Analysis of Tesco's Corporate Governance and Responsibility
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1.1 Overview of the project
Corporate governance and Corporate Responsibility have gained an increasing amount of importance over the last decade due to some of the world's greatest corporate scandals that have been taking place. These scandals have not been happening to the under developed or developing economies, which have a high rate of corruption, but instead have been taking place in the developed countries, which supposedly have had various safeguards to protect the interests of all the stakeholders.
Following the collapse of major multi-nationals such as the Maxwell Empire in the UK, Enron in the United States and Parmalat in Italy to name just a few, findings of fraud, dishonesty, irregular accounting and too much "power" held by one individual soon came to light. As a result, people and investors have lost the trust they placed in the financial markets and the big corporations to safeguard their assets and interests. The loss in confidence has seen big drops in the stock markets around the world and should the trend continues, the whole world economy would collapse which would lead to devastating consequences.
As a result of those alarming situations, governments around the globe have devised frameworks of good corporate governance and passed on various laws, rules and regulations to hold companies responsible for their own actions, known as Corporate Governance and Responsibility in order to ensure that such scandals are not repeated in the future.
The main corporate governance frameworks include the Organisation for Economic Co-operation and Developments (OECD) principles, the UK revised Combined Code (2003) and the Sarbanes-Oxley Act in the United States. Some of these are legally binding, such as the one in the United States while others operate on a "comply or explain" basis.
This project will place more emphasis on the governance framework in the UK, namely the revised Combined Code, though I will make brief analyses of other reports and frameworks. Why I chose this particular topic area is for many reasons. Firstly, I believe that there is still scope to improve corporate governance worldwide and hence, wished to learn more about it. Secondly, despite the fact that corporate governance and corporate responsibility have become increasingly important in today's world and that companies have to adhere to the rules or principles, reports of fraud and bad management are still emerging in the developed economies, which lead to the collapse or nationalisation of various organisations. Well known examples in the UK include the nationalisation of Northern Rock bank and the government pumping in money into its various other banks, including Lloyds and Royal Bank of Scotland among others. It therefore begs the question about the credibility of the corporate governance framework. In addition, as a business student, it is now imperative to have a good understanding of the subject and as a taxpayer and citizen, I am both directly and indirectly affected by corporate behaviour.
1.2 The Organisation in question
This thesis revolves around Tesco plc, one of the world's leading retailers. Opened in 1919 by founder Jack Cohen, his first day's sales were £4 with a profit of £1. By 1947, the company floated on the stock exchange with a share price of 25p and by 1979, its annual sales has reached £1 billion. In 1983, Tesco Stores (Holdings) Ltd becomes Tesco PLC. Nowadays, the company has entered various other markets including the USA, China, Korea and many other European countries. It has also diversified into other industries, including financial services and is currently making profits in excess of £2 billion. It is the UK's biggest supermarket in terms of turnover with 2,115 UK stores and employing 280, 373 staff in the UK alone (Tesco annual report 2008) .Such an organisation has been chosen for various reasons, namely because:
- It is a listed company, and hence according to the London Stock Exchange rules, it needs to adhere to the principles of the UK Combined Code on Corporate Governance on a Comply or Explain basis. Therefore, I will be able to determine whether such a big company is really being a good corporate citizen.
- Most of the data that I will need to conduct my research is readily accessible through its website, including its financial statements and annual reports.
- Data on similar organisations, such as Sainsbury's plc is also readily accessible, which would prove to be very useful for comparison purposes. This would help me to make an analysis on how those two similar organisations are complying with the UK combined code on corporate Governance and whether the departure from for example a specific code is usual for these companies or ot.
- Tesco plc has a very large number of stakeholders and hence it is interesting to find out how the company is working towards fulfilling its responsibility towards them. In other words, how it is being corporately responsible, especially how it is dealing with the principal-agent problem.
In addition, according to the company's annual report, Tesco follows a diversification strategy, laid down over 10 years ago and which has been the foundation of its enormous success in recent years.
Due to the company's size, Tesco has segmented itself into 5 main areas:
- CORE UK
- NON FOOD
- RETAILING SERVICES
The UK is its biggest market and the core of the business. The main aim here is to provide its customers with excellent value and choice.
As well as deriving high shareholder value, the company also tries to be a corporate citizen. In addition to its annual report, the company also publishes a Corporate Responsibility report to show that it is a responsible business.
Over the past decade, the company diversified into the non-food market whereby it offers a range of products, from laptops to mobile phones, etc...The aim here is to be as strong in food as in non-food, competing on price and value.
Following its success into the non-food market, the company went into retailing services, offering financial services to its customers. Again here, this sector has proven to be profitable for the company.
Nowadays, Tesco is not only operating in the UK but also in most European countries as well as in the US and Asia. The company has been expanding very quickly and is the number 1 retailer in Thailand today!
As can be seen, Tesco has followed through a diversification strategy throughout the last decade, expanding not only into other markets but into other industries as well. Considering that diversification is quite a risky strategy, the company has been performing exceptionally well, defying the current credit crunch to record profits of over 2 billion pounds!
Such a big and successful company provides us with ample opportunities to assess whether there are any irregularities in its reports, ie, whether there is good governance or not!
1.3 Research Questions
The dissertation is mainly an analytical one, in that an analysis on the company's corporate governance and its corporate responsibility report will be performed. The main objective is to determine whether the company is behaving responsibly, by complying with all the provisions of the code and how is it discharging its duties towards its stakeholders. The main questions that will therefore be investigated are the following:
- Has Tesco complied in all respect with the principles of Corporate Governance and if not, why has it departed from a particular provision?
- Is there a link between its Corporate Governance and Corporate Social Responsibility and its financial position?
- Is the company projecting an image of a good corporate citizen?
