1. Legislation
• Corporate governance is enforced by
Governments
• The main forms are the UK Corporate Governance
Code and the US Sarbannex Oxley Code
• Others that you need to be aware of are
international codes of corporate governance
2
2. Important supplementary reading
• UK Corporate Governance Code (Sep 2012)
• Guidance on Audit Committees (Smith Guidance)
• Internal Control Revised Guidance for Directors on
the Combined Code
3
4. Governance and Responsibility
• Meaning of Corporate
Governance (1.a)
• Responsibilities for
Corporate governance
• Source: 1992 Cadbury
Report
• Cadbury Committee – the
system by which
companies are directed
and controlled.
• BODs responsible for CG
• Shareholders role is to
appoint directors and
auditors
5
5. Background and Issues in Corporate
Governance (1.b)
•
•
•
•
•
Development of company limited by shares
Separation of ownership and control
Free market philosophy and globalisation
Financial scandals such as Enron, Maxwell
Continuing financial scandals seen recently in the
banking industry
6
7. Corporate Governance Theory – Agency
Problem
• The agency problem arises when the interests of
principals and agents are non-aligned ie in conflict
• 3 theories can be used to illustrate the agency
problem
Agency theory
Transaction cost theory
Stakeholder theory
8
8. Agency Theory Concepts
• An agent is employed by the principal to perform a task on its behalf
covering the Board, mgmt & staff
• Principals are the employers, the company
• Agency refers to the contractual relationship between a principal and
agent
• Agency costs are costs incurred by principals to monitor agency behavior
and performance. This is incurred due to a lack of trust
• Accountability refers to the agent’s accountability for his performance and
result to the principal
• Fidiuciary responsibilities mean that the agent should always act in the
principal’s best interests and avoid conflicts of interest
• Stakeholders are persons/groups that can be affected by the agency
9
10. Agency Theory – Separation of ownership
and management
• Expansion of business needs
more capital which is sourced
externally
• Increasing complexity in
business activities needs
professional agents
• The agency/corporate
governance problem arises
when the interests of
principals and agents are not
aligned
11
11. Agency Theory – agency accountability
and agency costs
• A principal has to incur agency costs to determine
agency accountability/performance
• Such costs comprise of:
Monitoring costs
Bonding costs
Residual loss
12
12. Agency Theory – ways to reduce agency
costs
• Remuneration package for agents which achieves
the goals of shareholders
• Having debt in the overall capital structure
• Having a capable Board
• Shareholders’ exercising their voting rights
effectively
• Role of Institutional investors
13
13. Agency Problem - Transaction cost theory
• Example the activity of
purchasing gives rise to the
following transaction costs
Sourcing seller – search &
information costs
Buying the component –
bargaining and decision costs
Checking quality – policing and
enforcement costs
• In terms of company profit and
looking after shareholders’
interests, goal is to minimise
transaction costs
• Minimising the costs depends on the
capabilities of management and also
how “opportunistic” they are
• Opportunitism is defined in
transaction cost theory as acting in
their best interests
• Therefore transaction cost theory
explains the agency problem by
managers’ opportunism
14
14. Agency Problem - Stakeholder theory
• Managers should take decisions that
take into consideration the interests
of all the stakeholders
• As stakeholders have different goals
from shareholders, the latter’s
interests will not be the main goal
• Therefore the agency problem exists
because of the need to look after
different interests
15
15. Corporate Governance – Purpose and
Objectives
• Purpose – what is the reason for
corporate governance? According to
the UKCGC, the purpose of corporate
governance is to facilitate
effective, entrepreneurial and
prudent management that can
deliver the long term success of the
company.
