The Corporate Governance of Listed Companies: A Manual For Investors

2015, Study Session # 11, Reading # 40
THE CORPORATE GOVERNANCE OF LISTED

COMPANIES: A MANUAL FOR INVESTORS
BOD = Board of Directors
41. a
Corporate Governance
Set of internal controls, processes and procedures to manage
firms.
Rights, roles and responsibilities of management, board of
directors and shareholders are defined.
Act as firms check & balance.
Corporate Governance Practices Ensure

41. b
BOD protects shareholders interests.

Shareholders have voice in governance.
Firm act ethically & lawfully in dealing with shareholders.
BOD acts independently from management.
Proper procedures and controls to check management.
Firms activities (operating, financial, governance) are reported to
shareholders in accurate &timely manner.
Practices and Characteristics Related To Board
Characteristics of Board
Board members majority should be independent (not in management).
Board should meet regularly without management.
Chairman must not be current or former CEO.
If chairman is not independent, independent members must have a lead
member.
Board members must not have aligned interest with organizations primary
stakeholders other than shareholders.

Duty of Board Members

Boards primary duty lies with the shareholders long term interests.
If board is effective and independent such duties will be performed.
If board is non-independent shareholders interest could be harmed.
Firm requires assistance of external consultants on several critical issues.
Board needs advice to check management.
Frequency of Board Elections

While evaluating the election policy an investor must see.
The frequency of board elections the the better.
Staggered vs. annually elected boards the latter provides more flexibility.
Any vacant position filled with/without shareholders consent with
consent is better.
Can shareholders remove any board members?
Size of the board appropriate to firms circumstances.
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41. c
Importance of Independent Board Members in Corporate Governance
Independent board decisions are unbiased and not influenced by management.

Board member must not have a material relationship with:
Firm employees & their families.
Shareholders with controlling interest.
Executive management (incl. families).
Entity with cross directorship relationship with the firm.
BOD should also be experienced and competent.
Firm should have policies to restrict BOD receiving consulting fee and compensation
beyond their board responsibilities.
Receiving personal benefits can create conflict of interest.
41. d
Factors Indicating Experience of Board Members
While evaluating board members, consider board members:

Make timely and informed decision about firms future.
Act with care & competence regarding:
Technologies, products & services the firm offers.
Financial & audit operations.
Risk associated with firm (business).
Strategic planning, management & legal issues.
Have public stance regarding ethical perspectives.
Competent and experienced.
Regularly attend meetings.
Committed to shareholders.
If served board for more than 10 years, may be too close or allied with management.
Any regulatory or legal problem while working in the board of other companies.
Provisions of training to board members.
Self assessment procedures for board.
Committees: Responsibility, Composition
41. e
Audit Committee
Ensures that financial information provided to shareholders is accurate, fair, reliable,

relevant, and timely.
External auditor is independent (from management influence).
Proper accounting and auditing procedures have been followed.
Any conflict resolved b/w auditor and firm must be in favor of the shareholders.
Members serving in the audit committee are independent.
Auditors have authority over company affiliates and divisions.
Committee members possess required expertise (financial).
Require shareholders vote over boards selected auditing firms.
Audit committees authority to approve/reject proposed non-audit engagement with
the audit firm.
Provision & procedures to specify internal auditors reporting and they must have no
restriction to report to auditing committee
Examine any discussion b/w audit committee & external auditors regarding altering
financial statements due to questionable interpretations of accounting rules, fraud &
the like.
Audit committee should control the audit budget.
41. e
Remuneration / Compensation Committee
Investors should determine whether the compensation committee is independent.

Committee must be independent and judge the compensation of top executives
commensurate their performance and responsibilities.
Compensation can be linked with long term performance and profitability.
Investors must examine:
Executive compensation to be appropriate.
Allowance of loans or company property to board members.
Board members meet regularly.
Check the policies and procedures of remuneration committee.
Firm has disclosed the details of compensation to shareholders.
Terms and conditions of options granted are reasonable.
Remuneration Plans
To meet share based compensation new shares are issued.
BOD and firm must require shareholders consent on share based compensation plans due to their dilution effect.
Must analyze cross-directorship links of executives.
Nominations Committee
Responsible for recruiting qualified board members.

Review performance, independence, skills, and experience of existing members
regularly.
Preparing top management succession plans.
Creates nomination procedures and policies.
Must ensure the proposed candidates will work for the betterment of shareholders
Investors should:
Review Company reports over several years to judge the recruitment of board
members.
Analyze criteria for selecting new board members.
Compare the expertise and background of existing board members with proposed
ones.
Input of management v/s input from outside firm in finding new members
Attendance records.
Committee report include discussion of decision and actions.
Other Board Committees

Additional committees provide insight into organizaons goals and strategies.

