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Prior introduction of proper corporate governance codes, many large corporations, such as Enron, Dot-Com and WorldCom, collapsed due to wrong behaviours of those charged with governance. This indicated that there is severe need of proper system of governance which will prevent collapses of companies in future. As a result of these collapses, United States established rule based approach "Sarbanes Oxley Act" and the best code of practise of United Kingdom, further amended to incorporate weaknesses which were identified by Higgs Report and Tyson Report during 2003.
The Code of Corporate Governance of United Kingdom
Currently UK Corporate Governance Code deals with four sections. Financial Reporting Council provides principles of these sections as follows (Financial Reporting Council, 2010):
An effective board to provide leadership
There should be a clear division of responsibilities, i.e. it should be clearly stated who is responsible for running the company i.e. a chief executive officer and who is responsible for running the board, i.e. a chairman. Members of the board of directors are collectively responsible for the long-term success of the company, who should possess the appropriate balance of skills, experience. UK's code of corporate governance states that there should be formal and transparent procedures for appointing directors and these appointments and re-appointments should be approved by shareholders. The code also requires for regular evaluation of the effectiveness of the board, its committees and individual directors.
Code states that board must present a balanced assessment of the company's position and it must determine the nature and extent of the significant risks it is willing to take. Board of directors is required to establish and oversee sound risk management and internal control systems. There should be formal and transparent procedures for carrying out these responsibilities. The code further states that there should be an audit committee made up of independent directors.
Code of corporate governance states that a remuneration committee should be made up of independent directors and there should be formal and transparent procedures for setting executive remuneration, including a remuneration committee made up of mix of non-executive directors and executive directors, but majority should be of executive directors. A further guideline of code is that a significant proportion of remuneration should be linked to performance conditions to promote the long-term success of the company.
Relations with shareholders
The guideline for shareholder is that they should monitor and engage with the management of companies in which they invest, so that the board has regular contact with shareholders to understand their opinions and concerns. Moreover, there should be separate resolutions on all substantial issues at general meetings.
Malaysian Code of Corporate Governance
Malaysian code of corporate governance sets 8 principles and their corresponding 26 recommendations (Suruhanjaya Sekuriti Securities Commission Malaysia, 2012). The primary objective of principles and recommendations is to enable laying a strong foundation for the board and its committees to, so that they can perform their roles effectively; and to ensure sufficient and appropriate disclosures; to ensure an integral process of financial reporting; to emphasize on the importance of establishing risk management and internal controls systems; and to encourage participation of the shareholders in general meetings. These principles and recommendations are briefly described below:
Establishment of clear roles and responsibilities
Malaysian code of corporate governance states that there should be a clear separation and division of responsibilities between those who are responsible for running the company and those who are responsible for steering the board. Moreover, the board should establish clear roles and responsibilities in discharging its fiduciary and headship functions. Code requires that board should formulate those strategies which ensure long-term success and sustainability, and it should devise ethical standards and it should take steps to ensure its compliance. There should be a company, possessing appropriate qualification, to manage the administrative tasks of the company. Members of board of directors should ensure that they have access to all information and they can take advice from company's secretary or from their lawyers. The board should ensure that it has formalized and reviewed charter and board should disclose its charter to public.
Malaysian code of corporate governance requires that the board should establish a Nominating Committee which should comprise totally of non-executive directors and majority of whom must be independent. Nomination Committee should establish, maintain and review the criteria to be followed in the process of recruitment and assessment of directors. Board should develop formal and transparent policies and procedures to attract and retain directors.
In order to ensure its independence, Malaysian code of corporate governance states that the board should carry-out an annual assessment of independence of its non-executive directors. It states that the time period of service for a non-executive director should not exceed nine years. After completion of nine years of service, a non-executive director can continue its service on the board subject to the director's re-designation as a non-independent director. However, the board must justify and obtain shareholders' approval if it retains a non-executive director who has served for nine years. The code states requires that chairman and chief executive officer should be separate individuals, and chairman should be a non-executive director. However, if the chairman is not independent, then code requires that there should be a majority of independent directors.