• This is achieved by monitoring those
parties in an organisation that have
control over the organisation’s
resources
• Objectives (goals) of corporate
governance
• Create long-term shareholder value
by helping to improve corporate
performance and accountability
• This would increase investor
confidence
• Help create a richer nation
16
16. Scope of CG – Impact on the Org
Areas in an Org
affected by Corp Gov
Board of Directors
•Duties and functions
•Appointments
•Composition/balance
•Remuneration
•Reliability of risk management
and internal control systems
•Reliability and compliance in
financial reporting
Relations with shareholders
•Dialogue with shareholders
•Constructive use of AGM
17
17. CG issues of different types of Orgs
CG issues
Public sector orgs
•Owned and controlled by
govt
•Agency problem difficult to
control as principals often do
not have power
•Problem is worsened by poor
culture and corruption
•Systems of audit often not as
efficient as in the private
sector
Private sector orgs
•Family owned and
managed
•Agency problem
theoretically
reduced as
business if
managed by
owners
Non-govt. orgs
•Owned and controlled by nongovt
•Agency problem worsened by
lack of transparency and
reporting standards
•Staff often non-commercial
and resistant to change
18
18. Stakeholders in Corporate governance
• A stakeholder can be defined as any group or individual
who is or can be affected by the company’s activities
• Examples include:
Employees
Directors
Shareholders
Local community
Govt and its institutions
Customers
suppliers
19
19. Classification of Stakeholders
• Internal and external stakeholders – internal are part of the company
(management, employees), external are not part of it (suppliers, customers)
• Narrow and wide - narrow are those that are the most affected by the actions
and decisions of the organization (shareholders, directors, other
management, employees, suppliers and customers). Wide are those groups that
are less dependent on the organization (government and the wider community)
• Primary and secondary - primary is a group that is essential for the continuation
of the company as a going concern (customers, suppliers and employees may be
primary stakeholders). Secondary stakeholders are those that the organisation
does not directly rely on for its continued survival, at least in the short term
• Active and Passive - active are those that seek to get involved in the company’s
activities and decisions (management, employees and sometimes pressure
groups). Passive are those stakeholders who do not usually try to get involved
with a company’s policy-making (govt and local communities)
20
20. Classification of Stakeholders (cont.)
• Voluntary and involuntary - voluntary is someone who becomes a stakeholder
voluntarily (employess, shareholder, customer, supplier). Involuntary are those
who do not choose to be stakeholders but have no choice (local communities,
stakeholders who suffer from the effect of the company’s operations on the
environment, and future generations. Most competitors are also involuntary
stakeholders)
• Legitimate and illegitimate - legitimate stakeholders are those with a ‘right’ to
make a claim on the company(a ‘legitimate’ claim). Illegitimate stakeholders are
those that do not have such a ‘right’. Deciding whether stakeholders have
legitimate or illegitimate claims on a company may depend on a person’s
viewpoint, and the distinction is therefore to some extent a matter of judgement
21
21. Role of internal parties of an org in CG
Stakeholder
Role in corporate
performance
Role in corporate governance
Directors
Long term success of org by
strategic management
Play a central role in success
of CG
Company secretary
Ensuring compliance with
rules and regulations
Assist Board in complying
with CG regulations
Sub-board management
Long term success of org by
executing strategic plans
Success in CG depends on
how well they ensure CG
systems are working well
Employees
Long term success of org by
implementing management
plans
Success in CG depends o n
how well they carry out their
duties and responsibilities
22
22. Role of external parties of an org in CG
Stakeholder
Role in corporate
performance
Role in corporate governance
Shareholders
Electing and effective Board
and auditors
Use their voting rights
effectively
Dialogue with board
Whistleblowing
Auditors
Provide independent
assurance of accuracy of
financial reporting
Highlight governance and
reporting issues to investors
Government
Provision of stable and
conducive conditions in the
country
Introduction,promotion,
improvement and monitoring
of CG activities
Stock exchanges
Provision of funds
Ensure that stock exchange
regulations are carried out
23
23. Role of external parties of an org in CG
(cont)
Stakeholder
Role in corporate
performance
Role in corporate governance
Small investors
Electing and effective Board
and auditors
Small shareholders can be
effective if they can find a
common group
Institutional investors
Electing and effective Board
and auditors
Use their status and power to
influence board performance
through various channels –
voting, dialogue, blacklist,
complaints to authorities
24
26. Unitary and Two-tier Boards – main
features
• Unitary
• Dual
Common in UK, US
1 Board comprising of EDs and NEDs
Performance of directors reviewed
by board members
Board members are elected by
shareholders
Common in Europe
Comprises of a supervisory board
and a management board
Management board is responsible
for managing the operations of the
business and is accountable to and
supervised by the supervisory board
Members of both boards are elected
by shareholders
Supervisory board consists of
Chairman and NEDs drawn from
unions, banks and majore
shareholders
27
27. Unitary and Two-tier Boards – which is
better? No universal answer!