The above will form the main research questions though I will also be looking at various other aspects briefly such as:
- Variety of directors at the organisation.
- The difficulty in finding the right people with the right skills for the company.
- The role of Tesco's audit committee, including independence issues.
- Public relations regarding the effect on the company if seems to flout regulations.
- The company's budget towards fulfilling its corporate responsibility
- How the company is working towards being eco-friendly
- Whether the company provides proper adequate training, pension provisions, etc...
1.4 Overall Research Approach
The starting point for the thesis indulges firstly into a broad explanation of both corporate governance and corporate responsibility. We will look at various definitions from a few sources in order to provide the reader with an understanding of the subject. Good corporate governance is incorporated into many reports. The main ones that will be the focus of the dissertation are notably the Cadbury report, Hambel report, Greenbury report, Higgs report, Smith report and the Turnbull Committee.
The main points of the UK Combined Code (revised July 2003) will be discussed in a bit more detail, since it will form the basis of our first topic of interest of the project. In addition, the London Stock Exchange now requires all its listed companies to comply with the above code, which includes Tesco. As such, the first project objective will be achieved, whereby we can make an analysis whether Tesco has complied fully with the code or not.
Whether there is a link between Tesco's governance system and its financial performance will be the second part of the project. An analysis of the company's financial statements will be performed to assess its financial performance using various accounting techniques, such as ratio analysis, industry, competitor and international comparisons. Other items, such as share price movements, off balance sheet finance, creative accounting and conflicts of interests between management and shareholders will also be looked at to ensure that the figures provided in the financial statements are not misleading, especially to both current and potential investors.
The impact of Tesco's corporate governance system on its various stakeholders will form the next point. The main stakeholders that will be investigated here will be:
- Loan provider
Each of the above points will be explored in details and an assessment on stakeholders' conflicts of interests will be discussed briefly if there are any.
Next on the agenda will be the topic of Corporate Responsibility. I will be making an analysis to determine how well Tesco is taking the responsibility to consider the interests of customers, employees, shareholders, society and the environment in its operational activities.
Lastly, the thesis will focus on any criticisms and possible recommendations on the organisation's corporate governance system and on its corporate social responsibility.
2.0 Information gathering
Gathering information and data effectively is key to achieving a good project. A great deal of research is needed and very often there might be data overload. When too much data is collected, it sometimes becomes very difficult to analyse and interpret them properly which may be problematic in doing well in the thesis. On the other hand, not collecting enough data may lead to the wrong conclusion, thus rendering the thesis useless or even misleading.
Therefore, it is of utmost importance that one must collect information properly and effectively in order to avoid wasting time and sometimes even money. We should always bear in mind that the data that needs to be collected should be sufficient so as to achieve the research objectives.
2.1 Sources of information
There are two types of data, mainly primary and secondary data. Primary data is data that is unique to the researcher, and that is unavailable anywhere else. There are different methods of collecting such types of data. The main ones though are:
- Observation and
Primary data is often very valuable since it is unavailable anywhere else. However, collecting it is very time consuming and costly. In addition to that, one must always ensure that a proper margin of error is selected and that a good sample size is chosen. Otherwise, all the benefits of primary data will be lost. As can be seen, though valuable, it is often very time consuming and costly.
Secondary data, as the name suggests, is data that is not unique. It is data that already exists somewhere else. Secondary data is data that has already been collected and collated by somebody for some reason other than the current study. It can be used to get a new perspective on the current study, to supplement or compare the work or to use parts of it, as another study may prove costly and time consuming e.g. the census.
Secondary data can further be divided into two parts, namely qualitative and quantitative. Qualitative data includes biographies, personal letters, diaries, records, documents, published material, computer database, policy statements, etc. Quantitative data would have market research, census, and Economic documents, planning documents or specimens. The list is endless and once the type of secondary data is identified, it becomes easy to locate the source.
The following is a list of where data has been collected and scrutinised for the purpose of the thesis:
Textbooks have always been a major source of information. In fact, due to the increased importance of corporate governance, corporate responsibility and responsibility accounting, many textbooks have attempted to explain the concept of those topics and their relevance of in today's financial world. In today's accounting profession, it is now recommended that all accountants be familiar with corporate governance and especially ethics. This is mainly due to those scandals such as Enron which shook the whole financial world. It has been one of the most talked topics in the recent decade regarding the top CFO's and CEO's integrity!
I found the texts regarding corporate governance and corporate responsibility to be well documented, which has been quite useful in analysing the topics in question. I made use of several textbooks, including many accounting ones. The main one I have used for my research is the BPP textbook for the Association of Certified Chartered Accountants - P1, Professional Accountant.
The textbook has provided me with a great insight about ethics and corporate governance and has helped a lot in preparing for this analysis.
In addition, I also found the Heriot-Watt University MBA textbook regarding corporate governance to be extremely useful. This has helped me to understand from scratch why corporate governance is so important!
The MBA textbook goes into much more details on the subject which really broadened my knowledge and provided me an insight from the barriers to improvement on governance systems to the various policy responses.
The benefits of using textbooks are that they contained a great deal of literature on the issue of corporate governance, which not only helped me in achieving some of my aims for my project but also opened my eyes on the effects it has on each and every one of us.
Unfortunately, textbooks have some drawbacks as well. Firstly, one needs to get the right texts for a particular research topic, which can take a lot of time. Next, there is a lot of reading to do, and if time is a constraint, this can pose a serious problem. In addition, although one may get the right books, one also has to make sure that they are the latest editions, since they tend to contain updated data and information.
2.1.2 Professional magazines
Professional magazines are another great source of information. As a regular subscriber to the economist, needless to say that they have been of tremendous help to my thesis. From an economic point of view, I understood how corporate governance impacts on everyone's life, no matter where you are or whichever country you are working in.
