International

Management,
Governance
and
Sustainability
(IMGS)

WEEK6: Corporate Governance I

Dr Posi Olatubosun PhD, FCCA,

FHEA.
 Lecture 6: Corporate Governance I

Learning Objectives:
By the end of this lecture you should be able
to understand:

 what is meant by “corporate governance”

 Some specific examples of good and bad
governance practices

 the “comply or explain” principle

 Principles of UK Code and UK stewardship code

 Comparison to Sarbanes Oxley Code (USA) Unit 2: Governance | 2

 Corporate Governance: background

 The industrial revolution prompted significant growth

of businesses

 Wealth owners realised that they are incapable of

effectively using their resources to maximise their
wealth

 Separation of ownership and control and agency

problem
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 3
 Corporate Governance: definitions
Definition 1: The system by which companies are
directed, structured and controlled.

Definition 2: The rights and responsibilities of a

company’s management, its board, shareholders and
various stakeholders.

Definition 3: ”The system of checks and balances,

both internal and external to companies, which
ensures that companies discharge their
accountability to all their stakeholders and act in a
socially responsible way in all areas of business
activity” (Solomon, 2013)
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 4
 Corporate Governance

“In a shareholder owned company, shareholder

interests are paramount but their long term
interests will be best served considering the
wider interests of society, the environment,
employees and other stakeholders.” ACCA 2008

New Code 2018, states in introduction:

‘directors need to build and maintain successful
relationships with a wide range of stakeholders’.

© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 5

 Agency Theory and Corporate Governance
Corporate
model
Society
Customers
Shareholders

Auditors
Suppliers £
Company

Employees Lenders
Manage £
Directors/
Managers Government

Can you think of any conflicts of interest arising from taking a stakeholder
approach?
© Dr Posi Olatubosun PhD, FCCA, FHEA
 Corporate Governance
Why Have Guidelines?:

Turner Review

© Dr Posi Olatubosun PhD, FCCA, FHEA 7

 Corporate Governance: major failures
The Maxwell Affair 1991
 Was Chairman and CEO of Maxwell Communications
Corporation. Also owned Mirror Group Newspapers
 Took money out of pension funds to finance other activities;
shareholders not informed
 Auditors and pension fund trustees did not notice the activities
 Lost £727 million in pension funds and £1b in shareholder value

© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 8

 Corporate Governance: major failures
• The Maxwell affair prompted the development of the first
corporate governance report
• Sir Adrian Cadbury assembled a committee utilising three
phases in addressing corporate governance issues:
– Education phase – to become aware of specific issues
– Analytical phase – to analyse issues with suggested solutions
– Implementation phase – to implement solutions
• Following extensive consultation, The Cadbury Report
(1992) emerged, focusing on the role of the board of
directors, constant monitoring and assessment

© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 9

 Corporate Governance:
major failures
The Fall of Barings 1995
 Nick Leeson, a stock market trader held dual position of General
Manager and Head Trader (trading on stock exchange floor and
trading accounts)
 Made significant losses that was transferred to ‘88888’ account
and traded on Nikkei 225 without authorisation
 Accumulated losses worth $400m before disappearing which
increased to £830m
 Management knew a large client was making huge losses but
did not act
Activity: what were the signs that suggests potential
problems?
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 10
 Corporate Governance: major failures
• Nick Leeson’s case resulted in the emergence of
The Turnbull Report (1999)
• Addresses internal control systems of companies
and risk management to reflect sound business
practices
• A conceptual framework that attempts to make
existing implicit corporate risk disclosure framework
explicit
• Following consultations, a revised guidance on
internal control was issued by FRC in 2005 for a
more flexible, principles based approach on the
issue
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 11
 Corporate Governance: major failures
The collapse of Enron 2002: A leading energy company that
gained a glittering success before crashing in a monumental
fashion
 Earned $100bill revenue in 2000, its management team were
depicted as arrogant and overambitious
 Overreliance on non-recurring items, derivatives trading and
off-balance sheet vehicles to boost profits, EPS and reduce
liabilities
 Executives sold over $1b shares without investors knowledge
 Auditors – Arthur Andersen – enjoyed ‘cosy relationship’ with
management that compromised their independence
 Filed for bankruptcy in December 2001 and directors charged
with fraud, money laundering and conspiracy to inflate profits
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 12
 Corporate Governance: major failures
 In the U.S., The Sarbanes Oxley Act was brought in
to address
 The effectiveness of audit and;
 The role of executives amongst other issues