In order to ensure commitment from directors, Malaysian code of corporate governance requires that the board should establish expectations on time commitment for its members and protocols for accepting new directorships. Board should make it sure that its members are up-dated in terms of knowledge by ensuring their access to appropriate continuing education programs.
Uphold integrity in financial reporting
The code of corporate governance states that the Audit Committee should ensure financial statements are in accordance and compliance with applicable financial reporting standards. Moreover, the Audit Committee should design policies and procedures to assess the suitability and independence of external auditors.
Recognize and manage risks
Malaysian code states that board should establish an appropriate framework for risk management. Moreover, the board should establish an internal audit function and it should ensure that internal audit function is making reports directly to the Audit Committee
Ensure timely and high quality disclosure
Guideline of Malaysian code of corporate governance regarding disclosure is that the board should motivate the company to invest in information technology to ensure effective and efficient provision of information, but before this the board should design appropriate corporate disclosure policies.
Strengthen relationship between company and shareholders
Malaysian code of corporate governance requires that the board should take reasonable steps to promote effective communication and proactive engagements with shareholders. In order to ensure this, the board should encourage shareholders to participate and cast their votes in general meetings.
Rule based approach is such approach in which companies are not provided an option regarding compliance. Rules and regulations defined in rules based approach are compulsory for companies to follow. Non compliance will result in legal action. While on other hand, principle base approach involves guiding companies regarding what are best practices which they could adopt, on their discretion, to increase effectiveness and public confidence in their company. Compliance with principles based codes is not compulsory. Sarbanes Oxley Act of United States is designed as rule based approach while Corporate Governance Codes of United Kingdom are designed as principle based approach.
Sarbanes Oxley Act clearly states that what is required from those with governance. It provides standardized guidance because every company in United States have to comply with while principle based approach is not standardized. Moreover, it is binding for companies to completely adopt Sarbanes Oxley Act otherwise they will be punished. Therefore, it ensures every company will comply with it on which it is applicable. It also increases confidence of shareholders on company.
On other hand, Corporate Governance Code is flexible approach. It is not like Sarbanes Oxley Act. It provides option of 'comply or explain' to all applicable companies (Sir Christopher Hogg, 2010). This 'comply or explain' option cultivates culture of good governance. Due to this option, management of companies feel flexibility in adopting corporate governance codes and adopt these codes step by step after understanding substance of making these codes rather than just ticking boxes on checklist to comply with regulation. Once its substance is clear, management will not look for loopholes in system like Sarbanes Oxley Act. Moreover, management will also try to act more ethically specifically where no guidance is provided yet.
Part 2 (1)
Intuitional shareholder is a non-bank person or organization that trades securities in large enough share quantities or cash amounts that they qualify for preferential treatment. Institutional investors invest in companies to earn short term gains through dividend. If company does not perform well then institutional investors sell their investment because institutional investors are investing money of others to earn good returns for money providers and themselves. Institutional investors face fewer protective regulations because it is assumed that they are more knowledgeable and better able to protect themselves in bad situations. In case of British American Tobacco, shareholders structure consists of individual shareholders, financial institutions/pension funds, nominee companies and other corporate holders (British American Tobacco, 2011). Financial institutions/pension funds, nominee companies and other corporate holders are institutional investors for British American Tobacco Company.
Proportion of institutional investors in British American Tobacco Company is increasing (British American Tobacco, 2011). Institutional investors i.e. financial institutions/pensions, nominee companies and other corporate holders, consists of 93.20% of total shareholders and holds 1.888 billion ordinary shares and representing 24,412 stockholder entities (British American Tobacco, 2011).
Increased proportion of institutional investors results in reduced voice of individual shareholders. Managers would try to pursue interest of institutional investors i.e. short term benefits/returns rather than pursuing long term success of business. Responsibilities of institutional investors increase with the proportion of increase in their shareholding proportion (Association of British Insurers, 1991).
Agency theory in explains the relationship between two parties, where one is a principal and the other is an agent who represents the principal in transactions with a third party. In case of a company, principal is shareholder and agent is management or directors acting on behalf of shareholders (David Campbell, 2010). Agency relationships occur when the principals i.e. shareholder hire the agent i.e. directors to perform run business on principals' behalf. Principals commonly delegate decision-making authority to the agents. Agency problems can arise because of inefficiencies and incomplete communication between agent and principal (Chrisostomos Florackis, 2008). In case of British American Tobacco, agent is board of directors of British American Tobacco and principal is all shareholders who have invested money in British American Tobacco.