The Enron scandal for example did not only affect its employees and the United States citizens but everyone else in the world. Now one may asks oneself how do i get affected if i live in Nepal for example. The answer to that - I understood it by reading the economist! When Enron collapsed, first of all, the employees and shareholders and whoever were directly connected were the first to suffer. But Enron was a major global player in the financial markets, which sent shockwaves across the whole world, meaning we were all impacted by their actions! It is therefore no wonder that legislations such as the Sarbanes-Oxley were quickly brought into force in the United States.
A lot of other countries also brought in their own codes of best practice on corporate governance and responsibility accounting. All this knowledge, I gained from those professional magazines, which are a great way of keeping up to date.
Other magazines that have been useful in my research include the various accountancy magazines, such as "Student Accountant" which i receive regularly, since I am also an accountancy student from the association of chartered certified accountants.
I visited various libraries in order to be able to collect as much information as possible for my research. There is a local library where I live and this helped a lot. I needed to find journal articles and specific books for corporate governance and corporate responsibility.
However, the problem I encountered at the library is that there were far too many books for me to choose from and that was very time consuming. I had no other option but to seek help from the librarians, who were most eager to help.
I spent a really long-time reading and summarising all the information that I believe would be useful to me. A big drawback was that there were a lot of outdated information which was very frustrating.
However libraries are a great source to get information from and they have been most useful to me.
2.1.4 The internet
The internet nowadays is one of the most indispensable tools for information gathering. It is an integral part on everyone's life and without it, mankind would be kind of lost! The big advantage of using the internet is the speed at which a large amount of data can be accessed. For that reason, it had been one of my principal sources of information.
The information is mostly free and it is easily accessible. Though some websites require a payment to get the information provided, most were free of charge.
Most of the information regarding this thesis has been accessed from the internet. As with every good thing, the internet has its drawbacks as well. First, one needs to make sure that by accessing information for our own use, we should make sure that we are not infringing anyone's copyright. We also have to be very careful due to the spread of viruses which can damage one's computer and stealing our private information.
In any case, the internet remains one of the most powerful tool to gather information.
2.1.5 Tesco plc annual report (2008)
The company's annual reports were easily accessible from the website and provided me with a wealth of information in regards to corporate governance and corporate responsibility. I managed to even get a 5 year summary of the company's financial statements which has helped me to draw out a lot of conclusions regarding performance.
However, as one would expect, the report portrayed Tesco as a good citizen which does everything ethically. I could not therefore rely a hundred percent on everything the report said about.
3.0 Ethical Issues
As in any thesis, ethics play a very important role. Therefore, one needs to make sure to being completely ethical whenever gathering information and using them for one's purpose.
3.1.1 Information gathering
Bias and Balance: Recognizing biased information, looking for balanced views, exploring opposing views, recognizing commercial interests in published information.
Fact or Opinion: Recognizing factual information, looking for evidence of factual truth, recognizing and valuing opinion.
Knowledge Gaps: Identifying missing information, locating missing information, stating research methodologies so that others can search further.
3.1.2 Information Evaluation
Accuracy: Is the information accurate when checked against other sources? How reliable and error-free is the information?
Authority: Does the information source qualify as an expert? Is the source rightly expected to know the facts and specifics? Are the qualifications of the author/speaker clearly stated? Is the author/speaker affiliated with an institution or organization? Is there contact information available for the author of a written document?
Content: What is the purpose of the information, i.e. to inform, convince, or sell? What does it contribute to your understanding of the issues? Who is the intended audience based on content, tone, and style? What is the overall value of the content compared to other resources on the topic?
Coverage: Does the information cover the subject adequately? Are there inexplicable omissions?
Currency: Is the publication date clearly stated? When was the information last revised? Is it maintained and updated regularly? Are the links on a web page up-to-date and useable?
Documentation: Are you certain the information is based on more than hearsay? Does the author explain where the information was obtained? Does the web page or article contain a bibliography or list of sources used?
3.1.3 Information Use
Fair Use of Information: Copyright law allows limited copying for educational and archival purposes, but does limit even that to no more than 10% of a work, among other restrictions.
Proper Citation: Complete citations of sources used is the most important issue, attributing information to its true author, and including enough information for another to locate the source.
The ethical issues above (3.1.1 - 3.1.3) were compiled by H. Heller-Ross, Plattsburgh State University. They have been included in this thesis to help readers take a grasp on the various ethical issues which may impact upon one's research.
4.0 Results and Analysis - Corporate Governance
4.1 Corporate Governance
Corporate governance is the system by which organisations are directed and controlled. (Cadbury A. 1992)
Corporate governance is a set of relationships between a company's directors, its shareholders and other stakeholders. It also provides the structure through which the objectives of the company are set, and the means of achieving those objectives and monitoring performance are determined. (Johnston D. J OECD Secretary - General)
Corporate governance, the system by which organisations are directed and controlled, is based on a number of concepts including transparency, independence, accountability and integrity. (BPP, P1 2007)
Corporate governance is the system by which companies are directed and controlled. It deals largely with the relationship between the constituent parts of a company - the directors, the board (and its sub-committees) and the shareholders.
Transparency and accountability are the most important elements of good corporate governance. This includes:
- the timely provision by companies of good quality information;
- a clear and credible company decision-making process;
- Shareholders giving proper consideration to the information provided and making considered judgements.
The corporate governance framework in the UK operates at a number of levels:
- through legislation particularly the Companies Act;
- Through regulation and in particular for listed companies through the listing rules, which are the responsibilities of theFinancial Services Authority.
