TRENDS IN CORPORATE GOVERNANCE AND THE
RELEVANCE FOR DIRECTORS AND INVESTORS
UN PRI 21 November 2018
Presented by Mervyn E King SC
Corporate Legal Advisers
17TH - 19TH CENTURIES
17th century unincorporated entities
With unlimited liability
Wealthy families baulked against it
Politicians wanted to create more jobs
By middle of 19th century question debated
Create an artificial person with limited liability?
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ACADEMIC OPPOSITION
An individual with immortality lacks a soul to be punished by the Almighty
Negative reaction by society to a person not being a creature of the Almighty
Lacks a body
Is a person without a conscience
“No soul to be damned and no body to be kicked.” Lord Thurlow 1844
The limited liability act was passed in the UK in the middle of the 19th century
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INCAPACITATED PERSON
Young healthy individual, soul and heart in the body
Incapacitated of mind
Artificial person no heart, mind or soul
Directors become the heart, mind and soul
Content to a director’s duties of good faith, care, skill and diligence
Conscious companies have conscious leaders
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“OWNERSHIP” – A SOCIAL CONSEQUENCE
Wealthy families provided the equity capital
Members of the families directors
Seen as “owners” of the company
Primacy of the shareholder developed
Public discourse of shareholders’ “ownership”
Focus on financial capital
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THE PRIMACY OF SHAREHOLDERS REINFORCED
The Dodge Brothers vs Henry Ford 1919 – minority shareholder
Ford wanted to use profits to pay better wages
Court ordered Ford to discharge its primary duty to shareholders and pay a special dividend
So thinking was directors had to act in the best interests of the shareholders - primacy
Corporate success was equated with profit, share price and dividends
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OWNERSHIP?
Shareholders are “the owners of the business” and the responsibility of the corporate executive is to “conduct the business in accordance with their designs, which generally will be to make as much money as possible while conforming to the basic rules of society …. There is one and only one responsibility of business – to use its resources and engage in activities designed to increase its profits as long as it stays within the rules of the game ….” Friedman
Tacit – company not part of society
Principal (shareholders) agent (directors and managers)
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OWNERSHIP
Entitles one to consume, waste or destroy a thing
Shareholders have shares
They own the shares – not assets of the company
Evidence of a conglomeration of important incorporeal rights – purpose, vote, dividends
They do not own the company
The company, a sovereign person
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TRANSIENT SHAREHOLDERS
IPOers
Secondary market traders
Transient shareholders
Have a claim to a future stream of income if company can pay its debts on due date and/or has readily realisable assets to pay its debts
On bankruptcy shareholders stand at the back of the queue
Shareholders self-protection - can disperse investment by investing in the equities of other companies
Stakeholders such as employees or managers cannot disperse these risks in other companies
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THE ERROR OF CORPORATE LEADERS
Duty to the company not shareholders
Agency theory requires directors to obey
Independence of mind fettered
A company’s health not its shareholder’s wealth
Time has come to challenge maximising shareholder value
Distracts boards from building the company’s health
Professors Stout (Cornell) and Paine (Harvard)
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UNTIL THE END OF THE 20TH CENTURY
Company and its activities seen through a financial lens
Corporate reporting was only financial
Backward looking
In automotive terms a car with rear view mirrors and no windscreen
20th century unsustainable development
21st century one of sustainable development
The SDGs of 2015
COMPONENTS OF MARKET VALUE
Source: OCEAN TOMO LLC
January 1,2015
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INTANGIBLE ASSETS – OPPORTUNITY – INFORMED OVERSIGHT
Ecological overshoot and population explosion
Strategy – long term value creation
Reputation – perceptions of stakeholders
Supply chain – legitimacy of operations
Human rights – child labour
Stakeholder relationships – civil society
Positive and negative impacts on triple context
The quality of governance of the organisation
How does the company make its money?
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INNOVATIONS IN CORPORATE REPORTING AT BEGINNING OF 21ST CENTURY
Enhanced business reporting
Balanced score cards
Triple bottom line – theory - context
Sustainability reporting
Each trying to communicate value creation
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BEYOND FINANCIAL REPORTING
Triple context – dimensions – SDG’s
Reporting in monetary terms
FR critical but not sufficient
SR critical but not sufficient
The two in silos divorced from reality
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SECOND DECADE OF 21ST CENTURY
2009 – UNCTAD and IFAC at Geneva
Chatham House Rules
Financial reporting critical but not sufficient
2010 – IIRC formed at St James’ Palace
IRC SA IR guidelines
SASB formed
2013 – December, IIRC Framework
2015 - SDGs
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Financial Manufactured Human Intellectual Social Natural
THE SIX CAPITALS
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AN ORGANISATION’S VALUE CREATION PROCESS
18
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W F E
88% of member exchanges
Embrace ESG initiatives
18 exchanges planning incorporation of TCFD
Exchanges now offering green or climate bonds
FSCA draft ESG disclosures
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FROM PROFIT TO VALUE CREATION
From Friedman’s “free” economy profits
21st century value creation by a company
Historically book value – the difference between total assets and total liabilities
Book value greater or less than the market value
Value of money – the present value of discounted future cash flows
All through a financial lens
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VALUE TODAY
How does the company make its money?