Agency problem arises when principal and agent have different goals. It is usual in every agency relation as principal would like to increase its wealth while agent will try to earn maximum return for himself rather than principal. This problem becomes severe if risk attitude of agent and principal is different. E.g. directors are retaining profits for future investments thus dividend payout ratio is low. If company have more proportion of institutional investors in its shareholders than institutional shareholders will resist investment plans by using their voting rights and may try to force management to increase dividend because institutional investors invested in company to earn regular income through dividend.
Corporate Governance Codes provide guidance that there are number of conditions under which institutional investors can intervene in company affairs. These conditions include strategy, operational performance and acquisitions and disposals of business, remuneration policy, internal controls and succession planning at workplace, social responsibility and failure to comply with relevant codes. Moreover, institutional shareholders must enter in a dialogue with companies for mutual understanding of objectives. In addition, institutional investors should give equal attention to each factor while assessing governance arrangements of companies. Furthermore, institutional investors have responsibility to properly use their voting rights. In case of British American Tobacco, institutional investors have regular dialogue with board of directors. Currently British American Tobacco pays 65% earnings in Dividends (British American Tobacco, 2011). This means that interest of institutional shareholders i.e. regular income through dividend is dealt by management with care. There are no indications regarding how many stockholders of British American Tobacco attended annual general meeting and used their voting rights. In absence of this information, it seems that institutional investors and board of directors of British American Tobacco understand their relevant responsibilities.
Scandals/Problems of British American Tobacco:
Use of Child Labour in Indonesia
Children in Indonesia as young as 11 years of age are working in hot weather for hours with materials that can poison them. If it was in the UK there would be an protest and bosses would have been arrested. The men paying a pittance to hire the youngsters in these pictures are beyond the reach of our laws - in Indonesia. But their child labour is alleged to be boosting profits of a powerful London-based multinational company, British American Tobacco (Natalie Evans, 2012).
Corporate Social Responsibility Disguise
British American Tobacco has also failed to report its expenditure on activities which it describes as corporate social responsibility. Under the euphemism of European Union stakeholder dialogue, British American Tobacco has been able to directly access European Union policy makers and put forward its views on legislation under discussion. By disguising this contact as Corporate Social Responsibility, British American Tobacco has clearly contravened the Commission's definition of lobbying (Corporate Europe Observatory, 2009).
Attempt to reduce Worker's Rights
British American Tobacco has launched two initiatives known as union busting at British American Tobacco Malaysia. These initiatives intended to seriously undermine the negotiating power of the British American Tobacco Employees Union. The key matter in this union busting strategy was job reclassification of employees to management status because under Malaysian labour laws managers are not eligible for having membership of union (Malaysian Trades Union Congress, 2009). Part 2 (2)
There are two types of board structures available for companies to follow. One is two-tier board structure and other is unitary board structure. In unitary board structure, executive and non-executive directors sit in same board and both are responsible for running the company. In case of British American Tobacco, structure of board seems to be unitary board as there is information regarding board meetings and in most cases, all directors attended board meetings (British American Tobacco, 2011).
There could be conflict between executive and non-executive directors regarding their roles. To avoid these conflicts, roles of non-executive directors are defined. These roles are divided into four categories i.e. risk role, strategy role, scrutinising role and people role.
Non-executive directors are responsible for ensuring that company have proper risk management systems to properly address different risks faced by the company. In case of British American Tobacco, chairman and two non-executive directors are in audit committee. Terms of reference of audit committee include that members of audit committee have responsibility for internal controls and risk management systems (British American Tobacco, 2011). This shows that non-executive directors are carefully fulfilling their risk role at British American Tobacco.
Non-executive directors should constructively challenge strategy proposals of executive directors presented at board meetings. Moreover, non-executive directors should also offer expert advice on direction of the company. In case of British American Tobacco, it is stated that non-executive directors help to develop strategy and constructively challenge to management's proposals to ensure that only those strategies are selected which ensure long-term success of the company (British American Tobacco, 2011). It shows that non-executive directors are fulfilling their strategy role at British American Tobacco.
