Lee Swee Seng - Newsletter

THE IMPORTANCE OF GOOD CORPORATE GOVERNANCE

By Lee Swee Seng LLB, LLM, MBA, Certified Mediator
sweeseng@tm.net.my
©copyright Lee Swee Seng

(Incorporating Recommendations of the Finance Committee on Corporate Governance Report January 2001)

What is "Corporate Governance"?

Broadly speaking, Corporate Governance refers to "the processes & structure by which the business & affairs of the company are directed and managed. Its goal is to enhance long term shareholder value through improving corporate performance & accountability while taking into account the interest of other shareholders".

"The defined interaction between the Board and management in the pursuit of sustained wealth creation."

"Corporate Governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants and spells out the rules and procedures for making decisions on corporate affairs."

OECD April 1999

"Corporate Governance-which can be defined narrowly as the relationship of a company to its shareholders or, more broadly, as its relationship to society."

Financial Times 1997

" Corporate Governance is about promoting corporate fairness, transparency and accountability."

J.Wolfenson, president of World Bank, Financial Times 1999

"Corporate Governance is a field of economics that investigates how corporation can be made more efficient by the use of institutional structures such as contracts, organisational designs & legislation."

Mathiesen, Henrik (1999) "Managerial Ownership & Performance:A Survey"

The Recommendations are aimed at public listed companies; its purpose is to establish reforms in standards of corporate governance at a micro level:

What about private companies?

The Corporate Governance debate has tended to proceed as if listed companies were the only companies worth considering.
In this respect, two points must be made.

Firstly, the law does not require a company issuing shares to the public to list on any exchange.
However, investors in a publicity-held but not listed company need as much protection as investors in a listed company.
Indeed, they need more because they do not have the protection of the Securities Commission & the KLSE.
But most importantly, shareholders in a public company have an exit whenever they face a grievance that cannot be remedied as there is usually a market for their shares.
By Contrast, no such remedy is available to shareholders in private companies.
It is therefore imperative that the governance issues affecting unlisted companies, both public & private are addressed fully in any review.

adapted from " Corporate Governance Reform: Hong Kong's Experience"

SIGNIFIGANCE OF GOOD CORPORATE GOVERNANCE

It allows a more constructive & flexible response to raise standards in running & managing a company as opposed to strict statutory requirements.The Malaysian code draws wisdom from outside jurisdictions mainly from the United Kingdom (Hampel Committee & Cadbury Committee) and Canada (Toronto Stock Exchange Committee).

3 broad approaches taken around the world:

1. Prescriptive approach
- sets standard specifications with a requirement to disclose compliance to the Code e.g London Stock Exchange

2. Non-prescriptive approach
- actual corporate governance practices to be disclosed. Different companies have different needs and approaches e.g Australian Stock Exchange

3. Hybrid approach
- preferred by the Hampel Committee :a need for broad principles, applied flexibly and with common sense to the varying circumstances of individual companies

Hampel Report recommends a written description in the annual report explaining the application of relevant principles to particular circumstances.

Application
Compliance
Justification from departure

The biggest problem with prescriptive approach: encourages concentration on form rather than exercising judgment on what corporate governance practices are best for the company i.e mere box ticking

A true safeguard:
Informed independent judgment by experienced & qualified individuals comprising executive & non-executive directors, shareholders & auditors.

RECOMMENDATIONS

Premised on a prescriptive approach consisting of:
Principles
Objective: a flexible application + common sense to varying circumstances of individual companies
The Listing Requirements of the KLSE requires the annual reports to state how companies have applied principles to given circumstances & sufficient disclosure to the public.

Best Practices
Guidelines to assist companies in designing their approach to corporate governance
The Listing Requirements again requires the annual report to show compliance to the Code in this respect and to explain reasons if there is any departure from it.