Usually fall outside corporate governance codes.
Usually comprise of executive management.
Independence might be an issue critical to maintain shareholders best interests.
41. f
Code of Ethics & Personal Use of Company Assets
Sets basic principal of morality, trust, integrity, and honesty.

Address conflict of interest and gives behavioral standards.
Breaches can lead to management turnover, fines, sanctions and
negative publicity.
Having code of ethics reflect companys strong corporate governance.
Analyzing Code
BOD receives relevant corporate information in time.

Ethics codes in compliant with prevailing corporate governance laws.
Ethics codes should prohibit advantage to insiders.
Officer responsible for corporate ethics should be designated.
In case of waiver of provision, it must be disclosed with reason.
Company must give disclosure of why they failed to comply with the
provision(s) of local corporate governance codes
Code of ethics must be audited and improved periodically.

Evaluating Management
Investors should:
Verify that firm has adopted ethical standards & framework.
Check if BOD permitted to use firms assets for personal reasons.
If allowed, reason must be evaluated and checked (independence of board
member is impaired or not).
Cross check executive compensation with responsibilities, performance and
industry standards.
Analyze purpose, size, and mode of financing and duration of any sharerepurchase program.
41. g
Voting
Investors should consider whether the firm

Limits the ability of voting.
Arrange its meeting in the same day with other companies in the same region and
requires attendance to cast votes.
Allows proxy voting using some form of remote mechanism.
Is allowed to use share blocking.
Share Blocking a mechanism that prevents investors who wish to vote their
shares from trading their shares during a period prior to the annual meeting.
41. g
Confidential Voting
It encourages unbiased voting.

Investors should consider
The firm uses external source to tabulate votes.
The external source retains voting records.
The tabulation is audited or not.
If present shareholders are entitled to vote only.
Cumulative Voting
A minority group e.g. founding family may use

this right to safeguard its own interests.
Cumulative voting information is filed in the
prospectus or Form 8-A with SEC.
Voting for Other Corporate Change
Changes to the following must be watched carefully

Articles of organization.
By-laws.
Governance structures.
Voting rights and procedures.
Poison pill provisions.
Change-in-control provisions.
If shareholders approval is required, consider shareholders ability:
For corporate change proposals supermajority votes required.
To vote on sale of firm or portion.
To vote on executive compensation issues.
To approve anti-takeover measures.
To vote for change in articles of organization, by-laws, voting rights and governance
structure.
To use their relatively small ownership to force a vote on special interest issue.
Investors should also watch:
Share buyback program which can be used for share- based compensation.
Amendments or other changes to a firms charter and by-laws.
Issuance of new capital stock.
Shareowner-Sponsored Board Nominations
Investors need to determine:

Can shareholders put forth independent board nominee, if so under what
circumstances posive for investors.
Can shareholders remove board members?
How firm handles contested board elections.
In US proxy statements can be used to know about these issues.
In Other jurisdictions arcles of organizaon & corporate by-laws are good
information sources.
41. g
Shareowner-Sponsored Resolutions
Right to propose initiatives important shareholder method to send message to

management.
Investors must look if:
Firm requires simple or super-majority vote pass the resoluon.
Special meeting allowed for shareholders to vote on a special initiative.
Shareholders proposal to benefit a small group or a majority of shareholders.
Advisory or Binding Shareowner Proposals
Investors must look if:

Firm has implemented or ignored such proposals in the past
Any regulatory authority has pressured the firm to act in accordance with approved
initiative.
Different Classes of Common Equity
Voting rights may be separated from economic values.

Firms with separate voting & economic rights historically had trouble in equity capital.
Shares classes information sources footnotes, proxy, website, or prospectus.
Investors while looking at ownership structure must examine:
By-law protection of shareholders with inferior voting rights.
If the selling entity retained voting rights shareholders may not get full value for their
shares.
Super voting rights impairing firm to equity capital alternatively debt financing can
increase leverage.
Shareowner Legal Rights
Better if shareholders:
Rights are protected by law.
Local market regulators have taken action to enforce their rights.
Allowed to take some legal action against the firm or the board in case of fraud.
Have dissenters rights in event of problem when rm repurchases its shares at
fair market price.
Takeover Defense
Provisions which make company unattractive for hostile bidder.

Golden Parachutes Rich severance packages for top executives who lose their jobs
when takeover happens.
Poison Pills rights granted to shareholders as a result of certain percentage of
shares acquired.
Greenmail buy companys shares at premium to counter hostile attempt.
Such techniques can decrease shares value to make them unattractive.
Investors should see whether:
Firm requires shareholders approval to implement takeover defense measures.
Firm had received any acquisition interest in the past.
Firm may use its cash to pay off a hostile bidder this must be discouraged.
There is any provision which could trigger the interest of national or local government
as a result the seller is enforced to change the terms of merger or acquisition.

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2015, Study Session # 11, Reading # 40