After the collapsed of ENRON, the U.S government decided that enough is enough. Corporate governance based on recommendation i.e for corporate players to comply or if the situation in their companies being that its difficult to comply; then explained; is insufficient to curb corporate governance problems. As such, the Sarbanes-Oxley Act (2002)of the US was a serious wakeup call. It has been much debated and there are very mild protests in some quarters. Nevertheless, it is a call to get back to fundamentals and it identifies 58 separate provisions that affect internal auditing and the question of Directors of Boards looking the other way is unacceptable and must change. This message is applicable to the public and private companies alike. Some of the vital extracts from the BIS review 2003 on SOX (2002).
• Boards of directors should uphold their responsibility for ensuring the effectiveness of the company’s overall governance process.
• Audit Committee should observe their responsibility for ensuring that the company’s internal and external audit processes are rigorous and effective.
• CEOs and senior management should strengthened their responsibility to maintain effective financial reporting and disclosure controls and adhere to high ethical standards.
This requires meaningful certifications, codes of ethics, and conduct of insiders that, if violated, will result in fines and criminal penalties, including imprisonment.
• External Auditors should focus only in their audit work.
• Internal auditors should uniquely be positioned within the company to ensure that its corporate governance, financial reporting and disclosure controls, and risk management practices are functioning effectively. Although internal auditors are not specifically mentioned in the Sarbanes-Oxley Act, they have within their purview of internal control the responsibility to examine and evaluate all of an entity’s systems, processes, operations, functions and activities.
However, a specific section of Sarbanes-Oxley Act requires senior management to assess and report on the effectiveness of disclosure controls and procedures as well as on internal controls for financial reporting. All of these have to be in the public disclosure domain of the reports but outside the financial statements.
Further an internal auditor must have the highest ethics and be willing to sacrifice everything (consultation assignments) to maintain their independence within the auditing company. If there are different sections of companies, which offer turn-key management consultation, at least those who are involved in the audit exercise should disassociate themselves from being a part of consulting side of the company’s work. Some of the provisions in the Act are quite draconian particularly one would be the internal auditor of publicly traded financial services company, as there are threats of fines and imprisonment, the internal auditor’s voice is heard loud and clear by the Board.
As such, the introduction and implementation of Sarbanes-Oxley Act (2002) in U.S is really a divergence of corporate governance as usually practiced in many other countries around the world such as U.K and South East Asia. Just wondering how long this divergence could sustain or whether someday in the future, there would be sort of convergence in corporate governance practices.
Friday, 9 December 2011
Corporate Governance Theory- Resource Dependence
The basic proposition of resource dependence theory is the need for environmental linkages between the firm and outside resources. In this perspective, directors serve to connect the firm with external factors by co-opting the resources needed to survive. This means that boards of directors are an important mechanism for absorbing critical elements of environmental uncertainty into the firm. Environmental linkages could reduce transaction costs associated with environmental interdependency. The organization’s need to require resources leads to the development of exchange relationships between organizations. Further, the uneven distribution of needed resources results in inter-dependent organizational relationships. Several factors would appear to intensify the character of this dependence, e.g. the importance of the resource(s), the relative shortage of the resource(s) and the extent to which the resource(s) is concentrated in the environment .
In this context, many of the resources are directly and indirectly controlled by the government. Hence, appointing directors that have influence and access to key policy-makers and government is seen as an important strategy for survival because of their knowledge and prestige in their professions and communities, firms are able to extract useful resources. This could enhance the firm's legitimacy in society and to help it achieve their goals and improve performance. Through the resource dependence role, directors may also bring resources such as specialized skills and expertise. This concept has important implications for the role of the board and its structure, which in turn affects performance. In summary, resource dependence theory provides a convincing justification for the creation of linkages between the firm and its external environment through boards as firms that create linkages could improve their survival and performance.
In this context, many of the resources are directly and indirectly controlled by the government. Hence, appointing directors that have influence and access to key policy-makers and government is seen as an important strategy for survival because of their knowledge and prestige in their professions and communities, firms are able to extract useful resources. This could enhance the firm's legitimacy in society and to help it achieve their goals and improve performance. Through the resource dependence role, directors may also bring resources such as specialized skills and expertise. This concept has important implications for the role of the board and its structure, which in turn affects performance. In summary, resource dependence theory provides a convincing justification for the creation of linkages between the firm and its external environment through boards as firms that create linkages could improve their survival and performance.
Thursday, 8 December 2011
Market of transforming Malaysian GLCs goes up to RM312bil
The Star reported that the Deputy Finance Minister Datuk Donald Lim Siang Chai said that, the market of government linked companies (GLCs) undergoing the GLC Transformation Programme (GLCT) has gone up to RM312 billion. The total collective returns to shareholders of this group of GLCs have also gone up by an annual 14 per cent as of October 14 this year since the GLCT was initiated in May 14, 2004. Four companies in the group also saw a rise in their key perfomance index (KPI) by 72 per cent last year compared with 64 per cent in 2009.
