, the tacit assumption of both
corporate chiefs and U.S. political leaders was that "the corporation existed for its shareholders,
and as they prospered, so would the nation." Yet that "root principle" may no longer be valid,
according to many critics of corporate aims and activities in a global economy.
REFERENCES:
http://www.stakeholdermap.com/stakeholder-theory.html
http://www.referenceforbusiness.com/encyclopedia/Sel-Str/StakeholderTheory.html#ixzz3s2u8FBYG
http://study.com/academy/lesson/what-is-stakeholder-theory-definition-ethics-quiz.html

POTENTIAL PROBLEMS OF CORPORATE GOVERNANCE

Corporate Governance Definition
-

Refers to the mechanisms, processes and relations by which corporations are controlled
and directed.
Broadly refers to the mechanisms, processes and relations by which corporations are
controlled and directed. Governance structures and principles identify the distribution of
rights and responsibilities among different participants in the corporation (such as the
board of directors, managers, shareholders, creditors, auditors, regulators, and other
stakeholders) and includes the rules and procedures for making decisions in corporate
affairs.
Refers to the method by which a firm is being governed, directed, administered, or
controlled, and to the goals for which it is being governed.
Is concerned with the relative roles, rights, and accountability of such stakeholder groups
as owners, boards of directors, managers, employees, and other stakeholders.

Potential Problems
I.

Separation of Chief Executive Officer and Chairman of the Board roles

This Diagram shows that even on big or small firms, CEO and chairmans roles can be
separated.

The Need for Board Independence

Outside directors are independent from the firm
Inside directors have some tie to the firm
Board independence from management is crucial to good governance.

Example case:

James Dimon is chairman,

president and chief executive
officer of JPMorgan Chase,
largest of the Big Four
American banks, and
previously served on the
Board of Directors of the
Federal Reserve Bank of New

In the wake of the financial crisis, calls to separate the Chairman of the Board and CEO roles in
corporations have become common. Most recently, Jamie Dimon of JPMorgan Chase
successfully fended off a challenge of his dual role from public employee unions and the
New York City Comptroller. The shareholders of JPMorgan Chase voted overwhelmingly to
retain the unified structure, with analysts pointing to declining profits at companies such as the
Walt Disney Company in the years following separation of the roles as a motivating factor.
Concerned shareholders often urge that a unified role leads to a lack of oversight and diminishes
the independence of a board. Executives and other corporate associations advise that a unified
role ensures strong, central leadership and increases efficiency, pointing to the relative success of
companies like JPMorgan Chase. Of the major banks, only Citigroup and Bank of America do
not have a unified CEO/Chairman. Prior to the financial crisis, several failed banks such as
Lehman Brothers and Bear Stearns employed unified Chairman and CEOs, a fact which has led
to criticism of the unified role.

Unified and Separate Role Pros

UNIFIED ROLE

Secured Leadership

Operate in both Capacities at once

Issues addressed easily

Superior knowledge

SEPARATE ROLE

Independent source of authority

Effectively addresses their roles

Avoidance of abusive dual roles

Safeguard of shareholders interest

II.

Issues surrounding Compensation

CEO Pay-Firm Performance Relationship

- Backdating
Allows the recipient to purchase stock at yesterdays price, resulting in immediate
wealth increase.
- Spring-Loading
Granting of a stock option at todays price, but with the inside knowledge that
stocks value is improving.
- Bullet Dodging
Delaying of a stock option grant until right after bad news.

Excessive CEO Pay

- Say on Pay
Evolved from concerns over excessive executive compensation.
- Claw back provisions
Compensation recovery mechanisms that enable a company to recoup CEO pay,
typically in the event of a financial restatement or executives misbehavior.

Executive Retirement Plans & exit Packages

- Retirement Packages have come under scrutiny.
o $210 million to Robert Nardelli when he was ousted from Home Depot.
o $125 million to outgoing Bank of America CEO, Ken Lewis
- In contrast, many of todays workers do not have a retirement plan.
- Those who do generally have a defined contribution plan, rather than a defined
benefit plan.