•
2 tier advantages:
•
2 tier disadvantages
•
Clear separation between those that manage
the company and those that own it or must
control it for the benefit of shareholders.
Implicit shareholder involvement in most
cases since these structures are used in
countries where insider control is prevalent.
Wider stakeholder involvement implicit
through the use of worker representation.
Independence of thought, discussion and
decision since board meetings and operation
are separate.
Direct power over management through the
right to appoint members of the management
board.
•
Dilution of power through stakeholder
involvement.
Isolation of supervisory board through nonparticipation in management meetings.
Agency problems between the two boards.
Added bureaucracy and slower decision
making.
Reliant upon an effective relationship
between chairman and CEO.
•
•
•
•
•
•
•
•
28
28. BOD – Roles and Responsibilities
(UKCGC A.1)
Responsibility
• The long-term success of
the company
Roles
•
•
•
•
•
•
•
•
Provide entrepreneurial leadership of the
company
Provide a framework of prudent and effective
controls which enables risk to be assessed and
managed
Set the company’s strategic aims
Ensure that the necessary financial and human
resources are available
Review management performance
Set the company’s values and standards
Ensure that its obligations to its shareholders
and others are understood and met
Act in the best interests of the company
29
29. BOD – Characteristics, composition and
types of directors
• Characteristics (B.1)
They should have skills, experience and knowledge of the company
• Composition (B.1)
Board should be of sufficient size to suit the business they are in
Board should comprise of an appropriate combination of executive and nonexecutive directors so that no individual group can dominate decision-taking
• Types (B.1)
EDs are both full-time employees and board members
NEDs are members of the Board who do not hold full time positions in the
company
30
30. BOD(NEDs) - Purpose, Roles and
Responsibilities
•
•
•
•
•
•
•
The main purpose is to ensure the long term success of the company
As NEDs their main responsibilities should be to constructively challenge and help
develop proposals on strategy
The main roles they can play are:
Strategy role – (A.4MP) constructively challenge and help develop proposals on
strategy
Scrutiny role – (A.4SP) scrutinize the performance of management in meeting agreed
goals and objectives and monitor the reporting of performance
Risk management role – (A.4SP) satisfy themselves on the integrity of financial
information and that financials controls and systems of risk management are robust
and defensible
HR role – (A.4SP) responsible for determining appropriate levels of remuneration of
EDs and have a prime role in appointing and where necessary removing EDs and in
succession planning
31
31. BOD(NEDs)-Qualifications (B.1.1)
• Code provision B.1.1 is designed to reduce threats to independence of NEDs. It
provides that a person cannot be an NED if he/she:
Has been an employee of the company within the last 5 years
Has within the last 3 years, a material business relationship with the company
either directly, or as a partner/director/shareholder/senior employee of an org
Has received additional remuneration from the company apart from directors
fee, has ESOS, pension payment
Has close family ties with any of the company’s advisors/directors/senior
employees
Holds cross directorships or has significant links with other directors of the
company
Represents a significant shareholder of the company
Has served on the board for more than 9 years from the date of his 1st election
32
32. Cross directorships
• A cross directorship occurs when 2
directors hold directorship positions
in 2 companies
• What is the problem here?