However, several GLCs also recorded a drop in their financial performances due to external factors not within their control such as higher oil and raw materal prices.These GLCs have taken various measures to face these problems including joining forces with their competing companies and the private sector as well as replanning their market sector.
Datuk Lim also mentioned that in order to avoid the problem of “overcrowding” in the domestic market, GLCs with potential have been advised to venture into larger overseas markets. This is because Malaysia's population is only 28 million compared with Asean's 600 million, and such a big market will provide our GLCs with a wider market.
(Adapted From The Star, Malaysia)
However, several GLCs also recorded a drop in their financial performances due to external factors not within their control such as higher oil and raw materal prices.These GLCs have taken various measures to face these problems including joining forces with their competing companies and the private sector as well as replanning their market sector.
Datuk Lim also mentioned that in order to avoid the problem of “overcrowding” in the domestic market, GLCs with potential have been advised to venture into larger overseas markets. This is because Malaysia's population is only 28 million compared with Asean's 600 million, and such a big market will provide our GLCs with a wider market.
(Adapted From The Star, Malaysia)
Corporate Governance Index up slightly: MSWG
The Star reported that the Corporate governance score of Malaysian public listed companies (PLCs) saw a slight improvement over last year, according to the Minority Shareholder Watchdog Group’s (MSWG) Malaysian Corporate Governance Index (CGI) 2011.
The score for the top 100 companies in the index was 66.9%, up one percentage point over last year, while the average base score on compliance with best practices for all the 864 PLCs assessed increased to 57.19% from 55.6% in 2010.
In terms of board of directors, 82% or 708 companies separated the roles between chairman and chief executive officer. This percentage is comparable to FTSE companies and is much higher than US-based Standard & Poor’s companies.
A further 35.2% had independent directors as chairman, up from 33.5% in 2010. The index also found that 42.5% had boards comprising half or more of independent directors compared with 40.2% last year.
On female board representation, MSWG said: “It is not encouraging to note that the percentage of women directors on boards had been almost stagnant at 8% and has dropped to 7% in the top 100 companies.
“Therefore, more needs to be done by companies to make a conscious effort to include gender diversity in boardrooms.”
The index found that there was an average of 9% foreigners on boards of the top 100 companies and 8% for the top 10 government-linked corporations (GLCs).
The average age at the top 100 companies is 58, similar with the top 10 GLCs.
On the disclosure of directors’ remuneration by individual directors, the index revealed that only 8.3% did so, up from 5.6% in 2010. The MSWG said many were not prepared to disclose the details, despite it being a best practice recommendation under the Malaysian Code on Corporate Governance as well as in other jurisdictions.
The overall average remuneration for executive directors was about RM824,000 per annum, versus the RM3.2mil per annum given to directors in the financial sectors.
For non-executive directors, the overall average remuneration per director is about RM100,000 per year.
Non-executive directors in the financial sector, again, received the highest average remuneration per director at around RM250,000 per year.
( Adapted from 'The Star Online News).
The score for the top 100 companies in the index was 66.9%, up one percentage point over last year, while the average base score on compliance with best practices for all the 864 PLCs assessed increased to 57.19% from 55.6% in 2010.
In terms of board of directors, 82% or 708 companies separated the roles between chairman and chief executive officer. This percentage is comparable to FTSE companies and is much higher than US-based Standard & Poor’s companies.
A further 35.2% had independent directors as chairman, up from 33.5% in 2010. The index also found that 42.5% had boards comprising half or more of independent directors compared with 40.2% last year.
On female board representation, MSWG said: “It is not encouraging to note that the percentage of women directors on boards had been almost stagnant at 8% and has dropped to 7% in the top 100 companies.
“Therefore, more needs to be done by companies to make a conscious effort to include gender diversity in boardrooms.”
The index found that there was an average of 9% foreigners on boards of the top 100 companies and 8% for the top 10 government-linked corporations (GLCs).
The average age at the top 100 companies is 58, similar with the top 10 GLCs.
On the disclosure of directors’ remuneration by individual directors, the index revealed that only 8.3% did so, up from 5.6% in 2010. The MSWG said many were not prepared to disclose the details, despite it being a best practice recommendation under the Malaysian Code on Corporate Governance as well as in other jurisdictions.
The overall average remuneration for executive directors was about RM824,000 per annum, versus the RM3.2mil per annum given to directors in the financial sectors.
For non-executive directors, the overall average remuneration per director is about RM100,000 per year.
Non-executive directors in the financial sector, again, received the highest average remuneration per director at around RM250,000 per year.
( Adapted from 'The Star Online News).