Other participants
-voluntary observance by investors & auditors

COMPLIANCE
in accordance with paragraph 15.26 KLSE Listing Requirements
- Application of principles
- Compliance with best practices
- Reasons for non-compliance (& any alternative practices adopted)

Sanctions
- KLSE may take action against companies/directors as set out in Listing Requirements and/or Section 11 Security Industry Act 1983

PRINCIPLES ON CORPORATE GOVERNANCE

DIRECTORS
DIRECTORS' RENUMERATION
SHAREHOLDERS

A. Directors
- Board
- effective leadership and control
  [There must be explicit assumption of principal responsibilities]
- Board Balance
- executive & non-executive directors(including independent) to avoid domination in decision -making [ Not only must they be independent but must be seen to be independent, showing objectivity & impartiality
- Supply of Information
- enables timely discharge of duties [There must be set procedures]
- Appointments
- to the Board " formal & transparent [nomination committee makes recommendation to the full Board]
- Re- election
- at regular intervals at least every 3 years
  [New appointments: -Board responsibility Re-election:-shareholders responsibility-an opportunity for review & replacement]
  [Chapter 7 of the Listing Requirements-public listed companies must have provisions in the AA for elections]

B. Directors' Remuneration
- Level & make-up
- Sufficient to attract & retain directors
- Executive directors' rewards to be linked to their corporate & individual performance
- Non-executive director's rewards to be linked to their experience and burden of responsibilities.
- Procedure
- Formal,transparent procedure on developing policy for executive remuneration
- Disclosure Details
- on remuneration of each director to be in the annual report [promotes principles of fairness and accountability]

C. Shareholders

Dialogue between companies and investors

AGM - Communication with private investors and encourage participation [ public access to all shareholders. FCCG recommends enhancing the value of GMs by developing best practices like that of the Institute of Chartered Secretaries in the UK.]

Accountability and Audit

Financial Reporting

- balanced & understandable assessment of the company's position & prospects

Internal Control

- safeguards shareholders' investments and company's assets

Relationship with Auditors

formal & transparent
Impose obligation to produce financial statements - annual reports & interim reports
Financial, operational & compliance controls, risks management
Duties of Audit Committee includes reviewing scope, results & cost-effectives of audit

Risks Management
Succession Planning
Investors & Shareholders relations policy
Internal controls system & management information systems( compliance with laws, regulations, directives, guidelines)

Effective Constitution

Chairman & CEO

Board Balance

- at least 1/3 non-executive membership

Size of Non-executive participation
through appointments to the Board and Directors' training

Structures & Procedures
- regular meetings
- due notice of issues to be discussed
- Record discharge of duties & responsibilities
- Disclosure of number of Board meetings & details of attendance
[ KLSE/Pricewaterhouse Coopers survey in 1998 showed that only 1/3 of companies held 3/less Board meetings a year. FCCG recommended disclosure in the number of meetings & attendance to enable shareholders to evaluate commitment.]

BEST PRACTICES ON CORPORATE GOVERNANCE

Board of Directors

6 Principal Responsibilities:
Strategic Plan
Overseeing & evaluation of conduct

Relationship With Management
Quality of Information
- quantitative & qualitative
Access to Information
Access to Advice

Accountability and Audit

The Audit Committee must comprise of at least 3 directors, a majority of which is independent with explicit authority and duties. The Chairman must be an independent non-executive director.

Duties:

Considering appointment of external auditors, audit fee, resignation & dismissal
Reviewing quarterly & year end financial statements of the Board
Discuss concerns from interim & final audits
Safeguards & steps in internal audit
Consider any Related Party Transactions

Attendance of Finance Director, Head of Internal Audit & representative of external auditors at meetings
at least once a year, a Committee Meeting of External Auditors without presence of executive Board members should be conducted
The Audit Committee must have an explicit authority to investigate, obtain resources & full access to information to any matter within its jurisdiction.
Arrange regular meetings, give due notice of issues to be discussed & record discharge of duties & responsibilities.
The Board of directors to disclosed details of activities
The Board should establish internal audit function or other means of appraisal of internal controls systems.
Internal audit- exercising impartiality, proficiency, due professional care

Shareholders

Board to maintain effective communications policy that enables the Board & management to communicate with:

Shareholders
Stakeholders
General public