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  • 8/3/2019 Best Corporate Governance Practice

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    Best Corporate Governance Practice

    In this section we present our Five Golden Rules of best corporate governance practice - key concepts in embracing good corporate governance andbest practices in business. Embracing these principles will mean the companys culture and therefore public image will shine out as an example of anopen, well and fairly run organisation.

    The public image of a corporation will quite accurately reflect the culture of that body. It follows, then, that good corporate governance has to be in

    the bones and bloodstream of the organisation since this in turn will be reflected in the culture. To carry the analogy further, in the same way thathealthy blood and bones are reflected in the naturally healthy look of a person, so an organisation whose internal functions are healthy will naturallylook so from an external perspective. Our Golden Rules of best corporate governance practice are like a health manual for your organisation andcome with a practical diagnosis and treatment programme which we set out in our good corporate governance implementation section.

    Corporate cultures and vision

    When Bill Hewlett and I put together the initial plans for our business enterprise in 1937 ... (we decided) that we wanted to direct our effortstowards making important technical contributions to the advancement of science, industry and human welfare.

    The above quotation expresses the early aspirations of two entrepreneurs when they started their business. The principles these two men espousedat the beginning became part of the ethos of the business they founded and persist to this day.

    Similarly, Ernest Butten shortly after he founded the management consultancy Personnel Administration in 1943, issued a document which he calledthe P.A. Charter. The clear vision behind this document shines through, and was to drive the business forward through his sale of the business intotrust for its staff and well through his retirement twenty five years later. "EB's" presence permeated the company and guided its behaviour for ageneration.

    This intention and ability to create a vision and turn it into a way of life for the company may be regarded as nothing unusual until one compares asupposed entrepreneur and builder of multinational corporations, Robert Maxwell, whose empire collapsed after he died, with another entrepreneurand business builder, Thomas J Watson, whose creation, International Business Machines, is still a global force to be reckoned with over eightyyears after he founded it.

    Principles of good corporate governance

    From the above examples, we can draw some conclusions and formulate a short set of rules regarding best corporate governance practice. All thegoodies, to a great degree, abided by these rules. All the baddies to a large extent ignored them. The principles underlying these rules are:

    ethical approach - culture, society; organisational paradigm balanced objectives - congruence of goals of all interested parties each party plays his part - roles of key players: owners/directors/staff

    a decision-making process is in place which is based on a model reflecting the above giving due weight to all stakeholders stakeholders are treated with equal concern - albeit some have greater weight than others accountability and transparency: to all stakeholders

    Hence, with due respect to Milton Friedman who is quoted as believing that the social responsibility of business begins and ends with increasingprofit, we contend that running the business successfully is not simply about market domination and shareholder value.

    And best corporate governance practice is not simply about a battle between distant, disloyal institutional shareholders and greedy directors butabout the ethos of the organisation and fulfilling its clearly agreed goals.

    These goals may be set by the entrepreneur who starts the business, but they are accepted by all parties as being high-minded and in everyonesinterests. This is notwithstanding the fact that some parties have bigger stakes and some benefit more than others. And, of course, different partieswant different things from the company. There has to be, therefore, a process of identifying the different needs and, as much as possible,harmonising them. This is the starting point for the smooth running of the business. Once dissonance in the common goal creeps in the danger ofthe standard of corporate governance deteriorating rises steadily.

    Clearly external regulation can only play a limited part in ensuring that such a deep-seated and beneficial culture as that described above exists.Equally clearly, however, the task of ensuring this desirable state and adhering to best corporate governance practice belongs to the variousstakeholders, who can and should, through their proper participation, bring this about.

    Five Golden Rules

    As we have iterated, this section of the website lays out and explains our view of best corporate governance practice and the holistic approach bywhich we believe an organisation can ensure that a state of good corporate governance exists, or is brought into being if its existence is uncertain.It takes the view that there is an over-riding moral dimension to running a business and that the standard of governance will depend on the moralcomplexion of the operation. Hence the approach developed is based on the belief that:

    the business morality or ethic must permeate the entire operation from top to bottom and embrace all stakeholders best corporate governancepractice is an integral part of good management practice also permeating the entire operation, and not an esoteric specialism addressed by lawyers,auditors and sociologists

    The principles of this approach are therefore framed in relation to the conventional way of looking at how a business should be properly run.

