Copyright © 2008 McGraw-Hill Ryerson Ltd. 1 Chapter Twelve Corporate Governance Prepared by Mark Schwartz, York University Canadian Business and Society: Ethics & Responsibilities

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.2 Chapter Outline Rights of Shareholders Responsibilities of Board, Membership, and Structure Disclosure and Transparency Evaluating Board and Director Performance Corporate Governance and Performance Criticism of Corporate Governance Reform Rebalancing Power in the Corporation Corporate Governance and Stakeholders

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.3 Corporate Governance: Definition The processes, structures, and relationships through which the shareholders, as represented by a board of directors, oversee the activities of the business enterprise.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.4 Rights of Shareholders Secure ownership registration Capability to transfer ownership Access to relevant corporate information Participation and voting at shareholder meetings Election and removal of board members Share in profits of the corporation Knowledge of extraordinary transactions or decisions Disclosure of dual-class shares Capability to exercise ownership rights Source: OECD, 2004

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.5 Responsibilities of Board Board of Directors: group of individuals elected by shareholders to govern or oversee the corporation’s affairs. Fiduciary duties: obligations of directors to shareholders that are prescribed by laws or regulations.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.6 Responsibilities of Board Board’s written mandate must include board’s satisfaction with integrity of CEO and other executives and that they are creating a culture of integrity (Canadian Stock Exchanges) Board must apply high ethical standards and take into account the interests of stakeholders (OECD, 2004)

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.7 Board Membership Independent director: A director who is free from any interest and any business or other relationship which could, or could reasonably be perceived to, materially interfere with the director’s ability to act in the best interests of the corporation.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.8 Board Structure Board committee examples:  audit; finance; human resources; pension; compensation; nominating; governance; and strategic planning. Audit committee is required to have independent members. Most experts recommend separation between the role of the board chair and the CEO.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.9 Disclosure and Transparency Disclosure requirements for Canadian public companies (National Instrument ):  Disclose whether board has adopted written code  Describe steps board takes to encourage and promote a culture of ethical business conduct  Disclosure of executives’ compensation Board’s audit committee oversees internal and external accounting auditing function to ensure accurate financial statements

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.10 U.S. Sarbanes-Oxley Act (2002) Public Company Accounting Oversight Board Auditor independence Corporate responsibility Enhanced financial disclosures Corporate and criminal fraud accountability White-collar crime penalty enhancements

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.11 Evaluating Board and Director Performance Criteria for evaluating board performance:  Legal  Strategic and social  Financial  Business  Human resources  Governance Source: Belcourt and Kluge, 1999

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.12 Corporate Governance and Performance Some research suggests that good corporate governance affects firm performance Annual rankings of governance practices:  Criteria: board composition, compensation, shareholder rights, disclosure, returns (Report on Business, The Globe and Mail)  Criteria: returns, independence, accountability, disclosure (Canadian Business Magazine)

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.13 Criticism of Corporate Governance Reform Audit fees have increased Management attention diverted away from operation of business Additional costs have made North American business less competitive in global market Changes may not make a difference to firm performance or in protection of shareholders Approach should be principles-based, not rule- based

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.14 Rebalancing Power in the Corporation CEOs have been too powerful New balance of power emerging among management, board, professional services (e.g., lawyers, auditors) Directors now playing bigger role in strategic decision making and ethical responsibilities Auditors more cautious Legal counsel representing everyone Some shareholders more active in pressuring boards

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.15 Corporate Governance and Stakeholders OECD Principles of Corporate Governance (2004):  Rights of stakeholders are to be respected  Effective redress for stakeholders when rights violated  Stakeholders should have access to information  Stakeholders should be allowed to blow whistle on illegal or unethical practices to board

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.16 The Corporation and Democracy At the shareholder level, voting rights are based upon share ownership and abuses occur, infringing upon the rights of some shareholders. Most employees have no say in the governance of the enterprise. The general public is removed from any access to the system of corporate governance. A number of stakeholders therefore not involved.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.17 Mintzberg’s Democratization of the Corporation Mintzberg proposed formal devices to broaden the governance of the corporation. Two means: representative democracy and participative democracy. Two groups involved: employees (internal) and interest groups (external).

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.18 Mintzberg’s Democratization of the Corporation Four basic forms of corporate democracy: 1. Worker Representation - workers have representatives on the Board of Directors. I.e. European ‘Co-Determination’. 2. Pluralistic Representation - ‘public interest’ representatives are elected to the Board of Directors. 3. Worker Participation - workers are given some control of decision making, I.e. worker councils. 4. Pluralistic participation - external influence groups are somehow included in internal decision making.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.19 Problems - Pluralistic Participation Seen with non-profit institutions. How to do you ascertain representation?

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.20 Problems - Co-determination Leads to politicization of decision making. Increases bureaucracy Hampers entrepreneurial drive Dilutes responsibilities Delays decision Endangers the unity and flexibility of management. Considered incompatible with the free market system and existing concept of private property rights.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.21 Problems -Worker-Representation Minor impact on business. Does not increase participation by workers. Concentrate power on the top (only labour is involved and selection of representatives is not easy). Representative may be remote from their constituents

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.22 Mintzberg’s Democratization of the Corporation Representative Democracy (Positives) Gives air of legitimacy to the governance of the corporation. Opens channels of communication, gets management to look at the human side, greater access to management information.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.23 Corporate Governance Reform Types of Governance Structure Issue #1 - ‘Inside’ Versus ‘Outside’ Members of the Board and Board Leadership.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.24 Corporate Governance Reform Rechner (1989) Type 1 - Majority Outsides and Independent Board Leadership. Considered this the ideal type of structure for effective governance. Avoids the lack of independence associated with insiders and the vested interest leadership of the combined CEO/Chairperson.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.25 Corporate Governance Reform Type 2 - Majority Outsiders and CEO Duality. Common among large industrial corporations. CEO exercises too much power? I.e. Type and quality of information presented, board’s agenda.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.26 Corporate Governance Reform Type III - Majority Insiders and CEO Duality. Rubber-stamp Board Total management control.

Chapter 12 Copyright © 2008 McGraw-Hill Ryerson Ltd.27 Corporate Governance Reform Type IV - Majority Insiders and Independent Board Leadership. Dominance of insiders is offset. However, least likely to occur.