• If B was admitted as an NED in Co
X, his independence may be under
threat because A is an NED in Co Y.
He could be tempted to treat issues
concerning A in a biased manner.
Co. X
Co. Y
Director A
ED
NED
Director B
NED
ED
33
33. NEDs – Advantages
•
•
•
•
•
•
NEDs may have knowledge from other companies, which they are able to contribute in
strategic decision-making.
Decision reached in consultation with NEDs is more likely to be acceptable to all
stakeholders due to their independent status.
NEDs sitting in the board can enhance confidence of investors in the company due to
having independent personnel safeguarding their investment
NEDs sitting in audit committee can provide significant independence to internal &
external auditors, to whom auditors can raise to issues of concern in the event of conflict
with management.
NEDs sitting in audit committee can enhance the reliability of financial information
presented to shareholders and other stakeholders
NEDs sitting in remuneration committee can prevent executive directors from rewarding
themselves excessive remunerations.
34
34. NEDs – Disadvantages
• Recommendations of NEDs can be easily disregarded on the grounds of lack of
company and industry related knowledge and experience.
• It is difficult to identify quality NEDs having sufficient
knowledge, skills, experience and degree of independence to make reasonable
and unbiased judgements.
• NEDs are highly skilled personnel and having at least equal number of them as
executive directors gives rise to significant costs. This cost may not exceed
benefits from having of non executive directors on the board.
• NEDs can make the decision making process slow. As more personnel will sit on
the board, more viewpoints have to be considered and an agreement may be
difficult to reach.
• NEDs may have executive responsibilities in other organizations. They may not
have sufficient time to devote to attend board meetings and monitor company
affairs
35
35. Chairman – Roles and Responsibilities
Responsibility
• Ensure the long-term success
of the company by having and
managing an effective Board
(The Code provides that the
Chairman should be
independent)
Roles (A.3)
•
•
•
•
•
•
•
responsible for the leadership of the Board
and ensuring it is effective
setting the board’s agenda and ensuring
that adequate time is available for
discussion of all agenda items
promote a culture of openness and debate
by facilitating effective contribution of
NEDs
ensure that directors receive
accurate, timely and clear info
ensure effective communication with
shareholders
[B.4.1] ensure that new directors receive a
full, formal and tailored induction on
joining the board
[B.4] ensure that directors continually
update their skills and knowledge and
familiarity with the company
36
36. CEO – Roles and Responsibilities
Responsibility
• Ensure the long term
success of the org by
managing the operations
of the company well
Roles
• Help to create appropriate strategies
and implements board’s strategic
objectives
• Ensures that adequate resources and
competences are in place to carry
out the strategic objectives
• Ensures that a proper system of
internal controls and risk
management is in place and
functioning well
37
37. Chairman and CEO - Comparison
Chairman
CEO
Part time, independent director
Full-time, executive director
Company secretary and CEO reports to the
Chairman
All executive managers report directly or
indirectly to the CEO
Chairman reports to the shareholders
CEO reports to the Chairman and main board
Leader of the Board
Leader of executive management
Ensure that directors contribute to the work
of the board effectively
Ensure that executive management work
effectively in carrying out the strategic plans
of the company
38
38. Chairman and CEO – Separation of the
Roles
• A.2.1 of the Code provides that the roles of chairman and
CEO should not be exercised by the same person
• As the Chairman is recommended by th Code to be
independent, it also follows that a CEO should not ascend
immediately to the post of Chairman
• The purpose of these guiding principles is to ensure that
no one person is able to dominate the Board and lose the
important quality of independence
39
42. BOD – Reasons for Committees
• Boards often work through committees
• Committees can help the board to use its
resources and the time of its members more
efficiently.
