MODULE 1

INTRODUCTION TO CORPORATE GOVERNANCE

ADB Private Sector Development InitiativeCorporate and Financial Governance TrainingSolomon Islands

Dr Ann WardropLa Trobe University

Acknowledgement

These materials were produced by the Asian Development Bank’s Pacific Private Sector Development Initiative (PSDI). PSDI is a regional technical assistance facility co-financed by the Asian Development Bank, Australian Aid and the New Zealand Aid Programme.

Module 1 Outline Introduction to corporate governance

Meaning of corporate governance Why is corporate governance important? The company – a legal person Overview of key company positions

relevant to corporate governance The directors Directors’ duties The board of directors Board committees

3

Meaning of Corporate Governance

Corporate governance can be described as the method of governing a company in a way that ensures responsible behavior by and within the company so the company can achieve its maximum level of efficiency and profitability.

4

Meaning of Corporate GovernanceGood corporate governance will ensure that a company complies not only with its:

legal obligations; and internal company rules;

But also ensures that the board and management are performing in a way that puts the interests of the company first.

5

Why is corporate governance important?

Protects the company from fraud and destruction of value

Makes it easier for the company to obtain finance

Enhances the reputational value of the company if it has values of integrity, trust and ethical behaviour

6

Exercise 1

What do you think are the most important issues concerning corporate governance for businesses in the Solomon Islands?

Think of 6 issues. Rank them 1 – 6 in order of importance.

7

Who are important in ensuring good corporate governance?

The board of directors

Management

Shareholders

All of these people have different roles in ensuring good corporate governance. Their roles are all important.

8

What are their different roles?In order to understand their different roles, you first need to understand the structure of a company compared to other business forms, for e.g. a sole trader.An important feature of a company is that it is a separate legal person from those: who formed it; its owners – the shareholders; and its directors.

9

What are the implications of it being a separate legal person?

A company can: sue and be sue in its own name; continue to exist despite changes to its

membership (its shareholders); own and dispose of assets –

shareholders own shares in the company – they do not own the assets of the company;

enter into contracts and incur liabilities in its own name

10

Implications of separate legal identity

Because the company is an artificial legal person it must have people to act on its behalf (sometimes referred to as the “organs” of the company)

The people authorised to act for the company are:The board of directors and their delegates

(business & affairs of the company managed or under direction or supervision of the directors)

The shareholders in general meeting (more limited role)

11

Implications of separate legal identity for corporate governance

As corporate governance is about good management of the company, a very important part of setting up good corporate governance is ensuring the board of directors functions well. The following slides describe:

different types of directors, and their duties the role of the board what makes an effective board

12

Types of DirectorsExecutive directorSenior full-time employee of the company and involved in the company management.

e.g. the managing director is an executive director. He or she is a member of the board and has all the duties of a director.

13

Types of Directors Terms “managing director” and “chief

executive officer” often used to mean the same thing.

CEO is only a director if he or she has been appointed as a director. If not appointed as a director, the CEO will attend board meetings and report to the board but will not vote at board meetings.

14

Types of DirectorsNon executive directorA part-time director who is not part of management. Can bring:

perspective from outside management; diverse skills; is not necessarily an “independent

director”

15

Types of DirectorsIndependent director

Is a type of non-executive director: not a substantial shareholder of the

company; not an executive or previous executive of

the company; is not a material supplier or consultant to

the company; does not have some other material

contractual relationship with the company.

16

Types of DirectorsNominee director

Appointed to represent the interests of stakeholders in the company. For example, could represent:

majority shareholder; employees; government agencies.

17

Types of DirectorsThe chair (or chairperson) Usually a non-executive director, heads the

board of directors Key responsibilities:

Setting the board agenda (in a broad sense) Runs board meetings, chairs general meeting Key advisor and mentor of other directors Ensures composition of the board effective Relationship with the CEO Provides leadership and external relations (with

CEO)

18

Types of Directors

Exercise 2

19

Directors Duties Contained in:

Companies Act 2009 (sections 64−70)

Directors of state-owned enterprises (SOEs) The State Owned Enterprises Regulations 2010

regulations 17−27 (made under the State Owned Enterprises Act 2007)

20

Directors Duties Directors’ duties are owed to the company.