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    Our Five Golden Rules of best corporate governance practice are:

    1. Ethics: a clearly ethical basis to the business2. Align Business Goals: appropriate goals, arrived at through the creation of a suitable stakeholder decision making model3. Strategic management: an effective strategy process which incorporates stakeholder value4. Organisation: an organisation suitably structured to effect good corporate governance5. Reporting: reporting systems structured to provide transparency and accountability

    This approach recognises that the interests of different stakeholders carry different weight, but it does not, by any means, suggest that those with amajor interest matter and the rest dont. On the contrary, best corporate governance practice dictates that all stakeholders should be treated withequal concern and respect. For obvious reasons, although the methodology we will propose involves taking major stakeholders into greater accountwhen formulating strategy, it is designed to generate all round support because of the fact that every stakeholder, no matter how small, is given theopportunity to express a view. It is key to the approach that organisations truly respect the minority interests. Like the spirit of the US constitution,the approach can be said to embrace liberty, equality and community, but like the US economy, it aspires to produce the most powerful andeffective result in the world.

    Best corporate governance practice = best management practice

    The regulatory approach to the subject would regard governance as something on its own, to do with ensuring a balance between the variousinterested parties in a companys affairs, or more particularly a way of making sure that the chairman or chief executive is under control, producingtransparency in reporting or curbing over-generous remuneration packages. This indeed is what the Cadbury recommendations and the subsequentreports and code are all about. However, as we express in the rest of this website, we regard this as much too limited a view of governance, andhence of best corporate governance practice.

    The essence of success in business is:

    having a clear and achievable goal having a feasible strategy to achieve it creating an organisation appropriate to deliver having in place a reporting system to guide progress.

    There are very many websites and publications advising on how to do this, and of course, this is what is described as good management.

    Best corporate governance practice is about achieving the stakeholders goal, and delivering success in an ethical way. Hence it follows that it mustentail a holistic application of good management.

    To demonstrate the totality, and the need for a holistic approach, we present below an illustration showing the pressures on a large organisation.

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    The Pressures on a Company

    It is important that a wide perspective is taken when considering corporate governance because we cannot emphasise too strongly our belief thatgood management practices, as described in the rest of this section of the website, will deliver good corporate governance. Compliance withchecklists of regulations and codes, in the setting of bad management or a lack of commitment to good management, will NOT deliver goodcorporate governance. The longer term consequences of this externally-applied regulatory approach will be a progressive introduction of more andmore rules which are held in less and less regard, and which produce less and less effect.

    The result benefits neither business nor its customers, and has only served to spawn a growing industry of specialist advisers in corporategovernance and lobby groups. It has also failed to prevent more and bigger corporate failures. So while the most of the provisions of the variousCodes of Conduct could certainly be considered best corporate governance practice - or at least good corporate governance, if they are imposedexternally and not truly bought into by every part of the company and its stakeholders, and monitored effectively, there will always be those whotry - and succeed - in hiding from or bending the rules.

    As Professor Sir George Bain once said to us, the big advantage of the shareholder model over the stakeholder model in management terms is thesimple goal it presents: maximise shareholder value. No such simple target attaches to the stakeholder approach, and yet without a clear goal,management faces an impossible task in trying to do its job properly - what exactly is its job?

    In our experience of working with and observing management over the past thirty years in all kinds of situations, from the leaders of some of thelargest companies in the world to the owner/managers of small entrepreneurial businesses, a general rule stands out. The governance, the goalsand the strategy of a business must be compatible, and there must be congruence between the expectations of the various interested parties.Clearly, in defining best corporate governance practice, this means that:

    there is a common view as to the ethic by which the business is conducted the views of all interested parties are taken into account when deciding the goal an appropriate weighting is given to those views to arrive at a conclusion as to how to achieve the greatest good a strategy is formulated to attain the chosen goal which takes account of the likely behaviour of the various interest groups an implementation programme is drawn up which makes the necessary organisational arrangements to fulfil the strategy and to protect

    the interests of the various stakeholders

    the implementation programme includes reporting systems which ensure transparency and regular feedback on matters which affectthem to the various stakeholders

    Much of this website is therefore devoted to the process whereby a board, and the main stakeholders, can ensure that the company complies withthe Five Golden Rules of best corporate governance practice.