• To avoid possible conflicts of interest, the Board
can delegate suitable directors to specific
committees
43
43. BOD – Committees
Role of NEDs
Committee
Role
Nominations
Independent non-executives should have some influence in
the nominations process to make sure that new appointments to the
board will not be selected ‘yes men’ and supporters of the CEO or
chairman.
Remunerations
As NEDs are not remunerated in the same way as executive directors
they are not likely to have a personal interest in the remuneration
structure for senior executives and so come up with a remuneration
policy with less bias
Audit
NEDs can monitor financial reporting and auditing, to satisfy
themselves that these are carried out to a satisfactory standard, and
that executive management are not ‘hiding’ information or
presenting a misleading picture of the company’s financial affairs.
Risk Management
NEDs should satisfy themselves that executive management have a
suitable system of risk management and internal controls in place,
and that these systems function effectively
44
44. Remuneration Committee
•
•
•
Purpose (D.1)
Come up with a remuneration policy for the
company which should be sufficient to attract, retain
and motivate directors to run the company
successfully
100% NEDs. For larger cos the remuneration
committe should have at least 3 NEDs or 2 NEDs for
smaller companies
•
•
•
•
•
•
•
•
•
•
Roles
Ensure that performance related elements of pay are
extensive and promote the long term success of the
co.
Be sensitive to pay and employment conditions in
the group (ensure fairness)
Judge where to place the company in relation to
other competitors
D.1.1 follow the provision sin schedule A of the Code
D.1.3 ensure that remuneration of NEDs should
reflect the time commitment and responsibilities of
the role. In particular they should not be paid ESOS,
performance related elements
D.1.4 avoid rewarding poor performance particularly
in the case of compensation to directors for loss of
office
D.1.5 ensure that contract periods are set at 1 year
or less.
D.2 Ensure that there is a formal and transparent
process for developing policy on remuneration of
directors
D.2 Ensure that no director may decide his own
remuneration
45
45. Nominations Committee
• Purpose (D.1)
• Ensure that there is a
formal, rigorous and
transparent procedure
for the appointment of
new directors
• Majority NEDs
• Roles
• Appointments to the board should
be on merit and against objective
criteria including making due regard
to the benefits of diversity on the
board. [B.2SP]
• Plans should be in place for orderly
succession for appointments to the
board and to senior management, so
as to maintain an appropriate
balance of skills and experience
within the company and on the
board and to ensure progressive
refreshing
46
46. Audit Committee
• Purpose (D.1)
•
To establish formal and transparent
arrangements to ensure that corporate
reporting, risk management and internal
controls principles are correctly done in the
company
•
•
•
•
•
•
•
Roles
Monitoring the integrity of financial
statements and formal announcements
including reviewing the judgements
contained in them
Reviewing the company’s internal control
and risk management systems
Monitor and review the effectiveness of
internal audit
Recommend to the board
appointment, reappointment and removal
of external auditors including their fee
Monitor and review the external auditor’s
independence and effectiveness
Recommend to the board a policy re use of
external auditor for non-audit services
47
47. Risk Committee
• Purpose (D.1)
•
To establish formal and transparent
arrangements to ensure that risk
management principles are correctly
done in the company
•
•
•
•
•
•
•
Roles
Agree and approve the risk
management strategy and risk
management policy.
Assist the board to define the risk
appetite of the organisation.
Provide general and explicit guidance
to the main board on emerging risks
and to report on existing risks.
Reviewing reports on key risks
prepared by management.
Monitor overall exposure and specific
risks.
Monitor the effectiveness of
independence risk management
functions throughout the organisation.
