Corporate Governance
Beyond Box-Ticking
Mak Yuen Teen
Regional Research Director for Asia Pacific,
Watson Wyatt Worldwide
Co-Director, Corporate Governance & Financial
Reporting Centre
Dinner Talk, 8 April 2008
Organised by CPA Australia and the Institute of
Certified Public Accountants of Singapore
1
“Box Ticking” in Corporate
Governance
•Causes of “box ticking”
• Inadequate understanding/apathy
• Legalistic approach to corporate
governance
• “Comply or else” perception
2
“Box Ticking” in Corporate
Governance
•Symptoms of “box ticking”
• standard “boilerplate” corporate
governance report
• drafting of corporate governance report is
outsourced to law or PR firm
• corporate governance report is not
reviewed by the board or a board
committee
• no formal process used by board or board
committee to assess application of the
Code
3
“Box Ticking” in Corporate
Governance
• Regulators, directors, market
professionals and investors have all
contributed to “box ticking” culture
• “Comply [with Guidelines] or Explain
[Deviations] vs “Apply [the
Principles] and Explain [the
Practices]”?
4
Principle 1:The Board’s Conduct of
Affairs
Principle 1: Every company shall be
headed by an effective Board to lead
and control the company. The Board
is collectively responsible for the
success of the company. The Board
works with Management to achieve
this and the Management remains
accountable to the Board.
5
Principle 1:The Board’s Conduct of
Affairs
• What is required of an effective
board?
• directors who have Character,
Competencies and Commitment
• board has a clear understanding of its
roles and responsibilities viz-a-viz
management
• board delegates clearly according to the
circumstances of the company,
supervises the delegation and holds the
delegate accountable (board’s “reserved
powers”)
6
Principle 1:The Board’s Conduct of
Affairs
•What is required of an effective
board?
• board sets the example in values and
standards
• board spends time in discussing and
making decisions
7
Principle 1:The Board’s Conduct
of Affairs
Examples of Reserved Powers of the
Board*
• Approval of vision, mission, values statement and
code of ethics
• Recommendation to appoint/change auditors
• Approval of remuneration of auditors
• Approval of auditors’ engagement letter
• Review of auditors’ recommendations and
observations
• Approval of all announcements, circulars and other
documents, including those required by any stock
exchange to be sent to shareholders
• Approval of press releases on matters decided by
the Board
• Approval/review of interested party transactions
8
Principle 1:The Board’s Conduct
of Affairs
Examples of Reserved Powers of the
Board*
• Approval of interim and final accounts and reports
• Approval of interim dividends and
recommendation of a final dividend
• Approval of all significant changes in accounting
policies and practices
• Approval of budget
• Approval of all changes to the organisation of
senior management
• Approval of CEO remuneration and policy
• Approval of individual items of expenditure in
excess of a stated amount
* Some powers could be delegated to board
committees
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Principle 1:The Board’s Conduct of
Affairs
• A word about meetings……
• provision for telephonic and
videoconference meetings is
encouraged by the Code but they are
not always suitable
• abuse of “attendance” and attendance
fees
• only about 1 in 10 boards meet at least
6 times per year – is this enough?
10
Principle 2: Board Composition and
Guidance
Principle 2: There should be a strong
and independent element on the
Board, which is able to exercise
objective judgement on corporate
affairs independently, in particular,
from management. No individual or
small group of individuals should be
allowed to dominate the Board’s
decision making.
11
Principle 2: Board Composition and
Guidance
An ‘independent director’ is one who
has no relationship with the
company, its related companies or its
officers that could interfere, or be
reasonably be perceived to interfere ,
with the exercise of the director’s
independent business judgement with
a view to the best interests of the
company” (Guideline 2.1)
•“
12
Principle 2: Board Composition and
Guidance
•NC’s assessment of independence
• “Rules-based” approach – NC confirms
that director is not caught by one of
the 4 relationships in 2.1 (or explains
it away without due consideration of
market perception)
13
Principle 2: Board Composition and
Guidance
•“Principles-based” approach – NC:
• Determines whether the director is caught by
one of the 4 relationships in 2.1
• Considers whether there is any other
relationship or factor which may influence the
director’s ability to act independently (e.g., long
tenure)
• Considers the director’s behaviour in the
boardroom – does he/she actually display
independent character and judgement?
14
Principle 2: Board Composition and
Guidance
•NC’s assessment of its strengths
and weaknesses (core competencies)
• What are the current competencies on
the board?
