corporate governance: an overview by wiparat chuanrommanee, ph.d. 2 of 2

Corporate Governance: An overview

By

Wiparat Chuanrommanee, Ph.D.

2 of 2

2

Key Aspects of Corporate Governance

Ownership structure Board governance structureShareholder protection Creditor protectionCEO compensation Risk management

3

Shareholder protection

How can shareholders effectively monitor managers and exercise control?

Shareholder rights

Transparency & information disclosure

4

Shareholder rights

Basic shareholder rights include the right to:

(i) secure methods of ownership registration;

(ii) convey or transfer shares;

(iii) obtain relevant information on the company regularly;

(iv) participate and vote in annual general meetings (AGMs) and special general meetings (SGMs), including electing members of the board and decisions concerning fundamental corporate changes such as mergers and dissolution;

5

Shareholder rights

(v) file derivative suits on behalf of the company;

(vi) adopt resolution making recommendations to the board of directors; and

(vii) share in the residual profits of the company.

6

Shareholder rights

The effectiveness of shareholder participation through voting also depends on the voting procedures.

notification of the dates and agenda of AGMs and SGMs voting methods, including “proxy voting” counting methods, including “cumulative voting” equal treatment of all shareholders of the same class

(one-share-one-vote rule)

7

Cumulative voting (accumulation voting, weighted voting or multi-voting)

A multiple-winner voting system intended to promote more proportional representation

than winner-take-all elections.

Voters are allowed to concentrate their full share of votes on fewer candidates than seats—unlike bloc voting (statutory voting), where a voter can only award one vote per candidate, up to the number of candidates as seats.

8

Cumulative voting

With cumulative voting, voters are permitted to not split their votes and instead concentrate them on a single candidate at full value.

Cumulative voting is used frequently in corporate governance

The procedure of voting for a company's directors; each shareholder is entitled one vote per share times the number of directors to be elected.

9

Proxy Voting

A vote by proxy is a vote that is delegated to another member of a voting body or cast in some other way while the person voting is physically absent.

This is most frequently used by shareholders in a company who are unable to attend the annual shareholder's meeting but still want their vote to count.

10

Six anti-director rights index

A summary measure of shareholder protection (La Porta et al., 2000; 1998)

The index provides different measurements of how strongly the law governing corporations protect minority shareholders against oppression by managers or dominant shareholders.

11

Six anti-director rights index

Shareholders are allowed to mail their proxy vote,

Shareholders are not required to deposit their shares prior to the general shareholders meeting,

Cumulative voting is allowed (whereby shareholders are allowed to cast their votes for one candidate thereby increasing the probability of outside directors),

The minimum percentage of share capital that entitles a shareholder to call for an extraordinary general meeting is reasonable i.e. 10% or less,

Shareholders have pre-emptive rights to new stock issues and,

An oppressed minority mechanism is in place

12

Transparency & Information Disclosure

Company information refers to both financial and non-financial information.

Financial information includes company financial results.

Non-financial information includes majority share ownership, members of the boards, key executives and their remuneration, foreseeable major risk factors, governance structures and company objectives and policies.

13


Defond et al. (2007) find that earning announcements are more informative in countries with strong investor protection.

Information transparency can influence the efficiency of corporate governance and enhances firm values (Hsu, 2007).

14


For the disclosure to be meaningful, it should be timely, fair, accurate and informative.

All information that might potentially involve infringement of minority shareholder interests should be disclosed.

The firm’s frequency in disclosing its financial statements and regular business reports are also essential.

Time-sensitive information should be regularly reported to regulatory authorities and published on the company’s website.

15


For the reliability of the information disclosed, it is critical to adopt internationally recognized accounting and auditing standards and to secure the independence of the audit process.

It is an absolute requirement that the appointment of internal and external auditors and audit committee members be free from influence by executive directors or controlling shareholders.

16

Creditor Protection

Creditor rights are measured by the ability of creditors to use the law to force companies to meet their credit commitments

La Porta et al. (1998) use four binary variables to proxy for creditor rights by adding 1 when the pro-investor right is granted by country law, and 0 otherwise.

17

Creditor Protection

Details of the variables are: There are restrictions for going into

reorganization. There is no automatic stay on secured assets. Secured creditors are paid first. Management is prevented from retaining

operating control during reorganization.

18

Creditor Protection

In addition to these four broad index of creditor rights, La Porta et al. (1998) also check for the existence of a “remedial” mechanism that may compensate to some extent for weak protection of creditors:

There is a legal reserve required, expressed as some percentage of capital

19

Types of CEO Compensation

There are two ways that firms can tie executive pay to firm performance.

First, firms can strive to make annual adjustments to CEO salary and bonus levels in accordance with the level of firm performance achieved, which is called “annual adjustment of pay”.

20

Types of CEO Compensation

Second, the board can structure CEO pay with long-term contingent forms of pay so that future pay levels are contractually tied to the level of firm performance attained, which is called “long-term contingent compensation” (e.g. stock options, performance plan and restricted stock).