- Through the Combined Code which is the responsibility of the Financial Reporting Council. It contains general principles and more detailed provisions relating to the corporate governance of listed companies. It is appended to the FSA's Listing Rules, which require these companies, in their annual report and accounts to, (i) report on how they apply the principles, and (ii) confirm that they comply with the Code's provisions or, where they do not, provide an explanation: hence the 'comply or explain' principle which, if applied effectively, underpins informed dialogue between directors and shareholders. contains general principles. (http://www.berr.gov.uk/whatwedo/businesslaw/corp-governance/page15267.html)
What the above definitions are about is that organisations should be managed in the best interest of everyone connected. In other words, directors should not forget that they are the agents of the companies they manage and they have a responsibility towards the various stakeholders. Therefore, they should act with integrity and honesty and should not just be concerned with filling their own pockets.
The principal - agent problem consists of trust and risk. (Lee, A.T. 2006). This trust may be breached by the agents by pursuing their own interest or through negligence and fraud. History is witness to this abuse, which has resulted in shareholders losing their investments and employees losing their jobs with no fault of theirs. As a consequence, stakeholders now want reassurance that such scandals are not repeated, resulting in corporate governance frameworks around the world.
The success of a company based on the principal-agent relationship is dependent on the effectiveness of its corporate governance - particularly the competence and independence of its board of directors and various subcommittees. (Lee, A.T. 2006)
4.2 Various Corporate Governance Reports
The various scandals around the financial world prompted governments to review corporate governance, especially about those companies that are listed in the stock markets. This lead to a wide range of corporate governance reports being written by scholars around the world. The main ones in the UK are listed below, with a brief explanation about it.
4.2.1 The Cadbury report
The Cadbury Report, titled Financial Aspects of Corporate Governance, is a report of a committee chaired by Adrian Cadbury that sets out recommendations on the arrangement of company boards and accounting systems to mitigate corporate governance risks and failures. The report was published in 1992. The report's recommendations have been adopted in varying degree by the European Union, the United States, the World Bank, and others.
4.2.2 The Greenbury Report
The Greenbury report was issued in 1995 by a committee under the chairmanship of Sir Richard Greenbury that developed a number of recommendations of the Cadbury Report on directors' remuneration. It stressed the importance of a remuneration committee of non executive directors , the provision of information on remuneration policy in the annual report and accounts, and the restriction of notice and contract periods to less than one year.
4.2.3 The Hambel Report
This was a committee set up under the chairmanship of Sir Ronald Hampel to review the implementation of the Cadbury Code and the recommendations of the Greenbury report. A report was issued in 1998 emphasizing that the primary duty of directors is to shareholders and that the recommendations of the two earlier reports should be treated as guidelines rather than prescriptive rules.
4.2.4 The Turnbull Report
The latest link in the UK corporate governance chain is the September 1999 publication - Internal Control: Guidance for Directors on the Combined Code - otherwise called, after its chairman (Nigel Turnbull, Executive Director of Reed Plc), the 'Turnbull Report' (Turnbull).
Turnbull's guidance is based upon the adoption by a company's board of a risk-based approach to establishing a sound system of internal control, and on Accountability, transparency, corporate social responsibility: a new mantra for a new millennium. reviewing its effectiveness. This should be incorporated by a company within its normal management and governance processes. The span of internal control contemplated by Turnbull stretches wider than financial controls, to encompass social and environmental issues - matters that have recently come to be grouped together under the generic heading of 'reputational risk'.
4.2.5 The Higgs Report
The Higgs Report, named after its author Derek Higgs focused on the role and effectiveness of the non-executive director so as to consolidate the UK's combined code on corporate governance. The report was published in January 2003 and it was expected that the revised combined code will come into effect in July 2003.
4.2.6 The Smith Report
Following the major financial scandals around the world, the Financial Reporting Council invited Sir Robert Smith to chair a report on the role and responsibilities of the audit committees. The aim was to develop the existing Combined Code guidance and to clarify the duties of the non executive directors meant to form the audit committee.
4.2.7 UK Combined Code
The Combined Code on Corporate Governance sets out standards of good practice in relation to issues such as board composition and development, remuneration, accountability and audit and relations with shareholders.
All companies incorporated in the UK and listed on the Main Market of the London Stock Exchange are required under the Listing Rules to report on how they have applied the Combined Code in their annual report and accounts. Overseas companies listed on the Main Market are required to disclose the significant ways in which their corporate governance practices differ from those set out in the Code.
The Combined Code contains broad principles and more specific provisions. Listed companies are required to report on how they have applied the main principles of the Code, and either to confirm that they have complied with the Code's provisions or - where they have not - to provide an explanation. (http://www.frc.org.uk/corporate/combinedcode.cfm)
The combined code on corporate governance will be the benchmark against which an analysis of corporate governance at Tesco will be made. Any areas of the code which have not been followed or where the company has tried to manipulate it will be looked at in detail and conclusions drawn out.
5.0 Analysis of Tesco's Governance system
5.1.1 The board
As at 28 February 2009, the Board of Tesco PLC comprised eight Executive Directors, seven independent Non-executive Directors and David Reid, Non-executive Chairman. The Company's Articles of Association require all new Directors to be submitted for election by shareholders in their first year following appointment. The Board has appointed one Non-executive Director, Rodney Chase, to act as Senior Independent Director. The Senior Independent Director is available to shareholders to assist in resolving concerns, should the alternative channels be inappropriate. The Senior Independent Director is also required to lead the discussion in relation to assessing the effectiveness of the Chairman's performance. The Non-executive Directors bring a wide range of skills and experience, as well as independent judgement on strategy, risk and performance to the Company.
The board is the link between the shareholders of the firm and the managers entrusted with undertaking the day to day operations of the organisation. (Stiles P, Bernard T,2001)
Tesco's board is well balanced in terms of the ratio of executive and non-executive directors. The Combined code states that at least half of a company's board should be made up of non executive directors, in order to ensure that the executive directors are working in the best interest of the shareholders. From the information obtained from Tesco's reports, this code seems to have been satisfied, and therefore, the conclusion on the board's composition is fully satisfied and I would infer that the company has satisfied this code fully.