48
48. Directors and the Law
Service
contracts
Removal
Retirement by
rotation
Disqualification
Conflict and
disclosure of
interest
Time-limited
appointments
Legal rights and
Responsibilities
Directors
Insider
dealing/trading
49
49. Directors’ Legal Rights and Responsibilities
Rights (Articles)
• inspect the company’s accounting
records
• claim reimbursement for expenses
incurred
• discharge their duties without
interference from co-directors
• participate in the strategic
management of the company and
attend and vote at board meetings
• receive reasonable notice of
meetings
• take independent professional
advice at the expense of the
company
Responsibilities (CA 2006)
• to act within powers
• to promote the success of the
company
• to exercise independent judgement
• to exercise reasonable care, skill and
diligence
• to avoid conflicts of interest
• not to accept benefits from third
parties
• to declare interests in proposed
transactions or arrangements with
the company
50
50. Time limited Appointments
• The Companies Act 2006 says that: Contracts of more than
two years’ duration need to be approved by shareholders in
general meeting. In the absence of such an approval, the
term is void and the contract terminable on reasonable
notice.
• The UK Corporate Governance Code says that: notice or
contract periods should be set at one year or less; if it is
necessary to offer longer notice or contract periods to new
directors recruited from outside, such periods should
reduce to one year or less after the initial period.
51
51. Retirement by Rotation
• At the 1st AGM of the company, all directors retire
by rotation
• At each subsequent AGM, 1/3 of the directors are
subject to retirement by rotation
• The directors to retire are those who have been
longest in office
• Directors should be re-elected at least every 3 yrs
52
52. Directors’ Service Contracts
• The Companies Act imposes certain constraints on
the length of notice periods and fixed terms.
• A director should not be personally involved in
their own service agreement and remuneration
package.
• There should be clarity about who has
responsibility for negotiating service agreements
and remuneration packages for directors.
53
53. Removal of Directors
• Under CA 2006 S168 by ordinary resolution
• Under provisions in the Articles
• If disqualified from acting
54
54. Disqualification by Law
A director shall lose his office if he becomes
disqualified by law. This can happen when a director
is guilty of:
• allowing the company to trade while insolvent
• not keeping proper accounting records
• failing to prepare and file accounts
• not sending returns to Companies House
• failing to send tax returns and pay tax
55
56. Insider Dealing/Trading
•
•
•
•
•
•
Insider trading/dealing is a criminal offense
Insider dealing/trading) is the buying or selling of company shares based on knowledge
not publicly available
It is illegal because if allowed, it will go against the duty of a director to always act in the
best interests of shareholders
Directors can trade in the shares of a company of which they are directors
They are required to disclose their transactions. The directors must inform their company
as soon as possible after the transaction and no later than the fifth business day after a
transaction for their own account or on behalf of their spouses and children in turn, a
company must inform the LSE without delay and no later than the end of the business day
following receipt of the information
They cannot trade during the two months preceding a preliminary, final or interim
earnings announcement and one month prior to a quarterly earnings
announcement. Outside the trading ban periods, directors still require clearance to trade
from the board’s chairman.
57
57. Directors’ Remuneration – Purposes
• Attraction – to attract the right people for the position
• Recruitment - to be able to recruit them
• Motivation – motivate directors by relating pay to
performance
• Retention – retain directors by good remuneration
58
58. Directors’ Remuneration – Caution
• A company should avoid paying more than is necessary
• As much of executive directors’ remuneration should be
linked to performance of the company and individual
• Be aware of the remuneration policy relative to other
companies
• Be aware also of remuneration elsewhere in the Group
59
60. Remuneration for NEDs
• The Code proposes that NEDs should be remunerated
based on the time commitment and responsibilities of
the role
• Remuneration should not include share options and
other performance related components in order to
protect independence
• If a company decides to give share options, it should
seek shareholder approval and the director cannot
sell the shares until 1 year after he leaves the position
61
61. Other Remuneration Principles – Link to
strategy
It is good management to link remuneration to the
different types of strategy followed. For example, if a
company pursues a policy of cost leadership, the
remuneration package will be expected to be
conservative and there might be more PL than fixed
components. OTOH, if the company pursues a
strategy of product differentiation where branding is