This flows from the fact that the company is a separate legal entity.

Because the directors are the ones who are controlling the company’s affairs, they are in a position to harm the company and the shareholders through:

fraud or enriching themselves at the company’s expense; and

mismanagement

21

Directors’ DutiesTwo fundamental types of directors’ duties

To act in good faith, and in a manner that the director believes to be in the interests of the company (the good faith and interests duty)

To act with due care: a director must exercise the care, diligence, and skill that a reasonable person would (the duty of care)

22

The good faith and interests duty

The key aspect of this duty is to act: honestly for the company

and NOT to treat the company assets as a treasure chest for the directors’ own personal use.

What if the directors and shareholders are all the same people?

23

The good faith and interests duty

Examples of breaches of this duty: stealing from the company making loans to friends, family, shareholders or other

directors on favourable terms writing off debts owed to the company for no good

reason (e.g. just so a director won’t have to repay a loan)

Acquiring a competitor of the director’s company and using company information to assist in acquiring the competitor

hiding company assets from creditors

24

The good faith and interests duty

Examples of breach (cont) Sole director of a company diverts company assets to

a new company the director has set up, sells the assets to the new company at an undervalue so that the original company is left with no assets only liabilities and the original company then goes into liquidation;

MD purchases shares in the company using mother’s share trading account, the price of the company’s shares goes up temporarily and he is able to claim a cash bonus (b/c his bonus was tied to the share price)

25

The good faith and interests duty MD authorises a large payment to

another company that he controls, where he knows it is not clear the payment is due, and: he pushes through the decision to make

the payment without debate or discussion at the board meeting;

there is a conflict of interest and nothing is done to protect the interest of the company from the conflict.

26

The good faith and interests duty Using a power for an improper purpose

is a breach of this duty. This means: powers given to the board or others cannot

be used for their own private purposes, e.g. Using the power to issue shares to create a

new majority of shareholders over the old majority; or

Changing contracts with employees or suppliers to discourage someone from buying the company.

27

Conflicts of interest A lot of the examples above involve

conflicts of interests between the director’s private interests and his or her duty to the company.

There are sections in the Companies Act and the SOE Act that specifically deal with conflicts of interest and the procedures a director must follow when there is a conflict. This will be covered in detail in a later training session.

28

Other duties specifically mentioned in the Act Duty to comply with the Act Duty to comply with the company rules Duty not to disclose information or make use of

company information unless in the interests of the company or required by law or in some other limited circumstances

Duty to prevent insolvent trading Note a D can be personally liable for the

company’s debts incurred after she or he fails to call a meeting to consider appointing a liquidator in certain circumstances

29

2nd fundamental duty: the duty of care

Director must exercise or perform her or his duties with care, diligence, and skill that a reasonable person would exercise in the same circumstances.

The director must actively consider all decisions and cannot sit passively by and allow other directors to make inquiries and effectively make the decision

30

The duty of care Director will be judged by what could

reasonably be expected of a person in the director’s position;

In other words, directors not required to exhibit a greater degree of skill than may be reasonably expected of people with the same degree of knowledge and experience in the circumstances

31

Duty of care So for example, if a director is a lawyer,

she or he would be expected to understand better the legal implications of what the company is doing;

But, while a director’s experience is taken into account, it is assumed a director will be reasonably informed about the company’s financial capacity

32

Examples of breaches of duty of care

Directors failed: To monitor management; Didn’t assess the company’s financial

position properly Didn’t ensure there was a proper system to

provide accurate and reliable financial information

To maintain enough cash to allow for liquidity

Failed to employ a qualified finance director

33

Examples of breaches of duty of care

MD breached his duty of care by authorising the company to make misleading and deceptive statements to the stock exchange;