5.1.2 The chairman and chief-executive.
No single person should be the chairman as well as the chief executive officer of a company. This is one of the most important codes brought about by the Cadbury recommendations. A major cause of the many failures in the financial world is due to the fact that there was no dissolution of power between the chairman and chief executive. Very often, the same person was responsible for both, resulting in too much power held by that individual.
Based on Tesco's report, clear divisions of accountability and responsibility exist and operate effectively for the positions of Chairmanand Chief Executive. The Chairman has primary responsibility for running the Board, while the Chief Executive has executive responsibilities for the operations and results of the Group and making proposals to the Board for the strategic development of the Group.
The relationship between the chairman and chief executive is of crucial importance since it lies at the heart of a network of other associations. Its quality has knock-on consequences, affecting relationships with other board members and the executive team. (Stiles P, Bernard T,2001)
This code of good governance can thus be said to have been fulfilled by Tesco plc.
5.1.3 Board balance and Independence
As stated before, Tesco's board is well balanced with half being non-executives. There is a total of sixteen members, who brings about a wealth of information and expertise in different areas and hence, represent a truly efficient board.
The Combined Code on Corporate Governance sets out guidance in the form of principles and provisions on how companies should be directed and controlled to follow good governance practice. The Financial Services Authority (FSA) requires companies listed in the UK to disclose, in relation to Section 1 of the Combined Code, how they have applied the principles and whether they have complied with its provisions throughout the financial year. Where the provisions have not been complied with companies must provide an explanation for this.
In respect of this code, Tesco was not in full compliance due to two of its non executive directors having resigned because of conflict of interests. Therefore, there was a larger number of executives than non-executives for part of the year for the company. Tesco needs to make sure that it can rectify this situation as soon as possible to ensure a balanced board and complying with the UK Combined Code.
5.1.4 Appointments to the board
The company has a nominations committee which oversees appointments to the board. This committee also leads the process for re-election and succession of directors. The committee is chaired by Mr Reid, chairman of the board and a separate section of the annual report describes the work of the committee, hence satisfying the code provision.
An analysis of the report shows that where conflicts of interests exist for board members, the nominations committee has ensured that these conflicts to be eradicated as soon as possible to uphold shareholder confidence in the board.
5.1.5 Information and Professional Development
Tesco's directors receive a personalised induction programme to develop their knowledge of the group's culture and operations. There is also regular assessment by the board for the need of director training. Unfortunately, I was unable to evaluate whether the board is supplied in a timely manner with information and of a quality appropriate to enable it to discharge its duties though it is stated that they have access to the company secretary.
5.1.6 Attendance at meetings
The Board scheduled nine meetings in the year ended 28 February 2009 including a two-day off-site meeting which considered the Group's strategy. Ad hoc meetings were also convened to deal with matters between scheduled meetings as appropriate. It is expected that all Directors attend scheduled Board and Committee meetings unless they are prevented from doing so by prior commitments and that all Directors will attend the AGM. Where Directors are unable to attend meetings due to conflicts in their schedules, they receive the papers scheduled for discussion in the relevant meetings, giving them the opportunity to relay any comments to the Chairman in advance of the meeting. Directors leave the meeting where matters relating to them or which may constitute a conflict of interest are being discussed.
The board has satisfied this requirement by having enough meetings to discuss the company's strategy and objectives. This is important in order to ensure that they are working for the best interests of the shareholders. Where matters related to the directors are to be discussed, they have not been allowed to participate so as not to create a conflict of interest or having undue influence.
5.2 THE BOARD PROCESS
5.2.1 Nominations Committee
The Nominations Committee leads the process for Board appointments and the re-election and succession of Directors, as well as making recommendations for the membership of statutory committees. The Committee is chaired by David Reid and the Company Secretary also attends meetings in his capacity as Secretary of the Committee. Where matters discussed relate to the Chairman, the Senior Independent Non-executive Director chairs the meeting. The Nominations Committee met four times in the year to discuss the ongoing shape and capability of the Board. As well as reviewing the performance and development of the Executive Directors and the senior executive levels below the Board, the Committee also regularly reviews board structure, size, composition, working arrangements and capability, and considers succession plans for Executive and Non-executive Directors.
As recommended by the combined code, Tesco plc has an effective nominations committee, whose main role is to nominate suitable candidates to the board. This is crucial to ensure that membership to the board is not biased. As is good practice, the board at Tesco is chaired by an independent non executive director.
5.2.2 Remuneration Committee
The Remuneration Committee's role is to determine and recommend to the Board the remuneration of the Executive Directors. It also monitors the levels and structure of remuneration for senior management and seeks to ensure that the remuneration arrangements are designed to attract, retain and motivate the Executive Directors needed to run the Company successfully.
At the invitation of the Committee the Chairman of the Board normally attends meetings and the Chief Executive attends as appropriate.
This is one of the most important committee to ensure that the principal - agent problem is solved or the very least, to ensure that executive directors do not set their pay packages themselves.
5.2.3 The level and make up of remuneration
The remuneration at Tesco considers external independent remuneration surveys and base salaries against a benchmark determined by reference to other large retailers. However, while Sir Terry Leahy's total package for 2007/2008 was £5.472 millions, that of his counterpart in Sainsbury's, Justin King was only £2.176 million. So, it begs the question whether he really deserves this amount. However, a significant proportion of the remuneration is based on performance - related emoluments, which could be justified? None of the non executives received any benefits in form of shares.
5.3 ACCOUNTABILITY AND AUDIT
5.3.1 Financial Reporting
The directors of Tesco have confirmed in their annual report that the financial statements have been prepared in accordance to the Companies Acts 1985 and 2006. They selected suitable accounting policies and applied them consistently and made reasonable and prudent judgements and estimates. They also stated that the financial statements have been prepared on the going concern basis.