• What are the most critical
competencies on the board?
• Where are the gaps?
15
Principle 3: Chairman and Chief
Executive Officer
Principle 3: There should be a clear
division of responsibilities at the top
of the company – the working of the
Board and the executive
responsibility of the company’s
business – which will ensure a
balance of power and authority, such
that no one individual represents a
considerable concentration of power.
16
Principle 3: Chairman and Chief
Executive Officer
• 58% have separate Chairman and CEO but
they are often related or Executive
Chairman/MD situation; only 13% have an
“independent” Chairman
• Considered one of the most important
practice by institutional investors (see recent
Mark & Spencer episode in U.K.)
• Companies which do not effectively separate
the roles need to do more to assure
shareholders about what checks and
balances they have in place
17
Principle 4: Board Membership
Principle 4: There should be a formal
and transparent process for the
appointment of new directors to the
Board.
18
Principle 4: Board Membership
• 1 in 5 companies make some form of
disclosure of the process
• Independent board searches (e.g., using
recruitment firms and advertisements)
are extremely rare
• Many directors (including independent
directors serving on nominating
committees) are still uncomfortable with
bringing in people who are unfamiliar to
them
19
Principle 5: Board Performance
Principle 5: There should be a formal
assessment of the effectiveness of the
Board as a whole and the
contribution of each director to the
effectiveness of the Board.
20
Principle 5: Board Performance
• Need clear understanding of the roles of
the board and assessment should be tied
to these roles
• Feedback from management?
• Feedback from key shareholders?
• Use of external party?
• Annual versus less regular assessments?
• Benchmarking to other boards?
• What is done with the results of
assessment?
21
Principle 6: Access to Information
Principle 6: In order to fulfil their
responsibilities, Board members
should be provided with complete,
adequate and timely information
prior to board meetings and on an ongoing basis.
22
Principle 6: Access to Information
• Boards need to be proactive in seeking
information from management,
including on:
• key risk metrics
• forward-looking, non-financial and
exception information
• Board’s independent access to “senior
management”. Should individual
directors have such access, or should it
be the Board as a whole or only through
the Board?
23
Principle 6: Access to Information
Long-term
shareholder value
Value
drivers
Information
Historical
Forward-looking
Financial
Non-financial
Qualitative
Routine
Exception
24
Principle 7: Procedures for
Developing Remuneration Policies
Principle 7: There should be a formal
and transparent procedure for
developing policy on executive
remuneration and for fixing the
remuneration packages of individual
directors. No director should be
involved in deciding his own
remuneration.
25
Principle 7: Procedures for
Developing Remuneration Policies
• CEO pay – remuneration committee or board
to approve? (Code assumes it is the board)
• Are all benefits-in-kind given to directors
and CEOs considered by the RC as the Code
intended?
• Director emoluments to be approved by
shareholders under s169. Are companies
complying with the spirit? Separate
consulting fees paid to directors? (s169 –
“any benefits received by him otherwise than
in cash in respect of his services as director”)
26
Principle 8: Level and Mix of
Remuneration
Principle 8: The level of remuneration
should be appropriate to attract, retain
and motivate directors needed to run
the company successfully but
companies should avoid paying more
than is necessary for this purpose. A
significant proportion of executive
directors’ remuneration should be
structured so as to link rewards to
corporate and individual performance.
27
Principle 8: Level and Mix of
Remuneration
• Is “performance” generally “corporate”
rather than “individual”?
• Over-reliance on profits and TSR? (where
is risk?)
• Do options with vesting schedule create
long-term incentives?
• Should there be negative bonuses for
exceptionally poor performance?
• Entrenched market practices and CEO
bargaining power limit ability to change
remuneration schemes
28
Share Options: Long-Term or
Short-Term Incentives?
Alternative
methods of
option vesting
Numbe
r of
unveste
d
options
1
2
3
4
5 ………………
Vesting period of options
(Years)
29
Principle 8: Level and Mix of
Remuneration
Yr 1
profit
Yr 1
Yr 2
bonus profit
(5%)
Yr 2
Yr 3
bonus profit
(5%)
Yr 3
Total
bonus profit
(5%)
Total
bonus
$1m
$50k
$1.5m
$75k
$2m
$100k
$4.5m
$225k
$2.5m
$125k
-$1.5m $0
$2m
$100k
$3m
$225k
30
Principle 8: Level and Mix of
Remuneration
• Restructuring NED fees?