an important factor, is likely to need an attractive
remuneration package not only to attract the right
candidate (who is likely to be in short supply) but also
to have more fixed components in the package
62
62. Other Remuneration Principles – Link to
Labor Market Conditions
There is much unhappiness in western countries
about the remuneration packages of directors which
are said to be obscene and not in alignment with high
unemployment rates. Directors defend their big pay
packages, citing scarcity of suitably qualified
people, the high stress and difficulty of their
jobs, others in the market are paying high rates for
talent. It should be the corporate duty of a company
to ensure that its remuneration levels is consistent
and not too different from that in the region which it
operates
63
64. Corporate ownership structure - features
•
•
•
•
Insider system
Shares of the company
normally illiquid
Small number of
controlling shareholders
Ownership and control of
the company in same
hands
Common in Europe, Asia
•
•
•
•
Outsider system
Liquid
Large number of small
shareholders
Ownership and control of
the company in different
hands
Common in the US, UK
65
65. Corporate ownership structure –
corporate governance issues
Insider system
• Agency problem and costs are relatively lower than compared with
outsider systems
• Senior management capability may be limited as choice is limited to
family members
• There is less transparency and openness
• Reduced agency problem is replaced by that of reduced Minority
protection
66
66. Corporate Governance Codes
• The main factors that determine the type of CG adopted by
different countries are:
• Culture and history – US is a legal culture and hence there is
a preference for a legalistic code; commonwealth countries
are heavily influenced by the colonial masters
• Corporate ownership structure – in east asia, insider
systems of ownership is common, hence the CG codes are
less well developed
• State of professionalism, education – 3rd world countries
would find it difficult to implement rigorous codes
67
68. Main Features of Rules and Principles
based approaches
Principles-based
• UK and Commonwealth countries
• Code of Corporate Governance is a
set of “best practices” that listed
companies should comply with
• Companies that do not comply with
the code are required to explain how
good corporate governance can be
achieved by the alternatives
• Shareholders and other interested
parties can then form their own
opinions and decide on their next
course of action
Rules-based
• US
• Code of Corporate Governance is a
set of provisions that listed
companies have to comply with as a
matter of law
• As it is a matter of law, non
compliance attracts heavy penalties
in the form of fines/imprisonment
69
69. Main advantages/disadvantages of Rules
based approach
Advantages
•
•
•
Companies do not have the choice of
ignoring the rules.
All companies are required to meet the
same minimum standards of corporate
governance.
Investor confidence in the stock
market might be improved if all the
stockmarket companies are required to
comply with recognised corporate
governance rules.
Disadvantages
•
•
•
•
•
In order for all cos to be able to
comply, the rules cannot be set too
high. Therefore, they are the minimum
standards of CG and can result in rules
which are not excellent.
Tends to encourage ways to play
around the rules or find loopholes
You need to cover all possibilities, this
is impossible to achieve
Tends to increase the cost of
compliance
Cos following CG adopt a checklist
approach
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70. Main advantages/disadvantages of
Principles based approach
Advantages
• Principles have no minimum
standards
• There is incentive to improve over
time due to investor confidence in
good companies
• Carefully worded principles avoids
the problem of covering all
circumstances
• Not as high in compliance costs
• Cos are encouraged to adopt CG by
following the spirit of the word
rather than the letter of the law
Disadvantages
• As companies have to decide by
themselves how to comply with the
principles, there is greater
uncertainty as to interpretation
• Slower implementation as cos can
have the option to explain non
compliance
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71. Comply or Explain
A criticism of the comply or explain approach is that cos do not explain
satisfactorily.
For example, in the principle of appointment of NEDs, some companies were not
complying and their explanations were unsatisfactory because:
• Failed to explain the specific reason why
• They tend to use the same standard explanation
This effectively means that they are choosing not to comply. The CG code has
included a specific write up on this issue. It now provides clear guidance of what
companies need to do when providing their explanations - reasons for
noncompliance should be explained clearly and carefully. It should explain why
its current practices are consistent with good corporate governance, the
background reasons and if it intends to comply in future, indicate when.
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