The company's external auditors, PricewaterhouseCoopers LLP, have also confirmed that the accounts present a true and fair view and been prepared in accordance with IFRSs and IAS Regulation. Thus paragraph C1 of the combined code has been satisfied.
5.3.2 Internal Control
Tesco has a group wide process to establish any risks that may cause material loss. The board has acknowledged that it its responsibility to ensure that internal controls are working efficiently and has conducted a review as such. It is satisfied with its internal controls.
5.3.3 Audit Committee and Auditors
The Audit Committee's primary responsibilities are to review the financial statements, to review the Group's internal control and risk assurance processes, to consider the appointment of the external auditors, their reports to the Committee and their independence, which includes an assessment of their appropriateness to conduct any non-audit work, as well as to review the programme of Internal Audit.
At the invitation of the Committee, the Chairman of the Board, the Finance Director and his representatives, the Head of Internal Audit, the Corporate and Legal Affairs Director, other relevant Executive Directors and representatives of the external auditors regularly attend meetings. The Company Secretary also attends in his capacity as Secretary of the Committee.
The Committee met five times this year and took advantage of an overseas Board meeting to meet with local management and review risks and controls. The Committee also had regular private meetings with the external auditors and Head of Internal Audit. During the year the Committee received presentations on whistle-blowing, IT security, fraud, bribery and corruption, business continuity and updates from business units. Each year the Committee conducts a review of its own effectiveness and its Terms of Reference.
Whether the participation of the executive directors has any significant impact on the ability of the audit committee to act in an independent manner is difficult to determine, but it will affect the dynamics of the audit committee meetings and does create a potential constraint on action... a requirement that audit committee members all be independent non-executives does not in itself guarantee audit committee actions will be independent of executive influence. (Zahman.M, Turley.S, 2003)
5.3.4 The Executive Committee
The Board delegates responsibility for formulating and implementing the Group's strategic plan and for management of the Group to the Executive Committee, which comprises the eight Executive Directors and is chaired by the Chief Executive. The Committee, which is not a statutory committee, has authority for decision-making in all areas except those set out in the Schedule of Matters Reserved for Board Decision and meets formally every week. A number of senior executives also attend the Committee and their valuable operational experience helps broaden the debate. Their attendance facilitates the communication of the Committee's decisions to the rest of the Group. The Company Secretary attends in his capacity as Secretary of the Committee.
The Executive Committee is responsible for implementing Group strategy and policy and for monitoring the performance and compliance of the business, drawing on the work of relevant committees, and reporting on these matters in full to the Board.
The Executive Committee has set up further non-statutory committees - including the Finance, Compliance and Corporate Responsibility Committees - and operational groups which have responsibility for implementing the key elements of the Group's strategic plan and managing its UK and international operations, joint ventures, property acquisitions, finance, funding and people matters.
These committees and groups have as members an appropriate mixture of Executive Directors and senior management from relevant functions.
The crucial point here is the effectiveness of the board in reviewing the work of the executive committee. Non executive directors need to be completely independent to ensure that they are seen to be taking the right actions and decisions in the interests of the external stakeholders. Based on the report from the company, it seems that procedures are being followed to meet this particular important criteria.
5.3.5 Tesco's procedures to deal with directors' conflicts of interests
The Company has procedures in place to deal with the situation where a Director has a conflict of interest. The procedures have been revised in accordance with the new provisions set out in Companies Act 2006.
As part of these procedures members of the Board are required to:
- consider each conflict situation separately on its particular facts;
- consider the conflict situation in conjunction with the rest of their duties under Companies Act 2006;
- keep records and board minutes as to authorisation granted by Directors and the scope of any approvals given; and
- regularly review conflict authorisation.
Based on the above, I would conclude that the company is complying in all respects in regards to procedures regarding conflicts of interests.
5.4 INTERNAL CONTROL AND RISK MANAGEMENT
The Board has overall responsibility for risk management and internal control within the context of achieving the Group's objectives. Executive management is responsible for implementing and maintaining the necessary control systems. The role of Internal Audit is to monitor the overall internal control systems and report on their effectiveness to Executive management, as well as to the Audit Committee, in order to facilitate its review of the systems.
Tesco has all the procedures in place to pursuing their growth strategy as well as managing their risk properly - a good governance system.
5.4.2 Risk Management
The Group maintains a Key Risk Register. The Register contains the key risks faced by the Group including their impact and likelihood as well as the controls and procedures implemented to mitigate these risks. The content of the Register is determined through regular discussions with senior management and review by the Executive Committee and the full Board. A balanced approach allows the degree of controllability to be taken into account when we consider the effectiveness of mitigation recognising that some necessary activities carry inherent risk which may be outside the Group's control. The risk management process recognises there are opportunities to improve the business to be built into future plans.
The risk management process is cascaded through the Group with every international CEO and local Boards maintaining their own risk registers and assessing their control systems. The same process also applies functionally in those parts of the Group requiring greater overview.
Tesco plc can therefore be said to have an appropriate internal control risk management process.
5.4.3 Internal Control
The Board is responsible for the Company's system of internal control and for reviewing the effectiveness of such a system. We have a Group-wide process for clearly establishing the risks and responsibilities assigned to each level of management and the controls which are required to be operated and monitored. The CEOs of subsidiary businesses are required to certify by way of annual statements of assurance that the Board's governance policies have been adopted both in practice and in spirit. For certain joint ventures, the Board places reliance upon the internal control systems operating within our partners' infrastructure and the obligations upon partners' Boards relating to the effectiveness of their own systems. Such a system is designed to manage rather than eliminate the risk of failure to achieve business objectives and can only provide reasonable and not absolute assurance against material misstatement or loss.
The Board has conducted a review of the effectiveness of internal controls and is satisfied that the controls in place remain appropriate.