    The importance of Corporate Governance

    Why do we have to take corporate governance seriously?

    The creators of this website have spent many years espousing the importance of corporate governance, as authors, lecturers and consultants. Evenbefore the issue came to the forefront of business with the Cadbury Committee following the Maxwell pensions scandal, we recognised that it wasnot actually a new concept at all and that as long as there has been large-scale trade people have recognised the importance of corporategovernance - that is, responsibility in the handling of money and the conduct of commercial activities. We discuss the history of corporategovernance and thedefinition of corporate governance in other areas of the website.

    With globalisation vastly increasing the scale of trade and the size and complexity of corporations and the bureaucracies constructed to attempt tocontrol it, the importance of corporate governance and internal regulation has been amplified as it becomes increasingly difficult to regulateexternally. Here we will explore four issues which in our view are key to understanding the importance of corporate governance:

    The issue ofintegrity: are the boards and management of companies carrying out their duties in an ethical way (wedefine businessethicshere)?

    Topicality - the bonus culture: could better corporate governance in financial institutions and their remuneration policies haveprevented the credit crunch and resulting financial crisis?

    The regulatory framework: introducing more regulation has clearly failed - we need better regulation which ensures businessesrecognise the importance of corporate governance as an integral part of management, not a box ticking exercise

    The importance of corporate governance in Directors' training: prevention is better than a cure, so including knowledge of theprincples and practice of corporate governance in mainstream director training is essential

    The Issue of Integrity

    Perception is in the eye of the beholder, and corporate governance, while a technical term for accountants, lawyers and the like, is known by thereaders of the popular newspapers by names such as honesty, decency, fairness. Similarly, what the professional would call questionable practice inthis arena is criticised by the general public using words such as rip-off, cheating and crooked.

    The central issue today therefore in the field of corporate governance is not whether most listed companies comply with the various provisions ofthe Combined Code, Sarbanes-Oxley, King, etc. The key point is whether the top management of large organisations especially, but actually of thatof business in general, is seen as possessed of integrity in the eyes of the general public. This is the spirit that gave support to the principle ofsetting up the Cadbury Committee, not simply a desire to lay down some rules on the financial aspects of corporate governance to prevent innocentfund managers being misled by greedy directors. And it is this integrity - perceived and actual - which underlines the importance of corporategovernance, as it is the tool by which integrity can be encouraged, measured and projected.

    The Bonus Culture

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    The current financial crisis has brought into sharp focus the system of bonuses and remuneration operated by financial institutions. It is argued thatit encouraged excessive risk taking and irresponsible lending. Combined with the complex financial instruments that the mainstream institutionsconstructed to move the risk off their books, this - highly simplistically stated - was, some say, what led to the so called 'credit crunch'. What iscertainly true is that there was excessive risk and irresponsible lending and this led to the downfall of some of the world's biggest lenders and inturn the insurers insuring that risk.

    The importance of corporate governance in this scenario is, in our minds, unquestionable. A better system of checks and balances (thecoredefinition of corporate governance) would have picked up the warning signs that many people were sending that the level and criteria of lendingwas getting dangerous. The OECD have publishedlessons from the financial crisis, which also conclude that "the financial crisis can be to an

    important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguardagainst excessive risk taking in a number of financial services companies."

    We strongly believe that our approach, which is different to the conventional, box ticking mechanisms, would have succeeded as it i s not only placescorporate governance andbusiness ethicsat the core of the organisation not as a separate issue, but is based on independent market research. Thisis covered in ourcorporate governance and researchsection.

    Directors' pay and the bonus culture are often seized upon by special interest groups and the media as a single issue, not in the context of businessand society as a whole, and is therefore blinkered to the underlying factors causing and affecting remuneration. While the la tter is an obviousmanifestation of good or bad governance (if only because it exposes the quality of stakeholder communication!), it misses the basic point thatcompanies should be run well and responsibly - in everyway, not simply in how they pay salaries and bonuses. In a well run company, goodperformance is rewarded and rightly so - to attract talent and people dedicated to improving performance, not simply doing a job.