Directors breached duty by allowing the company to overpay their directors’ fees make two loans to another director where no rate of

interest agreed or repayment terms, not in writing; sold assets of the company and distributed the

assets to shareholders and another director leaving the company insolvent

34

Examples of breaches of duty of care

Director: approved a payment of a dividend when

the company did not have any profits to pay a dividend;

Approved the company accounts knowing the profit included certain amounts but had not made proper inquiries as to whether the inclusion of these amounts would result in the accounts not providing a true and fair view of the company’s profit and loss

35

Directors of SOEs Their duties are similar to the duties we have just

been discussing – to act in good faith, in the best interests of the SOE and for a proper purpose;

Can’t allow the SOE to contravene legislation or rules Must exercise, care, diligence and skill that a

reasonable director would exercise in the same circs (2 specific obligations that would also be a breach of the care duty are also set out in the Act)

Must only use information for SOE purposes Duty against conflicts and managing those conflicts

36

Duties of Directors

Exercise 3

37

The board of directorsThe board has two fundamental roles:

The compliance and monitoring role: make sure the company complies with internal procedures and legal and regulatory requirements – including providing accountability to stakeholders by reporting

38

The board of directors The performance role – setting goals

and the strategic direction of the company. Also includes: monitoring performance of management

and company against strategic goals

identifying key issues, risks and opportunities to ensure performance of the company is enhanced

39

Division of task b/w management and the board

Division of tasks between senior executive, management and the board will depend on: size and complexity of the company

relative skills of directors and management

stage of company development

40

Division of task b/w management and the board

Generally board not involved in day-day-management, role to govern not manage

The board steers and management rows

41

Board tasks Strategy CEO Monitoring Compliance Communication Corporate culture ethics Board structure Approve appointment of senior executives Endorse T&C of senior management

Kiel, et al Directors at Work (2012)

Board composition Size of the board

Public company must have a minimum of 2 directors and maximum of 10

Composition of the board All executive board Majority executive board Majority non-executive board

43

Composition of the Board Board competencies

Behavioural Governance knowledge Technical professional skills Industry knowledge Diversity

44

Kiel, et al, Directors at Work (2012)

Composition of the board45

Terms of appointment of the board “new blood” versus retaining valuable

experience

Rules might provide for length of term

Full board delegate work to committees46

Large company may require board to delegate work to committees e.g. Audit committee Nominations committee Remuneration committee Compliance committee Governance committee Risk committee

PLANNING, REPORTING AND ACCOUNTABILITY

MODULE 2

47

SESSION 3

Introduction48

Where are we?

We’ve discussed what corporate governance is

Looked at the different organs of corporate governance and focused on directors and the board

We saw the board has 2 functions: the performance role and compliance role

Introduction49

In this module we are going to look at the board’s role in planning and how it connects to reporting, and accountability. It mixes both aspects of the board’s performance and monitoring role.

Why should the board plan and what types of plan should the board oversee?

How must the results of the company’s performance be reported externally?

External reporting is linked to accountability (good corporate governance)

Why Planning?50

Devising and monitoring strategy has been described as “the heart of business success and failure” and therefore central to corporate governance (the business argument)

Strategic planning also seen as part of directors’ duties (the legal argument)

What role does the board have?

51

Precise role and extent of board’s role in devising strategy will depend on the company’s size;

Directors of small companies deeply engaged in strategy

Directors of large companies only able to review and test strategy devised by management

The strategic plan52

A strategic plan is an aspirational document that communicates the long term goals of an organisation describing at a general level the actions required to achieve those goals and setting high level measurable targets against which achievement of the plan’s goals may be measured.

The strategic plan53

Has an “end in mind”

Sets framework for 3-5 years or more

Typically in three parts Vision statement Key Initiatives to achieve the vision Translation of strategic initiatives into the

budget

The strategic plan54

‘Budget’ refers to the first year of the plan; forecasts are provisional

Strategic plan will require detailed plans that set out precisely how the strategic objectives will be achieved.

The strategic plan55

The more detailed documents include: The annual business plan – how the company

will achieve annual milestones on the way to the overall strategic goal;

Plans for division of the business that relate to annual business plan

All of these plans should be aligned with the overall strategic plan

The business plan56

Business plan can be used for different purposes.

