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MODULE 1 INTRODUCTION TO CORPORATE GOVERNANCE ADB Private Sector Development Initiative Corporate and Financial Governance Training Solomon Islands Dr.

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Presentation on theme: "MODULE 1 INTRODUCTION TO CORPORATE GOVERNANCE ADB Private Sector Development Initiative Corporate and Financial Governance Training Solomon Islands Dr."— Presentation transcript:

1 MODULE 1 INTRODUCTION TO CORPORATE GOVERNANCE ADB Private Sector Development Initiative Corporate and Financial Governance Training Solomon Islands Dr Ann Wardrop La Trobe University

2 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.

3 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

4 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

5 Meaning of Corporate Governance Good 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

6 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

7 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

8 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

9 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

10 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

11 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

12 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

13 Types of Directors Executive director Senior 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

14 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

15 Types of Directors Non executive director A part-time director who is not part of management. Can bring:  perspective from outside management;  diverse skills;  is not necessarily an “independent director” 15

16 Types of Directors Independent 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

17 Types of Directors Nominee director Appointed to represent the interests of stakeholders in the company. For example, could represent:  majority shareholder;  employees;  government agencies. 17

18 Types of Directors The 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

19 Types of Directors Exercise 2 19

20 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

21 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

22 Directors’ Duties Two 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

23 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

24 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

25 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

26 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

27 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

28 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

29 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

30 2 nd 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

31 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

32 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

33 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

34 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

35 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

36 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

37 Duties of Directors Exercise 3 37

38 The board of directors The 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

39 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

40 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

41 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

42 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)

43 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

44 Composition of the Board  Board competencies  Behavioural  Governance knowledge  Technical professional skills  Industry knowledge  Diversity 44 Kiel, et al, Directors at Work (2012)

45 Composition of the board 45  Terms of appointment of the board  “new blood” versus retaining valuable experience  Rules might provide for length of term

46 Full board delegate work to committees 46  Large company may require board to delegate work to committees e.g.  Audit committee  Nominations committee  Remuneration committee  Compliance committee  Governance committee  Risk committee

47 PLANNING, REPORTING AND ACCOUNTABILITY MODULE 2 47 SESSION 3

48 Introduction 48 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

49 Introduction 49 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)

50 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)

51 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

52 The strategic plan 52 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.

53 The strategic plan 53  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

54 The strategic plan 54  ‘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.

55 The strategic plan 55  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

56 The business plan 56  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

57 Kind of information in a business plan 57  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"

58 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"

59 Example of SWOT analysis 59 Strengths Recently updated technology Reliable suppliers Quality product Reputation for customer service Weaknesses Insufficient working capital Inadequate cash flow Opportunities Market opening up in different geographical area Demand is increasing Competitor weak in a particular area Threats Downturn in the economy New competitor Threatened regulatory change that will increase costs

60 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.

61 Asset management plan 61  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

62 Asset management plan 62  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

63 The asset register 63  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

64 Other plans 64  Human resources plan  Risk management plans  Review and adjustment of plans  Monitoring discussed in next module  Review should make adjustments to plan if necessary

65 Reporting to Stakeholders 65  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

66 Reporting: Companies Act 66  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

67 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

68 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

69 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

70 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

71 SOE reporting 71  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

72 EFFECTIVE BOARD MONITORING MODULE 3 SESSION 4

73 Effective board monitoring 73  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?

74 Effective board monitoring 74  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

75 Effective board monitoring 75  To perform this function it must have:  An effective reporting system Relevant timely  What kind of information/reports should the board receive?

76 Effective board monitoring 76  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

77 Effective board monitoring 77  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

78 Board report 78  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)

79 Board report 79  Non-financial reports  Human resources  Relevant committee reports for particular meetings  Progress against strategic plans

80 Board reports 80  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

81 Board reports 81  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

82 Reporting dashboard 82 *Image by Klipfolio: http://www.klipfolio.com

83 Dashboard reporting 83  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

84 Performance review and its relationship to planning 84 PlansPerformance review Strategic 5 year plan Sets the long term objectives Annual review of strategic plan Reviews progress and relevance of strategic plan reported to the board Annual business planQuarterly 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 planMonthly 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 staffAnnual performance reviews

85 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)

86 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

87 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

88 Assessing the CEO 88  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

89 Assessing the CEO 89  Chair or committee carry out the assessment  Informal discussions or written questionnaire  Companies with resources engage outside consultants to facilitate corporate governance

90 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?

91 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)

92 Effective board monitoring 92 Exercise 4


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