    In its Principles of Corporate Governance, the OECD acknowledges that: "Good corporate governance should provide proper incentives for the boardand management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring."Clearly, it is not in the best interests of the company for it to go out of business or be bailed out by governments. So it is not the principle thatshould be debated here, but the implementation . As we said earlier, while the board, management - and even the shareholders - may feel thatremuneration is fair, it is clear that current corporate policy is not in line with public perception. In the US this is perhaps more evident than in morereserved UK society if the internet searches are anything to go by - Wordtracker, the keyword research tool, reports nearly 8,500 searches over thelast year relating to the AIG bonus payouts alone, the vast majority including the word 'outrage'.

    So in spite of the bonus culture being hijacked at times to attack business generally, the issue does highlight the importance of corporategovernance and the need to assess the quality of the system of checks and balances in all sizes of company (bearing in mind many of the "toxicmortgages" were sold by small local brokers).

    The Regulatory Framework - better not more regulation

    As we argue elsewhere, the importance of corporate governance could be restated as the importance of good management. Put in that simple way itseems obvious, but we see instances daily of a lack of recognition that good governance is actually just good management and a failure ofgovernance is a failure of management. Awarding bank and insurance company bosses generous bonuses and pension packages after governmentbailouts of failing institutions, apart from being a huge public relations gaff is rewarding poor management and hence poor management itself.

    But while reform is clearly needed, a knee-jerk reaction will always result in building a sledge hammer to miss a nut. The regulators have openlyadmitted that they did not understand the complex financial instruments that ultimately folded in on themselves and led to the collapse of the

    financial system. Constructing new regulations to try to control circumstances that have yet to emerge - every crisis has different causes - is a futiletask. Restricting the range of products available to address the problem has major implications on innovation and consumer choice. Some of theknock-on effects of this are that products become more expensive; large providers will not take on certain sectors of society because they are notprofitable; and niche providers providing those innovative products will cease to operate or be closed down by the regulators. That clearlyrepresents a significant backward step in the financial services market.

    The importance of corporate governance in the financial markets is particularly topical but the solution to bad governance is universal and anysystem of regulation needs to strike the right balance between encouraging innovation and customer choice and enforcing a minimum set ofstandards. Fundamentally, though, it should provide the incentives to go far beyond these minimum standards and try to demonstrate that, bychanging the corporate culture, the long term rewards are actually greater (not least because it should result in less regulation!) Just as punitive taxregimes encourage evasion, avoidance or relocation, it has been proven that the regulatory burden, while in many cases adding cost and confusion,has caused people to invent more and more complex systems to avoid detection.

    There is, of course, much excellent regulation which has indeed improved the consumers' lot by forcing companies to disclose information, reducecosts/charges and generally act in a fair manner. We need to build on those good aspects and not simply impose more box ticking exercises.

    The importance of corporate governance in directors' training

    A corollary to the focus on corporate behaviour and the behaviour of senior corporate employees is the attention increaseingly being paid to thequalification of these senior people to carry out their responsibilities. There has never been any formal qualification required to run an organisation,and none to be a director - although in recent years organisations like the UK Institute of Directors has introduced qualifications such astheChartered Directorto address the issue. In practice, of course, most large and well run organisations will look for suitable professionalqualifications in their senior staff, and there is an increasing number of organisations offering non-executive director training and selection services.

    In the last ten years or so, especially following the dot com boom and bust and the collapse of Enron and WorldCom, the role of direction has finallybegun to be seen as a profession or at least a discipline requiring specific training and development. It is clear that it is the importance of corporategovernance has been a major influence here and the IoD qualifications specifically mention corporate governance as a significant element - andbenefit.

    To make a real difference long term, it should start much earlier in professional development, and corporate governance is starting to filter down,with some MBA courses, especially in Australia, offering it as part or all of the course content (though the latter has the potential to persist thenotion of corporate governance being a separate issue, which as you will realise by now, we think it wrong. Others, such as the London BusinessSchool, include modules on ethics and Corporate Social Responsibility.