Non-executive directors are required to make executive directors accountable for the decision which they took and results which were achieved due to implementation of the their decisions. In case of British American Tobacco, non-executive directors are responsible for scrutinising the performance of management, agreed goals and objectives and for monitoring the reporting of performance (British American Tobacco, 2011). In addition to this, non-executive directors remain available to meet with major investors in order to understand their views and concerns, so that if they come to know with any issue facing the shareholders, they can held executive directors accountable (British American Tobacco, 2011). Good or bad results or decisions of the British American Tobacco, in eyes of shareholders, will be communicated to non-executive through regular communication with them. This indicates that non-executive directors are effectively performing their scrutinising role at British American Tobacco.
People role of non-executive directors means that they are responsible for appointment and remuneration setting of executive directors, and dealing with contractual and disciplinary issues faced by their company. In case of British American Tobacco, board of directors have established nomination committee and remuneration committee for appointment for board of directors and setting remuneration. Both committees consist of chairman and non-executive directors. In addition to this, non-executive directors remain available to meet with major investors in order to understand their views and concerns (British American Tobacco, 2011). It indicates that non-executive directors are performing their people role effectively at British American Tobacco.
There are some practical problems with the corporate governance code of UK. These problems with their suggested solutions are as follow:
The process of the development of UK corporate governance code is reactionary. It responds to problems when they occur. Therefore, it is suggested that the development of the code should be proactive and should be setting the agenda in advance. The proactive approach may help to overcome problems and corporate failures that may arise in the future.
Another problem with the corporate code of governance of UK is that its impact varies depending on the nature and size of the companies, resulting in different global viewpoints. For example, it is difficult or almost impossible for the small and medium sized entities to adhere to all or many of the provisions of the corporate governance code. This shortcoming can be overcome by developing and establishing different codes of corporate governance. Doing so will result in more focused corporate governance codes depending on the size and nature of the entities.
Code of corporate governance of UK does not focus on corporate social responsibilities and environmental issues. It focuses only on the governance of the company in way that maximises the value of shareholders only by generating profits. It should also include the guidelines regarding corporate social responsibility and environmental issues (Lance Moir, 2001). It will create a good image of the code itself and of the companies in the eyes of public at large. It will also help to ensure the sustainability of the natural resources and will also help to reduce the environmental pollution.
It is claimed that adherence to governance requirements harms the competitiveness and brings substantial costs to companies. This problem may be overcome by educating the companies' management and shareholders that although its adherence brings costs with it but in the long-run it increases the shareholders' value, for example, by reducing the instances of frauds and increased scrutinizing of executives directors by non-executive directors.
Further suggestions for improving corporate governance code are as follows:
According to Paul Seitz, Japan has very limited land space, yet its corporations have achieved success. Their secret of success is that they focused on capturing foreign markets rather than wasting resources in competing with domestic companies (Paul Seitz, 2001). Codes of Corporate Governance should include such instructions for companies to increase organizational success.
Current success of corporate is based on the research conducted during 1990s. If that research was not conducted, then corporation would have never been so successful. Therefore, for success of corporations in coming future, it is required that research should be conducted continuously to ensure success of corporations in future (J.P. (Ian) Percy, 2007).
According to Andrew Ross and Kenny Crossan, current corporate governance code of United Kingdom and Germany is not appropriate for complex issues caused by the financial crisis and that changes need to be implemented. Moreover, there is no doubt that it played good role in financial crisis but if such events are to be prevented, then regulatory environment should need to be strengthened (Andrew Ross and Kenny Crossan, 2012) in order to ensure that corporations follow guidance provided by codes of corporate governance.
Furthermore, corporate governance code can include different principles presented by Organization for Economic Cooperation and Development (OECD) and The International Corporate Governance Network (ICGN) to improve combined codes. Principles of OECD cover different areas regarding shareholders. In addition, OECD principles deal with roles of stakeholders in corporate governance, responsibilities of the board and disclosure and transparency requirements of financial statements (OECD, 2004). Moreover, principles of ICGN are almost similar to principles of OECD and corporate governance (ICGN, 2009).