21

Study Type of CEO Compensation: Independent Variable (s)

Corporate Performance: Dependent Variable (s)

Attaway (2000) The sum of annual adjustment of pay and long term contingent compensation

Positive relationship to corporate performance (ROE) in the computer & electronic industry

Wilson and Higgins (2001)

The sum of annual adjustment of pay and long term contingent compensation

Positive relationship to corporate performance (EPS) in the insurance industry

Sigler and Porterfield (2001)

The sum of annual adjustment of pay and long term contingent compensation in banking industry

Positive relationship to corporate performance in the banking industry (ROA)

Cyert, Kang and Kumar (2002)

The sum of annual adjustment of pay and long term contingent compensation

Positive relationship to corporate performance (ROA)

Sanders (2001) Annual adjustment of pay &Long term contingent compensation

Stronger, positive relationship to corporate performance for companies emphasizing annual adjustment of pay

Joyce (2001) Annual adjustment of pay in banking industry

Positive and linear relationship to corporate performance (ROA) in the banking industry

Tan and Ching (2001) CEO share ownership Positive relationship to corporate performance (AQ; AQ = simple approximation of Tobin’s Q)

22

Risk Management

Risk management is a process for dealing with the possibility that some future events or situations will prevent the business from meeting its objectives or cause it harm.

Management is ultimately responsible for internal control and risk management.

23

Risk Management

Since the establishment of Cadbury (1992), which recommends that directors report on the effectiveness of internal control, there have been several variations of the scope and responsibility of the boards on risk management based on Cadbury, including Rutteman (1995), Greenbury (1995), Hampel (1998) and finally Turnbull (1999).

24

Scope and Requirements for Reporting on Internal Control Effectiveness

Cadbury Rutterman Hampel Turnbull

Scope Internal financial control

Internal financial control

Internal control (all controls, including financial, operational and compliance controls and risk management)

Internal control and risk management

Reporting Effectiveness Review undertaken may report on effectiveness

Review undertaken Review undertaken

25

Sarbanes-Oxley Act (2002)

Five interrelated components: A control environment that sets the tone for an

organization; Risk assessment to identify and evaluate risks

from external and internal sources; Policies and procedures to ensure that

management directives are carried out; Systems to capture and communicate

information; and Ongoing monitoring for compliance

26

Risk Management

Emerging market banks in Asia still lag far behind mature market banks in maintaining robust risk management practices. They are particularly weak in areas such as operational and market risk management and the use of sophisticated risk management systems.

27

Risk Management

Most of the Asian banks experience serious resource constraints, especially with respect to technology, data availability and staffing.

28

Concluding remarks

It is time for the East Asian regulators to review what has been achieved over the past years.

A few years ago Asian financial regulators were being praised for rapidly modernizing their corporate governance regulatory regime (Allen, 2006).

29

Concluding remarks

Today, it is apparent that many of these new rules and best practices are having only a limited effect on behavior and thinking of the East Asian financial corporations.

East Asian regulators need to put more effort in improving their weak corporate governance culture and enforcement in order to enhance more organizational commitment to good corporate governance.

30

Bibliography

Allen, J. (2006). Where is Asia Going with Corporate Governance?. Internal Corporate Governance, 155, 6-7.

Attaway, M.C. (2000). A Study of Relationship between Company Performance and CEO Compensation. American Business Review, 18 (1).

Berger, A.N., Clark,e R.G., Cull, R., Klapper, L and Udell, G.F (2005), Corporate Governance and Bank Performance: A Joint Analysis of the Static, Selection, and Dynamic Effects of Domestic, Foreign and State Ownership. Working Paper 3632. World Bank Policy Research.

Ho, S.S.M. and Wong, K.S. (2001). A Study of The Relationship between Corporate Governance Structures and the Extent of Voluntary Disclosure. Journal of International Accounting, Auditing and Taxation, 10, 139-156.

31

Bibliography

Ho, S.S.M. and Wong, K.S. (2003). Preparers’ Perceptions of Corporate Reporting and Disclosures. International Journal of Disclosure and Governance, 1, 71-81.

IMD (2005). World Competitiveness Yearbook 2005. International Institute for Management Development, Lausanne, Switzerland.

Institute of Chartered Accountants in England & Wales (The) (1999).

Internal Control Guidance for Directors on the Combined Code. London

Jiraporn, P., Kim, Y.S. and Davidson, W.N. (2005). CEO Compensation, Shareholder Rights, and Corporate Governance: An Empirical Investigation. Journal of Economics and Finance. Summer 2005, 29 (2)

32

Bibliography

Khan, H.A. (2004). Global Markets and Financial Crises in Asia: Towards a Theory for the 21st Century. Palgrave / Macmillan. N.Y.

Klapper, F. and Love (2002). Corporate Governance, Investor Protection and Performance in Emerging Markets. Working Paper 2818. World Bank Policy Research

OECD (2004), OECD Principles of Corporate Governance, Organization for Economic Co-operation and Development.

Parrenas, J.C. (2005). Bank’s Risk Management Practices: A Survey of Four Asian Emerging Markets. (Paper Presented at the Second ADB Institute Seminar on Corporate Governance of Banks in Asia, January 21-22, 2005).

33

Bibliography

Weir, C. and Laing, D. (2000). The Performance-Governance Relationship: The Effect of Cadbury Compliance on UK Quoted Companies. Journal of Management and Governance, 4, 265-281.

Joyce, W.B. (2001). Return and Reward: Bank Performance and CEO Compensation. American Business Review. 19 (2).

Parrenas, J.C. (2006). Strengthening Banks’ Risk Management Practices in Developing Asian Economies. ADB Institute, Tokyo (April 3th, 2006).