    It is our sincerest hope that this trend continues and that the true importance of corporate governance is fully recognised and acted upon.

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    The Role of Corporate Governance in Strategic Decision Making

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    Corporate governance directs organizations' decisions.

    One of the most important roles of corporate governance is to ensure that strategic decisions are made in the interest of those with a stake in successful outcomes.Boards have increasingly become more focused on corporate shareholders, but a shift may be beginning to occur.The interests of stakeholders, such as customers,potential customers and non-customers impacted by the decisions of a company, may begin to get attention as corporate governance plays an increasingly strategic role.

    1. Policy Setting

    o Corporate governance is the system used to direct and control organizations. One of the many important roles played by corporate boards and executive committees is toestablish and enforce policies deemed necessary for the effective operation of the company. These may include codes of ethical conduct towards customers, vendors,employees and shareholders, input into the organization's structure, as well as approval of functional positions and responsibilities. This may include input into thecorporate culture, or a host of subtle governance cues that affect the transparency or opaqueness of strategic decision making.

    Establishing Corporate Strategy

    o An organization's corporate board must be intimately involved with establishing a clear definition for the organization's purpose and desired outcomes. If a company setsthe goal to become the global leader in telecom technology for the military market, for instance, then corporate objectives, strategic plans, financial allocations andmeasurable outcomes should all be measured against their ability to move the company toward that goal. If resources are being allocated to places that do not supportthis strategic goal, then the board's due diligence must identify the reason why and give input into which is off-strategy: the strategic goal itself or the resource actions thatappear initially to be out-of-sync.

    Assurance That Actions Support Strategic Positions

    o A company's executive team is directly accountable to the board of directors. This requires that major corporate decisions and results tracked against the corporate goalsshould be vetted, if not by the full board, then by the board's executive committee. Key strategic actions, such as mergers and acquisitions, major new market entries,exiting markets, closing plants, or changing the diversification mix or pricing position, are examples of decisions that require the oversight of corporate governance.

    Monitoring Investment Decisions and Capital Investments

    o It is the responsibility of the corporate board to review and understand the financial statements of the company and to guide the prudent investment of funds to maximizenet income and returns. Especially since the Sarbanes-Oxley Act of 2002 which introduced new responsibilities for financial reporting, corporate boards must be vigilantregarding the strategic impact of new requirements for internal controls. Corporate boards must also review and understand product portfolio and support the executivemanagement team, offering strategic oversight regarding adjustments to the product mix, approving or shifting capital investment to product categories with the mostpotential to maintain and grow revenue streams and manage expenses. At the same time, corporate board members have a difficult task: helping the executive teambalance the short-term goals so desired by shareholders with the long-term investment necessary to ensure the company's future.

    Accountability to Stakeholders

    o From a governance perspective, accountability, while often focused on stock shareholders, can sometimes become something heretofore unconsidered. Historically,business school curriculum has emphasized responsibility primarily for stock shareholder returns, leaving the responsibilities of a corporation to be a good corporatecitizen often overlooked. As stock prices and quarterly dividends have taken center stage, long-term investments are often set aside. Critical aspects of corporategovernance responsibilities, such as infrastructure investment, plant retooling, workplace safety or disaster planning, have often been ignored or delayed past safe timeparameters. The Gulf oil disaster in 2010 demonstrated questionable judgment by the corporate governance of British Petroleum (BP). While the lapse was perhapsshared by many oil producers, it followed years of unprecedented revenue growth and shareholder returns. As unprecedented profits rolled in, it appeared that little to nocorporate investment was designated to technology, safety inspections or deep water disaster response plans, even as oil reserves were tapped in deeper and deeperwater. Surely the stakeholders in this disaster go far beyond BP shareholders and include the fishermen and small business people whose livelihoods were destroyed, thewildlife being killed by it and the people of the Gulf, whose lives would be impacted for decades to come. A corporate board that does not prepare for crisis, or considerthe broad impact of their operational decisions, is not fulfilling its board mandate.

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