As mentioned above, it can be used in the context of the strategic plan;

Can also be used to support an application for finance, government grants or to attract investors

Kind of information in a business plan57

Description of your business Description of the target market Analysis of the competition Description of the management team

and staff Operations Marketing Financial performance

National Australia Bank "How to write a business plan"

Kind of information in a business plan*58

Financial performance

Include a SWOT analysis This analysis useful for all sorts of planning

National Australia Bank, "How to write a business plan"

Example of SWOT analysis59

StrengthsRecently updated technologyReliable suppliersQuality productReputation for customer service

WeaknessesInsufficient working capitalInadequate cash flow

OpportunitiesMarket opening up in different geographical areaDemand is increasingCompetitor weak in a particular area

ThreatsDownturn in the economyNew competitorThreatened regulatory change that will increase costs

The financial plan and importance of financial forecasts

60

Dr Judy Taylor will be dealing with these tomorrow.

Dr Taylor will show how to do these plans, how to evaluate them and how they become a mechanism for control and evaluation of the strategic plan.

Asset management plan61

Object to ensure the company’s assets are used efficiently and promote profitability.

They set out “how physical infrastructure assets will be managed over a specific period of time” to achieve asset management objectives defined in a strategic plan or business plan.

WA, Dept of Local Government and Communities, Integrated Planning Website

Asset management plan62

Asset register (record of all assets and what happened to them)

Define level of service expected Identify assets critical to operation Forecast demand for various asset categories Include possible alternative delivery progams Provide financial information about the assets Include strategies to manage funding gaps Include schedule for asset performance and

review WA, Dept of Local Govt and Communities, Integrated

Planning Website

The asset register63

Very important For tax purposes – ensuring assets are

being correctly depreciated; For financiers – can value assets of

company; and If you wish to sell the company

Other plans64

Human resources plan Risk management plans

Review and adjustment of plans Monitoring discussed in next module Review should make adjustments to plan if

necessary

Reporting to Stakeholders65

External reporting is part of the governance process

Reporting is an important legal and business requirement

Reports provide accountability, providing they are true and honest, not misleading

Part of the governance process is to ensure that correct data is collected to include in the reports

Reporting: Companies Act66

Public company must send an annual report about the company within 20 days after it’s required to complete its financial statements.

Private company and a community company don’t have to provide an annual report unless a shareholder gives written notice requiring one if their rules say so.

However, if they don’t prepare an annual report they have to send a notice to each shareholder to that effect within certain time limits

Contents of the annual report

67

You should refer to the Companies Act and the company’s rules to determine what should be included.

Legal requirements in the Act are it must be: In writing and be dated; Include financial statements that comply

with the Act Include an auditor’s report if required

Contents of the annual report

68

Include the names of the directors and previous directors during relevant accounting period;

Contain any other information required by the regulations or the rules

Be signed on behalf of 2 directors, or if there is only 1 director by that director

Contents of the annual report

69

Additional requirements for public companies: State separately the total remuneration and

value of other benefits received by each director or former director;

Total amount of donations made by the company during the period;

Audit fees, and other amounts payable to the auditor

The annual report as a marketing document

70

Opportunity to communicate the company’s vision, include headline achievements for the year, a snapshot of the company

What community service projects

Chair’s statement and CEO’s strategic review

SOE reporting71

Also required to provide an annual report but also a half-yearly report;

Reports tabled in parliament Government assistance to be disclosed Statement of corporate objectives

Include board’s estimate of the current commercial value of the Crown’s investment in the SOE group and a statement of the manner by which that value was assessed

EFFECTIVE BOARD MONITORING

MODULE 3SESSION 4

Effective board monitoring73

The previous module discussed why plans are needed and how they are reported externally as part of the company being accountable to its stakeholders.

This module will examine the question how does the board internally monitor the company’s performance?

Effective board monitoring74

Recall that ‘monitoring’ is one of the board’s critical roles.

Oversight extends to all aspects of the company’s objectives: operational, strategic, and financial.