Outside Director Compensation

- Paying board members is a recent idea.
- Today, outside board members are paid.
- From 2003-2010, their median pay rose about a third, from $175,800 to $233,800.
- Controversy over whether directors should be paid at all, and whether they are
paid enough.

Transparency; SEC Rules

- Exec compensation packages may include deferred pay, Severance, pension
benefits, & other perks over $10,000
- SEC Rules require disclosure of executive compensation
- Such disclosures may have a moderating impact prior to implementation.

Emerging issues

Systematic Problems
Demand for information: In order to influence the directors, the shareholders must
combine with others to form a voting group which can pose a real threat of carrying
resolutions or appointing directors at a general meeting.
Monitoring costs: A barrier to shareholders using good information is the cost of
processing it, especially to a small shareholder. The traditional answer to this problem is
the efficient-market hypothesis (in finance, the efficient market hypothesis (EMH) asserts
that financial markets are efficient), which suggests that the small shareholder will free
ride on the judgments of larger professional investors.
Supply of accounting information: Financial accounts form a crucial link in enabling
providers of finance to monitor directors. Imperfections in the financial reporting process
will cause imperfections in the effectiveness of corporate governance. This should,
ideally, be corrected by the working of the external auditing process.

Philippines SEC Code of Corporate Governance

A recent study finds that countries quality of public securities enforcement is unrelated to
stock market development. In contrast, countries quality of disclosure is strongly related
to their stock market development. This study suggests that securities laws do matter but
probably not as much as many of us would have thought. In any case, we find that the
SEC is an important corporate monitor. Empirical work required: Relationship between
quality of public securities enforcement and stock market development; Relationship
between quality of disclosure and stock market development.

I dont believe in taking right decisions. I take decisions and make them right Ratan Tata

INDIVIDUAL AND SITUATIONAL INFLUENCES ON ETHICAL BEHAVIOR

In a survey of 300 companies across the world, over 85% of senior executives indicated that the
following issues were among their top ethical concerns.

Employee conflicts of interests

Inappropriate gifts
Sexual harassment
Unauthorized payments

INFLUENCES ON ETHICAL BEHAVIOR

Individual influence - unique characteristics of the individual making the relevant decision

Given at birth
Acquired by experience and socialization

Situational influence - particular features of the context that influence whether the individual will
make an ethical or unethical decision

Work context
The issue itself including: Intensity and ethical framing

Individual Factors

Personal values and morals

Family influences
Peer influences
Life experiences

Stages of Moral Development

Individual undergo two stages of moral development

The minor or prepubescent stage

The adulthood stage

Moral development is the process through which children develop proper attitudes and behaviour
toward others in society, based on social and culture, norms, rules and laws

Personality Values and Personality

A key personality variable which may affect the ethical behavior of an individual is
his/her LOCUS OF CONTROL which was developed by Julian B. Rotter
An individual has an INTERNAL LOCUS OF CONTROL if he/she believes that he/she
can control the events in his/her life

An individual with an EXTERNAL LOCUS OF CONTROL believes that fate or luck or

other people affect his life.

Family Influences

Individuals start to form ethical standard as children in response to their perception of

their parents behavior.

Peer Influences

Colleagues who are always around us in conducting our daily work affect the ethical
behavior of an individual.

Life Experience

Whether positive or negative, key events affect the lives of individuals and determine
their ethical beliefs and behavior.

Situational Factors

Issue Related
Context Related
Authority
Systems of Rewards
Work Roles
Organizational Norms and Culture

How Ethical Behavior are justified

Authority
People do what they are told to do or what they think theyre being told to do

Systems of Rewards
Adherence to ethical principles and standards stands less chance of being repeated and spread
throughout a company when it goes unnoticed and unrewarded

Work roles
Work roles can encapsulate a whole set of expectations about what to value, how to relate to
others, and how to behave
Can be either functional or hierarchical

Organizational Norms and Culture

Group norms delineate acceptable standards of behaviour within the work community