 In the U.K., 3 separate reports were introduced

 The Higgs Report on non-executive directors

 The Tyson Report on boardroom diversity and

 The Smith Reports on audit and auditors.
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 13
 2008 Banking Crisis : Turner Review &
Walker Report
Banking Crisis caused by lack of liquidity in financial markets due to
lack of confidence in banking structures. Lead to collapse of leading
financial institutions:
USA – Fannie Mae & Freddie Mac, Lehman Brothers, Merrill Lynch, AIG
UK - RBS, HBOS, Bradford & Bingley
Turner Review (2009) – The crucial issue was the link between the
structure of remuneration for bank executives and its impact on their
attitude towards risk-taking.
Recommendations:
 Ensure remuneration policies are consistent with effective risk
management;
 Remuneration committees should arrive at independent judgements
 Greater emphasis on internal control and risk management.
Walker Report 2009 – Recommended increase in non-executive
directors with dedicated to risk management and increased role of
scrutiny from corporate investors.
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 6: Governance | 14
 Why Corporate Governance?
Scandals
Do they still happen?
• Tesco 2014 –
https://www.accaglobal.com/gb/en/student/sa/features/tesco-scandal.html
• BHS 2015
https://www.independent.co.uk/news/business/news/bhs-what-s-the-real-stor
y-behind-the-collapse-a7000166.html

“Accounting scandals happen because there is pressure to meet

short-term market expectations in terms of financial and share
price performance.” Centre for Financial Analysis and Reporting
Research
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 15
Governance frameworks
• Principles or rules?
– Principles are not legally binding whereas
rules have legal status
Major governance frameworks
• OECD principles of corporate governance

• Sarbanes Oxley Act 2002

• UK Governance Code

© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 16

 OECD corporate governance principles
OECD Principles

protect shareholders’ rights

Effective framework
…and treat them equitably

recognise stakeholders’ rights

transparency and disclosure

responsible board
© Dr Posi Olatubosun PhD, FCCA, FHEA 17
 Governance frameworks: OECD
The OECD Principles of Corporate Governance
• Update launched by G20 members in 2015
• One of the 12 key standards for sound financial systems
of the Financial Stability Board (FSB)
• Adopted by the World Bank Group as a component of
the Report on the Observance of Standards and Codes

“intended to help policy makers evaluate and improve the

legal, regulatory and institutional framework for corporate
governance with a view to support economic efficiency,
sustainable growth and financial stability” OECD 2015
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 18
Corporate Governance | United States

Sarbanes Oxley 2002 (known as SOX)

Applies to any company listed on US

stock exchange

UK company listed in US
must obey SOX rules
e.g. BP

© Dr Posi Olatubosun PhD, FCCA, FHEA 19

 Governance frameworks: SOX
• The US congress passed the Sarbanes-Oxley Act in 2002
• Applies to all companies listed in the New York Stock
Exchange (NYSE)
• Comprised of 11 major sections with more than 1,000
requirements
• Primary aim is to protect investors by improving accuracy
and reliability of corporate disclosures

Improve internal control Role of external auditors

Extensive corporate Internal and external monitoring
disclosures
Prevent accounting fraud Senior executives’ responsibilities
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 20
 Corporate Governance | United States

SOX
Lots and lots of rules
more than 1,000 requirements!!!!
Criticism:
 One size fits all – big or small companies
 High Costs
 Box ticking – no dialogue with investors

21
 Governance frameworks: FRC
• UK Governance Code (formally the Combined Code)
• Published by The Financial Reporting Council (FRC),
The Code prescribes expected behaviour of board of
directors
• Applies to ‘all companies with a premium listing of equity
shares’
• The concept ‘comply or explain’.
Underlying principles are based on:
“Accountability, transparency, probity and focus on
sustainable success of an entity over the longer term”
(FRC, 2016)
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 22
UK Corporate Governance | United
Kingdom

comply
or
explain

© Dr Posi Olatubosun PhD, FCCA, FHEA 23

 Governance frameworks: FRC
‘Comply or explain’
Vodafone Group, 2017: “During the period under review (and
as of the date of publication of this report) we have fully
complied with the provisions and applied the main principles of
the 2014 UK Corporate Governance Code” p.44

Zoopla Property Group 2016: “The Board is currently

comprised of a Non-Executive Chairman and nine other
Directors, of whom four are considered to be wholly
independent.” p.44 “Therefore, the Company does not currently
fully comply with the requirements of the Governance Code.”
Activity: What is the key difference between the two
compliance statements?
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 24
Old UK Corporate Governance | United
Kingdom
Essential Features:
Leadership

Effectiveness

Accountability

Remuneration

Shareholders

© Dr Posi Olatubosun PhD, FCCA, FHEA 25

New 2018 UK Corporate Governance |
applies to accounting periods beginning on or after
1st January 2019Kingdom

Essential Features:
Leadership
& Stakeholders
Effectiveness
Division of responsibilities
Composition, Succession &
Evaluation

CLEAR Accountability
Remuneration
© Dr Posi Olatubosun PhD, FCCA, FHEA 26
 The role of the Board: an effective board with
collectively responsible for the long-term success
of the company
Leadership
& Company Purpose
 Establish prudent effective controls

 Effective engagement with

shareholders
New 2018
 Workforce should be able to raise
concerns – have processes in
place
 Align culture to strategy and lead
by example (show integrity)