The Board oversees the monitoring system and has set specific responsibilities for itself and the various committees as set out below. Both Internal Audit and our external auditors play key roles in the monitoring process, as do several non-statutory committees including the Finance Committee, Compliance Committee and Corporate Responsibility Committee.
5.4.5 Audit Committee
The Audit Committee reports to the Board each year on its review of the effectiveness of the internal control systems for the financial year and the period to the date of approval of the financial statements. Throughout the year the Committee receives regular reports from the external auditors covering topics such as quality of earnings and technical accounting developments. The Committee also receives updates from Internal Audit and has dialogue with senior managers on their control responsibilities. It should be understood that such systems are designed to provide reasonable, but not absolute, assurance against material misstatement or loss.
5.4.6 Internal Audit
The Internal Audit department is fully independent of business operations and has a Group-wide mandate. It undertakes a programme to address internal control and risk management processes with particular reference to the Turnbull Guidance. It operates a risk based methodology, ensuring that the Group's key risks receive appropriate regular examination. Its responsibilities include maintaining the Key Risk Register, reviewing and reporting on the effectiveness of risk management systems and internal control with the Executive Committee, the Audit Committee and ultimately to the Board. Internal Audit facilitates oversight of risk and control systems across the Group through audit and compliance committees in each of our international businesses and our joint ventures. The Head of Internal Audit also attends all Audit Committee meetings.
5.4.7 External Audit
The engagement and independence of external auditors is considered annually by the Audit Committee before it recommends its selection to the Board. The Committee has satisfied itself that PricewaterhouseCoopers LLP is independent and there are adequate controls in place to safeguard its objectivity. One such measure is the non-audit services policy that sets out criteria for employing external auditors and identifies areas where it is inappropriate for PricewaterhouseCoopers LLP to work. Non-audit services work carried out by PricewaterhouseCoopers LLP is predominantly the review of subsidiary undertakings' statutory accounts, transaction work and corporate tax services, where PwC's services are considered to be the most appropriate. PricewaterhouseCoopers LLP also follows its own ethical guidelines and continually reviews its audit team to ensure its independence is not compromised.
5.4.8 Other Committees
In addition to the above committees, Tesco also has other non statutory committees, namely, a Finance Committee, a Compliance Committee and a Corporate Responsibility committee among others. Considering the fact that the company does not need to have such committees in place, it can be argued that Tesco is trying to look good in the eyes of the stakeholders.
5.5 RELATIONS WITH STAKEHOLDERS
Tesco is committed to having a constructive dialogue with stakeholders to ensure it understands what is important to them and allow itself the opportunity to present its position. Engagement helps it to identify new risks and opportunities to ensure that its long-term strategy is sustainable.
5.5.2 Shareholder Engagement
During the year, the Chairman, Chief Executive and Finance Director met with most of our leading shareholders to discuss issues relating to the board, strategy and governance matters, as well as new developments within the business. The Chairman's meetings with major shareholders took place independently from the Executive team. In addition to this the Company Secretary's office, Investor Relations and other teams within the business engage with shareholders on a regular basis, and on a wide range of issues.
5.5.3 Constructive use of the AGM
The whole of Tesco's board attends the annual general meeting and is available to answer questions from shareholders present. In order to encourage shareholder participation, Tesco offers the incentive of electronic voting, which allows the company to count all the votes. In addition, all the shareholders can choose to receive a full annual report and financial statements or the annual review and summary financial statement either in paper or electronic form. The reports are also available to download from the company's website.
6.0 CONCLUSION ON CORPORATE GOVERNANCE
The London Stock Exchange has made it a requirement that all companies on its listing to declare whether they have fully complied with the combined code or not. Where compliance has not been observed, the company has to explain why it departed from the code provisions.
The board of Tesco, in its annual report, considers that Tesco PLC complied in all respects with the Combined Code Principles of Corporate Governance and Code of Best Practice for the year ended 23 February 2008.
Corporate governance measures in the form of boards of directors, financial reporting and auditing. (Lee, T.A 2006)
From my analysis above, I would say that Tesco PLC operates an excellent corporate governance framework. However, there are few issues that I believe need to be addressed.
Firstly, there is the case of the 2 non-executive directors, who will be offering themselves for re-election at the next AGM, although they have already served for nine years. I believe that it would be best to get new people on the board in order to ensure that the issue of independence will not be threatened.
The second issue that I am not very comfortable with is the level of remuneration for the chief executive, which is double the figure of his counterpart at Sainsbury's. However, considering the fact that Tesco is much bigger than Sainsbury's, there could be a justification for this remuneration.
Lastly, I think that the audit committee should as far as possible, conduct their meetings without any of the executives present. This would ensure independence of their decisions and provides shareholders with more reassurance that their investments are well looked after.
Except for the above three issues, and on the assumption that the organisation's annual report contains factual and reliable information, I would say that the corporate governance framework is good.
7.0 CORPORATE RESPONSIBILITY AT TESCO
Corporate Responsibility is the way in which a company fulfils the obligations it has to its stakeholders including our employees, customers, regulators, suppliers, investors and Government bodies.
It involves a more comprehensive and public reporting of our performance beyond financial reporting, to include environmental, social, governance and ethical dimensions of our activities and the way we manage our relationships with our stakeholders and communicate our values and principles affects the long-term success of our business.
Another aspect of Corporate Social Responsibility is a company's application of ethical values to its business decision making. This generally refers to business ethics, where adherence to ethical principles reflects the values of the company's good behaviour towards its stakeholders including the environment.
The stakeholders outside the circle are not only interested into the company's performance but also about the way the company runs its business, taking into consideration its corporate responsibility in society.