• Practice has moved from basic fees, to basic fees
plus additional fees for additional responsibilities
and commitments
• Need for wider differentials between Chairman
and average NED fees in some cases?
• Differentiate fees for individual directors based
on “market value”? (e.g., US director versus
Singaporean director?)
• Drop attendance fees and set minimum
attendance expectations instead?
31
Principle 9: Disclosure on
Remuneration
Principle 9: Each company should provide
clear disclosure of its remuneration policy,
level and mix of remuneration, and the
procedure for setting remuneration in the
company’s annual report. It should provide
disclosure in relation to its remuneration
policies to enable investors to understand
the link between remuneration paid to
directors and key executives, and
performance.
32
Principle 9: Disclosure on
Remuneration
• Few companies disclose metrics (KPIs)
for their CEO and executive directors
(let alone targets)
• Band disclosure – why disclose by bands
of $250k when CEO earns millions?
• “$500k or more” disclosure by companies
• Disclosure of metrics and thresholds for
annual bonuses is common in IPO
prospectuses but rare after IPO
33
Principle 10: Accountability
Principle 10: The Board should
present a balanced and
understandable assessment of the
company’s performance, position and
prospects.
• OFR disclosures, especially in areas of key
drivers (financial and non-financial), risks
and risk management strategies, indications
of earnings prospects and plans, and
discussion and explanation of critical
accounting policies and estimates could be
improved
34
Principle 11: Audit Committee
Principle 11: The Board should
establish an Audit Committee (“AC”)
with written terms of reference which
clearly sets out its authority and
duties
35
Principle 11: Audit Committee
• Are boards too liberal in interpreting
“accounting or related financial
management expertise or experience”?
IDs with accounting/finance
backgrounds
50.00%
46.30%
45.00%
40.00%
31.64%
30.00%
25.00%
19.16%
20.00%
15.00%
10.00%
5.00%
2.47%
0.44%
s
ID
4
3
ID
s
s
ID
2
ID
1
ID
0.00%
no
Percentage
35.00%
36
Principle 11: Audit Committee
Breakdown of ACs by presence of lawyers
60.00%
51.67%
Percentage
50.00%
42.38%
40.00%
30.00%
20.00%
5.22%
10.00%
0.73%
0.00%
ACs with no
lawyers
ACs with 1
lawyers
ACs with 2
lawyers
ACs with 3
lawyers
37
Principle 11: Audit Committee
Percentage
Percentage of AC with lawyers chairman
100.00%
90.00%
80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
91.15%
8.85%
ACs without lawyers
as chairman
ACs with lawyers as
chairman
38
Principle 12: Internal Controls
Principle 12: The Board should ensure
that the Management maintains a
sound system of internal controls to
safeguard the shareholders’
investments and the company’s assets
• Only 31% of companies include “a
statement by the board on adequacy of
internal controls, including financial,
operational and compliance controls
and risk management policies and
systems established by management”
39
Principle 12: Internal Controls
• In 2005, SGX proposed to require “an annual
confirmation from the Board and CEO that:
a. responsibilities for staffing internal control
functions are explicitly assigned;
b. procedures exist for assessing the effectiveness
of the company's internal controls;
c. channels for reporting significant risk and
internal control matters to the Board and CEO
are clearly specified; and
d. nothing has come to the attention of the Board
and CEO with regards to internal controls that
would have a materially adverse effect on the
company.”
This was abandoned. Why? Isn’t this a minimal
standard that ought to be expected on internal
40
Principle 13: Internal Audit
Principle 13: The company should
establish an internal audit function
that is independent of the activities it
audits
41
Principle 13: Internal Audit
• Significant increase in emphasis on
internal audit and improvement in
stature of internal auditor
• Should internal audit be mandatory for
listed companies?
• About 20% disclosed that their internal
auditor meets standards set by
recognised professional bodies. Should
there be more control over the meaning
of “internal audit”?
42
Principle 14: Communication with
Shareholders
Principle 14: Companies should
engage in regular, effective and fair
communication with shareholders
• Companies should make greater use of
technology to communicate with
shareholders
• Include more corporate governance
and other information on the website
43
Principle 15: Communication with
Shareholders
Principle 15: Companies should
encourage greater shareholder
participation at AGMs, and allow
shareholders the opportunity to
communicate their views on various
matters affecting the company
• Proper proxy voting should be
introduced for all companies
• “Two proxies” rule must be addressed
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Email: [email protected]
[email protected]
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