© Dr Posi Olatubosun PhD, FCCA, FHEA 27

  The board should ensure effective engagement
with, and encourage participation from
shareholders and stakeholders.
Stakeholders
NEW 2018
 When 20 per cent or more of votes
have been cast against the board
the company should explain what
actions it intends to take to consult
shareholders in order to
understand

 The board should understand the

views of the company’s other key
stakeholders
© Dr Posi Olatubosun PhD, FCCA, FHEA 28
 UK Stewardship Code 2012
Aims to promote the long term success of companies in
such a way that the ultimate providers of capital also
prosper. Effective stewardship benefits companies,
investors and the economy as a whole.
Assists institutional investors to exercise better
stewardship responsibilities
Investor activities may include monitoring and engaging
on matters such as strategy, performance, risk, capital
structure, and corporate governance, including culture
and remuneration.
Investors should be willing to act collectively with other
investors where appropriate and have clear voting policy
Applied on ‘Comply or Explain’ principle
© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 6: Governance | 29
 The chair responsible for its overall effectiveness
in directing the company. Demonstrate objective
judgement and promote a culture of openness
and debate. Effectiveness
Division of responsibilities
 Balance of non-execs vs execs, no-
one is dominant
 Non-Execs should be able to offer
constructive strategic advice and
have sufficient time for
responsibilities
 Timely and appropriate information

© Dr Posi Olatubosun PhD, FCCA, FHEA 30

 Promote diversity of gender, social and ethnic
backgrounds, cognitive and personal strengths.
Composition, Succession &
Evaluation
 Rigorous, transparent appointment
procedure with succession plan
 Skill, experience, independence,
knowledge, training and regularly
refreshed
 Consider composition, diversity and
how effectively members work
together to achieve objectives.
 Evaluation based on contribution
© Dr Posi Olatubosun PhD, FCCA, FHEA 31
  Transparent policies and procedures to ensure
the independence and effectiveness of internal
and external audit functions and ensure integrity
of financial and narrative statements.
Accountability
Audit, Risk & Internal Control
 Present a fair, balanced,
understandable assessment of the
company’s position and prospects.
 Nature and significance of risks
 Maintain sound risk management
and internal control systems.
https://www.ey.com/uk/en/issues/governance-and-
reporting/corporate-governance/ey-emerging-risks-
the-uk-corporate-governance-code-revisions-2018
© Dr Posi Olatubosun PhD, FCCA, FHEA 32
 Remuneration policies and practices should be designed
to support strategy and promote long-term sustainable
success.
Remuneration
 Clearly linked to long-term success of
company and strategy
 Transparent procedures no director
responsible for setting own pay
 Take into account wider
circumstances when setting pay

 Remuneration committee of non-

executive directors
 Proportionality between success and
rewards
© Dr Posi Olatubosun PhD, FCCA, FHEA 33
 Salient Points to remember on good CG practice I:
 Every company must have at least equal number of EDs and
NED and a Chair. More NEDs than EDs on a Board is even
better.
 Directors should meet regularly to appraise strategy, risks and
direction of the business.
 NEDs should run committees such as Risk, Audit,
Remuneration, Strategy, Nomination, whilst the EDs are
responsible for the day-to-day running of the company.
 Directors’ remuneration should encourage long-term focus
(e.g., Salaries + LTIPs [Long-Term Incentive Plans] rather than
salaries + Bonuses)
 No one should act the combined role of MD and Chair.
 No MD should proceed from being an MD to becoming the
Chair in the same company as this would make them to be too
powerful
© Dr Posi Olatubosun PhD, FCCA, FHEA Lecture 6: Governance | 34
 Salient Points to remember on good CG practice II:
 Directors should hold meetings with and communicate with key
stakeholders periodically.
 Directors should hold Investors’ Relations meetings periodically
with and communicate with key shareholders.
 Directors should be made to go for re-elections periodically, say
every 3-5 years. This encourages long-term performance
orientation and accountability
 Every business must have an Internal Audit (or Compliance)
unit that reports to the Audit or Risk Committee and NOT to the
Managing Director.
 The MD runs the company while the Chair runs the Board.
 The Chair should only cast his/her vote when there is a tie

© Dr Posi Olatubosun PhD, FCCA, FHEA Lecture 6: Governance | 35

 Summary
 Governance emerged as a result of the evolution of
companies structure and aims to promote long term
success
 Promotes relationships with a wide range of stakeholders.
 Major corporate scandals emphasised the significance of
governance
 The Sarbanes Oxley Act (USA) is a rules based approach
to governance
 The UK Governance Code 2018 applies a principles based
approach centred on the concept of ‘comply or explain’
 UK Stewardship Code 2012 assists institutional investors to
exercise better stewardship through effective dialogue

© Dr Posi Olatubosun PhD, FCCA, FHEA Unit 2: Governance | 36