Wednesday, 7 December 2011
Corporate Governance Theories- Stewardship theory
Unlike agency theory, stewardship theory assumes that managers are stewards whose behaviors are aligned with the objectives of their principals. The theory argues and looks at a different form of motivation for managers drawn from organizational theory. Managers are viewed as loyal to the company and interested in achieving high performance. The dominant motive, which directs managers to accomplish their job, is their desire to perform excellently. Specifically, managers are conceived as being motivated by a need to achieve, to gain intrinsic satisfaction through successfully performing inherently challenging work, to exercise responsibility and authority, and thereby to gain recognition from peers and bosses. Therefore, there are non-financial motivators for managers.
The theory also argues that an organization requires a structure that allows harmonization to be achieved most efficiently between managers and owners. In the context of firm’s leadership, this situation is attained more readily if the CEO is also the chairman of the board. This leadership structure will assist them to attain superior performance to the extent that the CEO exercises complete authority over the corporation and that their role is unambiguous and unchallenged. In this situation, power and authority are concentrated in a single person. Hence, the expectations about corporate leadership will be clearer and more consistent both for subordinate managers and for other members of the corporate board. Thus, there is no room for uncertainty as to who has authority or responsibility over a particular matter. The organization will enjoy the benefits of unity of direction and of strong command and control.
The theory also argues that an organization requires a structure that allows harmonization to be achieved most efficiently between managers and owners. In the context of firm’s leadership, this situation is attained more readily if the CEO is also the chairman of the board. This leadership structure will assist them to attain superior performance to the extent that the CEO exercises complete authority over the corporation and that their role is unambiguous and unchallenged. In this situation, power and authority are concentrated in a single person. Hence, the expectations about corporate leadership will be clearer and more consistent both for subordinate managers and for other members of the corporate board. Thus, there is no room for uncertainty as to who has authority or responsibility over a particular matter. The organization will enjoy the benefits of unity of direction and of strong command and control.
Corporate governance theories
There are five major theoretical frameworks that can be identified from the corporate governance literature: agency, stewardship, resource dependence, stakeholder and managerial-hegemony . These theories have evolved from many disciplines such as finance, economics, accounting, law, management and organizational behavior. For example, agency theory arises from the field of finance and economics and stakeholder theory from a more social-oriented perspective on corporate governance. All these disciplines have contributed to the development of theoretical aspects of corporate governance . Two of the theories; agency and stewardship were generally associated with several previous corporate governance researches in Malaysia and East Asia.
Nevertheless, a number of characteristics of the five governance theories are embedded in Malaysia’s business and corporations. This is because, Malaysia has the business culture and environment of a developing country combined with a unique socio-political background. As such, multi-faceted theories exist in Malaysia.
The first is Agency theory
The agency relationship is seen as a contractual link between the shareholders (the principals) that provide capital to the company and the management (agent) who runs the company. The principals engage the agent to perform some services on their behalf and would normally delegate some decision-making authority. However, as the number of shareholders and the complexity of operations grew, management, who had the expertise and essential knowledge to operate the company, increasingly gained effective control and put them in a position where they were prone to pursue their own interests .
The literature on agency theory addresses three types of problems that could transpire from the separation of ownership and management, which might consequently affect firm value. They are the effort problem, the assets’ use problem and differential risk preferences problem. The effort problem concerns whether or not managers apply proper effort in managing corporations so as to maximize shareholders’ wealth. Problems arise because principals are not able to determine if the managers are performing their work appropriately. Managers may not exert the same high effort levels required for firm value maximization as they would if they owned the firm.
The use of assets problem concerned the insiders who control corporate assets. They might abuse these assets for purposes that are harmful to the interests of shareholders such as diverting corporate assets, claiming excessive salaries and manipulating transfer prices of assets with other entities they control . The differential risk preferences problem arises because the principal and managers have different views on risk taking. Managers may not act in the best interest of shareholders and may have different interests and risks preferences. For example, managers have a wider range of economic and psychological needs (such as to maximize compensation, security, status and to boost their own reputation), which may be adversely affected by a project that increases a firm’s total risk or has rewards in the longer-term. This may result in managers being too cautious in making investments and thus failing to maximise shareholders’ wealth.
Hence, agency theorists recommended that corporate governance mechanisms are needed to reduce these agency conflicts and to align the interests of the agent with those of the principal. These mechanisms include incentive schemes for managers which reward them financially for maximising shareholder interests. Such schemes typically include strategies whereby senior executives acquire shares, conceivably at a bargain price, thus aligning financial interests of executives with those of shareholders. Other mechanisms include fixing executive compensation and levels of benefits to shareholders returns and having part of executive compensation deferred to the future to reward long-run value maximisation of the corporation. Besides that, appointing more NEX on the boards to check on managers’ behaviour could also reduce agency costs.
