WHAT IS CORPORATE GOVERNANCE?
• Theory of a Firm (Company) – Assume you want to make ice cream yourself!!!
Assoc. Prof Dr Mohd Ismail Ramli
You need to go to the forest to get this
Assoc. Prof Dr Mohd Ismail Ramli
You need to grow this
Assoc. Prof Dr Mohd Ismail Ramli
You need to grow Sugarcane
Assoc. Prof Dr Mohd Ismail Ramli
You need the knowledge and materials to make this
Assoc. Prof Dr Mohd Ismail Ramli
• Therefore the firm (company) is formed to provide/supply: – Timber – Orange – Sugarcane – Refrigerator – etc, etc, etc….to you so that you can make and eat ice cream.
Assoc. Prof Dr Mohd Ismail Ramli
• Types of Firm: – Sole proprietor – Partnership – Joint-Stock company
Assoc. Prof Dr Mohd Ismail Ramli
• Joint-Stock Company Shareholders Provide $$$$$ (Capital) to the
Management to run the company on their behalf
Assoc. Prof Dr Mohd Ismail Ramli
• The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private company frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. Adam Smith (1776) Assoc. Prof Dr Mohd Ismail Ramli
• Agency Problems. “All rational individuals are utility maximizer” Dividends & Returns
Benefits using Shareholders $$$$, apart from fees.
How? Solutions!!! Jensen & Meckling (1976) ‘Agency Theory’
Assoc. Prof Dr Mohd Ismail Ramli
• Agency Problems – Monitoring Costs “All rational individuals are utility maximizer” Dividends &Returns
Monitor management! But How?
Benefits using Shareholders $$$$, apart from fees.
Hire Auditor But Auditors are also rational individuals, they need $$$$$
-Monitoring Costs-
To monitor Management activities Assoc. Prof Dr Mohd Ismail Ramli
• Agency Problems – Shareholders Dilemma!! “All rational individuals are utility maximizer” Dividends &Returns
Shareholders in dilemma, since they are also rational individuals. What to do? Reduce management fees to compensate Auditor fees
Assoc. Prof Dr Mohd Ismail Ramli
Benefits using shareholders $$$$, apart from fees.
• Agency Problems -Bonding Costs “All rational individuals are utility maximizerâ€? Dividends &Returns
Managements are also rational individuals. They are not willing their fees to be reduced.
The management take the initiative to report to the shareholders on the affairs of the company so the Shareholders can monitor them. -
Bonding CostsAssoc. Prof Dr Mohd Ismail Ramli
Benefits using shareholders $$$$, apart from fees.
• Agency Problems – Residual Loss “All rational individuals are utility maximizer” Dividends &Returns
Residual Loss
Assoc. Prof Dr Mohd Ismail Ramli
Benefits using shareholders $$$$, apart from fees.
• Agency Problems – Board of Directors “All rational individuals are utility maximizer” Appoint/elect among themselves Shareholders
Board of Directors
Report Direct
While others just provided finance
Control
Report
Management Team Assoc. Prof Dr Mohd Ismail Ramli
• Agency Problems – Separation of ownership from operations (modern corporation) Appoint/elect Shareholders x 1,000
Board of Directors
Report Direct
Control
Report
Management Team Assoc. Prof Dr Mohd Ismail Ramli
• What is your comment to the above scenario? – 1. – 2. – 3. – 4. – 5.
Assoc. Prof Dr Mohd Ismail Ramli
• Until early 20th century many companies formed – all public • Then family firm/sole traders incorporated – to benefit from limited liability • Some companies merged – new company formed original wound up • Then seen that companies could own others – beginnings of complex groups.
Assoc. Prof Dr Mohd Ismail Ramli
• Problems of the modern corporations – USA in the 1930s • Domination by top management • Berle and Means (1932) – separation • Securities and Exchange Commission
– EU in the 1970s – two tier boards • UK – Bullock Report
– In the 1970s – first stakeholder ideas • Watkinson (UK) • Nader (US) • Corporate Report (UK)
Assoc. Prof Dr Mohd Ismail Ramli
• Corporate collapses of the 1980s – Maxwell (UK) – Bond (Australia) – Nomura (Japan) – Bumham Drexal/Boesky (USA) – Carrian Investment (Hong Kong)
Assoc. Prof Dr Mohd Ismail Ramli
• Codes of best practice around the world – UK 1992 – Australia 1993 – Canada 1994 – Netherlands 1997 – Hong Kong, Italy, India, Japan 1998 – Russia 2001 – Etc, etc.
Assoc. Prof Dr Mohd Ismail Ramli
• Despite the codes problems persisted …. – Enron (USA) – HIH Insurance (Australia) – Independent Insurance (UK) – Parmalat (Italy) – Tyco (USA) – Tomkins (UK) – Worldcom (USA) – Sarbanes Oxley Act (USA – 2002)
Assoc. Prof Dr Mohd Ismail Ramli
• Some key questions remain: – Should the CEO also be Chairman of the board? – Should a retiring CEO go on to be chairman? – Can outside directors be genuinely independent? – How should directors’ remuneration be determined? – Should shareholders be able to nominate directors? – Should institutional investors exercise more power? – Are external auditors really independent? – How should complex, dynamic and often global corporate entities be governed? – Are governance processes around the world converging? – Are rules for governance of listed companies appropriate to family companies, small firms, partnership. Or not for profit entities? Assoc. Prof Dr Mohd Ismail Ramli
Another Historical origins of Corporate Governance • The term ‘corporate governance’ derives from an analogy between the government of cities, nations or states and the governance of corporations. • Earlier corporate finance practitioners saw ‘representative government’ as an important advantage of the corporation over partnerships but there has been and still is little agreement on how representative corporate governance really is, or whom it should represent. Assoc. Prof Dr Mohd Ismail Ramli
• How representative is Corporate Government? – The institutional arrangements surrounding corporate elections and the role and fiduciary duties of the board have been the central themes in the corporate governance literature from its inception. – The dilemma of how to balance limits on managerial discretion and small investor protection is ever present. • Should one limit the power of corporate plutocrats (large shareholders or voting trusts) or should one tolerate concentrated voting power as a way of limiting managerial discretion?
Assoc. Prof Dr Mohd Ismail Ramli
– Concern of early writers of corporate charters was the establishment of ‘corporate suffrage (right to vote)’, where each member (shareholder) had one vote. • The aim was to establish ‘democracy’ by eliminating special privileges of some members and by limiting the number of votes each shareholder could cast, irrespective of the number of shares held. • However, just as ‘corporate democracy’ was being established it was already being transformed into ‘plutocracy’ by moving towards ‘oneshare one-vote’ and thus allowing for concentrated ownership and control.
Assoc. Prof Dr Mohd Ismail Ramli
Why corporate governance is currently such a prominent issue • • • • • •
The world-wide privatization wave. Pension funds and active investor. Mergers and takeovers. Deregulation and capital market integration. The 1998 Russia, East Asia and Brazil crisis. Scandals and failures at major USA/UK corporations • Recurring failures. Assoc. Prof Dr Mohd Ismail Ramli
Definition of Corporate Governance • From: – An operational perspective – A relationship perspective – A stakeholder perspective – A financial economics perspective – A societal perspective.
Assoc. Prof Dr Mohd Ismail Ramli
Assoc. Prof Dr Mohd Ismail Ramli
Assoc. Prof Dr Mohd Ismail Ramli
Assoc. Prof Dr Mohd Ismail Ramli