Board also assesses the CEO Board should also assess itself and

individual directors

Effective board monitoring75

To perform this function it must have: An effective reporting system

Relevant timely

What kind of information/reports should the board receive?

Effective board monitoring76

Board information should include: Key results indicators of business compared

to: Plans, strategic, annual, and others

Timing of reports will differ: Strategic review annually Business plan quarterly or monthly

Effective board monitoring77

Object of reports to board should show overall performance to ensure board focussed on strategic issues and not detail of management

Following monthly report items should include: Actual result against budget Year to date Results for previous year Forecast for next quarter and year-end

Board report78

General Overview of operations

Financial Profit and loss, balance sheet, cash flow,

capital expenditure Working capital trends and analysis Loans Foreign exchange exposure Sales Costs

Archer & Thornton, "Seeing the wood for the trees" Co Dir Magazine (2012)

Board report79

Non-financial reports Human resources

Relevant committee reports for particular meetings

Progress against strategic plans

Board reports80

Too much information or not enough time to review information

This is an area of risk for the board Board needs to consider what

information they need in line with directors’ duties

Director packs can be large No defence to say that you have been

provided with too much information

Board reports81

If there is a lot of information then you need to ensure there is sufficient time to read it

The board controls the information it receives so work with management to ensure it provides information in a format that is useful for the board.

One mechanism used: dashboard reporting

Reporting dashboard82

*Image by Klipfolio: http://www.klipfolio.com

Dashboard reporting83

Useful, also has its limitations If too much information over a large variety

of factors, can be just as confusing to read

If dashboard highlights any problems the detail of the problem should be provided in a separate report

Performance review and its relationship to planning

84

Plans Performance review

Strategic 5 year planSets the long term objectives

Annual review of strategic planReviews progress and relevance of strategic plan reported to the board

Annual business plan Quarterly review of business plan

Sets out annual objectives and initiatives that are determined in relation to strategic 5 year plan

Reviews progress and reported to the Board

Divisional plan Monthly performance review of the division

Sets out detail of how annual plan is to be implemented

Reported to the CEO/management and forms the basis of report to the board

Performance development plans of staff

Annual performance reviews

Guidelines for developing performance measures

85

Board’s role is to oversee management set up a workable planning program that is linked to performance review

Performance measures or key performance indicators (KPIs): valid verifiable global communicable achievable

Kiel, et al, Directors at Work (2012)

Guidelines for developing performance measures

86

Number of performance measures of the business should not be excessive;

Assessment of the business should not only relate to financial performance

“Balanced scorecard” approach Financial Customer Internal processes Learning and growth

Guidelines for developing performance measures

87

If badly designed lead to “gaming” by executives and staff

Lead to short termism Gaming reduced by better design and a

values-driven culture in the company Are managers acting within organisational values

Conduct staff attitude survey Look at rates of absenteeism, sick leave and

retention rates

Assessing the CEO88

Agree performance indicators and their objectives Are they related to remuneration? Should be related to strategic plan Mix of quantitative indicators and

qualitative indicators Qualitative indicators not easily be measured Heavy emphasis on annual financial indicators

– short termism

Assessing the CEO89

Chair or committee carry out the assessment

Informal discussions or written questionnaire

Companies with resources engage outside consultants to facilitate corporate governance

Assessing the Board and Individual Directors

90

Can be a sensitive issue In addition to usual methods (co performance)

formal performance appraisal should be used Review of board and individual directors should

be annual, gaps identified previously form basis of following year review

Review entire board and its mix of skills, diversity Are there regular meetings? Reports sent on time so members can read? Minutes kept?

Review of individual directors

91

Questions to be asked: ‘Do the directors understand the company business

and strategy? Do they stay abreast of current issues and trends in

the industry? Do they attend all board and committee meetings? Are they well prepared and do they actively

contribute? Do they challenge management when necessary? Do they effectively enquire into major performance

deficiencies?’

AICD, Appraisal of Board and Individual Directors: Director Q&A (2013)

Effective board monitoring92

Exercise 4