7.2 Tesco's CR strategy
The company manages all aspects of the business using the Steering Wheel - a balanced scorecard of the key elements of our business: Customers, Operations, People, Finance and Community. The Steering Wheel is used to emphasise that corporate responsibility (CR) is not a specialist function in Tesco - it is part of everybody's job every day.
The Community segment of the Steering Wheel reflects new Community Promises, which were launched this year in the UK and will be launched internationally in 2009:
- Actively supporting local communities
- Buying and selling our products responsibly
- Caring for the environment
- Giving customers healthy choices
- Creating good jobs and careers
Tesco was one of the first major retailers to carbon label 100 of their own brand products in Ireland and the UK, including detergent and potatoes. This year they plan to introduce them to other countries.
Their new store format in Cheetam hill In the UK is environmentally friendly and has a 70% smaller carbon footprint than an equivalent store built in 2006. From now on, they intend to open new stores based on this format.
The company has introduced biofuel into their petrol stations and have asked the sustainable consumption institute at Manchester University to look at this issue in more detail. However, they have not yet been able to report on Group water use, which is disappointing.
The company is also working hard to reduce packaging used in their products, which will lead to a decrease of plastics sent to refills.
Overall, the company has scored pretty well in environmental reporting.
The company has over 250 store Community Champions in China, the Czech Republic, Malaysia, Slovakia, South Korea and the UK. Tesco launched its Community promises to show to its staff the many ways in which they can make a difference. It raised a record £6.2 million for UK charity of the year, Marie Curie Cancer Care.
The company has also done more to increase the local impact of community activities, building on the success of initiatives such as the 951 South Korean Culture Centres.
7.5 Suppliers and Ethical trading
The company signed up 726 skilled and vetted auditors from 11 audit bodies around the world to carry out independent audits of its supply chain. Based on data collected, over 90% of suppliers around the world believe Tesco treat them with respect.
The company risk assessed 100% of supplier sites and increased the number of high-risk sites to 87%. They are also engaged in an active dialogue with animal welfare organisations to continue to improve industry welfare standards.
7.6 Customer Choice and Health
The company helped over 4.6 million people around the world to get active by removing over 2500 tonnes of saturated fat and 3,000 tonnes of salt from their products in the UK since 2005.
Tesco has continued working with governments, health organisations and industry bodies to develop common standards and targets for nutritional labelling.
7.7 People at Tesco
86% of new managers were appointed from within Tesco. In the UK the local employment partnerships provide jobs for the long term unemployed and other disadvantaged job seekers wherever the company open new stores.
8.0 CONCLUSION ON CORPORATE RESPONSIBILITY
Tesco has fared pretty well in being a good corporate citizen. This conclusion is further consolidated from the report "forum for the future - action for a sustainable world." The following extract is taken from the above mentioned report - by Peter Madden, the chief executive.
Tesco has had a number of notable achievements over the past 12 months. We are very encouraged to see Tesco reduce the amount of in-store waste going to landfill by one-third in the space of a year. We welcome Tesco's redefining of what constitutes 'local' and its growing support for local products. The commitment to roll out the blueprint from its Cheetham Hill eco-store across all its other new stores is commendable and we urge Tesco to also retrofit all its existing stores. We are also pleased to see Tesco step up its efforts to educate consumers on the carbon footprints of what they buy. And we support the idea of 'Regeneration Partnerships', offering training and employment for the long-term unemployed.
There is still, however, a lot further to go. We would urge Tesco to use its influence to take a bolder position on issues such as healthy eating. Tesco should be leading the industry on radically reducing salt and sugar in foods. We would encourage Tesco to further improve the nutritional content and sustainability profile of its Value range so that it offers healthy, affordable food to the mainstream. We would also like to see consensus between the major supermarkets on universal nutritional labelling.
On climate change, customers driving to its stores generate a major proportion of Tesco's indirect carbon footprint. We would therefore urge Tesco to provide its customers with low-carbon access to its products and services, and to incorporate this into its eco-store blueprint. We would encourage Tesco to accelerate its carbon labelling roll-out, because the process of understanding the carbon footprint of a product can be a very valuable step in helping to drive emissions out of the supply chain. Tesco should also start to apply relevant lessons it has learned on tackling climate change to tackling embedded water.
If Tesco is to truly 'lead by example' on climate change, it must reduce its own absolute carbon emissions year-on-year. The next big challenge for Tesco is to address how it can grow whilst respecting environmental limits. Humankind is already placing intolerable stress on the planet's resources and its ability to deal with our emissions. As Tesco continues to expand its business, it must simultaneously reduce its environmental impact. It has already shown that it can deliver radical environmental improvements in specific areas. Next it needs to look at the whole picture. To do this, it will have to ask some big questions about what a truly sustainable supermarket looks like, develop some new business models and set - and then achieve - some ambitious global sustainability targets."
9.0 CORPORATE GOVERNANCE, CORPORATE RESPONSIBILITY AND FINANCIAL PERFORMANCE
It might be inferred that managers willing to assume the risks associated with a professional board are better able to generate higher returns to shareholders. (Cadbury.A .2002)
The analysis above suggests Tesco operates a good corporate governance framework. As such, investors are provided with a reassurance that their investments are being managed properly. We should therefore expect a good financial performance from the company.
Based on the company's annual report, growth on 2007 showed an 11.1% increase on group sales, including VAT. Group profit before tax increased to 5.7% while diluted earnings per share was up by 14.2%.
Underlying group profit before tax was up by 11.8% while underlying diluted earnings per share increased by an impressive 20.8%. Dividend per share was also up by 13.1%.
Tesco share price increased by an impressive 45% in 2008, (Figure 1) but it gradually declined during the year. Total shareholder return also followed a similar trend, increasingly by nearly 50% over the last 3 years and then falling down during 2008. (Figure 2). This decline can be explained by the current credit crisis. In addition, dividend prices rose consistently over the years.
In comparison with
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