The positive and negative impacts on the triple aspects of the company’s business model and output – financial, social and environmental
Enhancing the positives, eradicating or ameliorating the negatives
Embedding sustainability issues into strategy
As water is critical to the beverage manufacturer
Now value is seen through a sustainable lens in a resource deprived world
In the long term better interests of shareholders
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NEW THINKING
Understanding, knowing and then planning:
How the company makes it money?
How the company will sustain value creation in the long term?
Board should determine, inputs, how, outputs and outcomes
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INTEGRATED THINKING
Every company dependent on relationships and sources of value creation
Mindset change at board & senior management level, including the CFO
Symphony of resources and relationships
Knowledge of stakeholders’ legitimate NIE’s
Greater stakeholder expectations
Agenda items: Inputs to outcomes
stakeholder relationships
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BLACKROCK
At the beginning of February 2016, Larry Fink, CEO of BlackRock, the world’s largest investor with $6 trillion in assets under management, sent a letter to the CEOs of the S&P 500 and a number of large European companies. In his letter Mr. Fink urges CEOs to “lay out for shareholders each year a strategic framework for long-term value creation”.
He repeated that in 2017
In 2018 – what is the purpose of the company and ESG metrics in the next five years
OM open letter to CEO’s on ESG
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STRATEGY – NEW CHALLENGE AND OPPORTUNITY
Strategy no longer stops at output
Board needs to be informed of stakeholder relationships, sources of value creation and how the company makes its money
Board needs an informed oversight
Hence agenda items of inputs to outcomes and
stakeholder relationships
“CFO” working with C-suite on an integrated strategy – guardian of values - CVO
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CORPORATE TOOL BOX
Ethical effective leadership
Adequate and effective controls
Informed oversight
Changed agendas
Sustainability issues and outcomes embedded into strategy
Value creation in a sustainable manner
Knowledge not lost in information
Trust and confidence in the company
Legitimacy of operations
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NEW CHALLENGES
Mindset changes
Capitals and stakeholder relationships
Population growth, technological advances and diminishing natural assets
Greater stakeholder expectations
Responsible investment –UNPRI
Financial capital to inclusive capital
Short term capital to sustainable capital
Outcomes based approach to governance
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COMPANY CENTRIC GOVERNANCE
What are common sense principles of corporate governance in this changed corporate world?
I C R A F T
It must be company centric
Has to be in the context of value creation in a sustainable manner – the health of the company
It has to be mindful and a value add with positive outcomes for the company
Cannot be a mindless check list approach
SDG’s “indivisible and integrated” – outcomes based
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NEW THINKING
Inclusive company centric model
16 basic good governance principles – King IV
To achieve four outcomes
Regimen of apply principles and explain practices
Equal consideration to the sources of value creation and stakeholder relationships in the decision making process in the best interests of the company
(King IV)
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FOUR OUTCOMES
Ethical culture and effective leadership
Value creation in a sustainable manner
Adequate and effective controls/informed oversight
Trust and confidence of community and legitimacy of operations
(King IV)
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QUALITY VS QUANTITY
Quality governance needs to be mindful
Quality governance needs to be a value add
Needs to achieve the four outcomes
If basic principles are practised and the four outcomes are achieved, a company has practised good governance
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DIRECTOR
Century of intangible assets and sustainable development
Approve a business model
Strive for positive impacts
On all three dimensions – strategy for positive and negative impacts
CRISA – raising capital - UNPRI
BJR
Collective spends more time understanding
Report in clear, concise and understandable language
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CRITICAL QUESTIONS FOR INVESTORS (1)
1. What is the purpose of the company?
2. How has this company made its money and how does it intend creating value long term in a sustainable manner?
3. Does it have a business model which will result in the long term health of the company?
4. Are the customers of the company paying up on due date?
5. What could really hurt the company in the next few years?
6. How is the company doing relative to its competitors?
7. If the CEO were headhunted tomorrow, who would assume the position as CEO?
8. How is the company going to grow – either organically or by acquisition? If by acquisition, how is it going to be financed?
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CRITICAL QUESTIONS FOR INVESTORS (2)
9. Is the company living within its means?
10. How much does the CEO get paid having regard to the inequality gap between the tone at the top and the beat of the feet at the bottom? Is remuneration variable?
11. How does bad news in the company get to the tone at the top, or are the people at the top the last people to hear of bad news?
12. What are the pertinent sustainability issues?
13. Are they embedded into strategy?
14. How has company dealt with ESG issues?
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INVESTORS
Representative shareholders
Due diligence changed
Four outcomes – value – business model
Financial not sufficient
FSCA on ESG for pension funds – Blackrock
Stranded assets
CRISA principle one
King IV principle 17
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HELEN KELLER
“The only thing worse than being blind is having sight and no vision”
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NEW CHALLENGES, OPPORTUNITIES AND THINKING The vision must be to have a company centric
governance model which moves away from yesterday’s primacy of the shareholder. It needs to be implemented mindfully to achieve the four outcomes of effective leadership, value creation in a sustainable manner, adequate controls and legitimacy of operations
We don’t have to grope in the dark
We have the light – the IIRC Framework of December 2013 and outcomes based governance as per King IV
THANK YOU
Prof Mervyn E King SC