I will discuss the other four corporate governance theories in my next posting.
Nevertheless, a number of characteristics of the five governance theories are embedded in Malaysia’s business and corporations. This is because, Malaysia has the business culture and environment of a developing country combined with a unique socio-political background. As such, multi-faceted theories exist in Malaysia.
The first is Agency theory
The agency relationship is seen as a contractual link between the shareholders (the principals) that provide capital to the company and the management (agent) who runs the company. The principals engage the agent to perform some services on their behalf and would normally delegate some decision-making authority. However, as the number of shareholders and the complexity of operations grew, management, who had the expertise and essential knowledge to operate the company, increasingly gained effective control and put them in a position where they were prone to pursue their own interests .
The literature on agency theory addresses three types of problems that could transpire from the separation of ownership and management, which might consequently affect firm value. They are the effort problem, the assets’ use problem and differential risk preferences problem. The effort problem concerns whether or not managers apply proper effort in managing corporations so as to maximize shareholders’ wealth. Problems arise because principals are not able to determine if the managers are performing their work appropriately. Managers may not exert the same high effort levels required for firm value maximization as they would if they owned the firm.
The use of assets problem concerned the insiders who control corporate assets. They might abuse these assets for purposes that are harmful to the interests of shareholders such as diverting corporate assets, claiming excessive salaries and manipulating transfer prices of assets with other entities they control . The differential risk preferences problem arises because the principal and managers have different views on risk taking. Managers may not act in the best interest of shareholders and may have different interests and risks preferences. For example, managers have a wider range of economic and psychological needs (such as to maximize compensation, security, status and to boost their own reputation), which may be adversely affected by a project that increases a firm’s total risk or has rewards in the longer-term. This may result in managers being too cautious in making investments and thus failing to maximise shareholders’ wealth.
Hence, agency theorists recommended that corporate governance mechanisms are needed to reduce these agency conflicts and to align the interests of the agent with those of the principal. These mechanisms include incentive schemes for managers which reward them financially for maximising shareholder interests. Such schemes typically include strategies whereby senior executives acquire shares, conceivably at a bargain price, thus aligning financial interests of executives with those of shareholders. Other mechanisms include fixing executive compensation and levels of benefits to shareholders returns and having part of executive compensation deferred to the future to reward long-run value maximisation of the corporation. Besides that, appointing more NEX on the boards to check on managers’ behaviour could also reduce agency costs.
I will discuss the other four corporate governance theories in my next posting.
Tuesday, 6 December 2011
Board's Culture
Effective boards understand their role and duties, are actively engaged in the work of governance, and accept accountability for their performance and the performance of the organization they govern. Over time, either deliberately or not, every board of directors creates a governance culture—a pattern of beliefs, traditions and practices that prevail when the board convenes to carry out their duties. Each board is responsible for shaping its own culture. As stated by Joaan Reed:
“Good governance is hard work. Boards must develop a culture of accountability and engagement. Board leaders should pay strict attention to how much board time is spent passively listening to reports and how much time is spent discussing strategic issues and the duties of care and loyalty. Active and vigorous board discussion, debate and questioning is not only a sign of a good board, it is the sign of an engaged board. Board members should not allow a ‘don’t-ask-questions’ culture to thrive and become the norm. An open culture of cooperation and transparency is healthy and will attract skilled board members.”
In too many cases, boards are insufficiently committed, the governance culture is passive, and the result is under performance. There is a growing belief that effective governance requires a proactive culture of commitment and engagement that drives both the board and the organization it governs toward high performance.Non executive directors must be bold enough to challenge the CEO's decision so as to create healthy discussion and debate on company's business strategies. Board meetings is a place where board's members are able to contribute their ideas in decision making process. Many research findings has shown that an active board is able to drive company's performance.A good corporate governance practices must always be observed so that shareholders' interests is always paramount.
“Good governance is hard work. Boards must develop a culture of accountability and engagement. Board leaders should pay strict attention to how much board time is spent passively listening to reports and how much time is spent discussing strategic issues and the duties of care and loyalty. Active and vigorous board discussion, debate and questioning is not only a sign of a good board, it is the sign of an engaged board. Board members should not allow a ‘don’t-ask-questions’ culture to thrive and become the norm. An open culture of cooperation and transparency is healthy and will attract skilled board members.”
In too many cases, boards are insufficiently committed, the governance culture is passive, and the result is under performance. There is a growing belief that effective governance requires a proactive culture of commitment and engagement that drives both the board and the organization it governs toward high performance.Non executive directors must be bold enough to challenge the CEO's decision so as to create healthy discussion and debate on company's business strategies. Board meetings is a place where board's members are able to contribute their ideas in decision making process. Many research findings has shown that an active board is able to drive company's performance.A good corporate governance practices must always be observed so that shareholders' interests is always paramount.
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