ACCA P1 Governance, Risk and Ethics - 2011 - Study text - Emile Woolf Publishing
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Paper P1: Governance, risk and ethics
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markets and the information that is available to investors about companies
(‘transparency’ in the markets). It is useful to think about this principle in terms of
countries that fail to provide transparency in markets, or stock markets that function
efficiently, or markets in which the rule of law is fair and properly applied.
Principle II: The rights of shareholders and key ownership functions
‘The corporate governance framework should protect and facilitate the exercise of
shareholders’ rights. This principle is concerned with the basic rights of
shareholders, which should include the right to transfer the ownership of their
shares, the right to receive regular and relevant information about the company, the
right to vote at general meetings of company shareholders, the right to share in the
company’s profits and the right to remove directors from the board.’
These basic shareholder rights might seem ‘obvious’. However, there are countries
in which these rights do not properly exist, especially for foreign shareholders. For
example the laws of a country may permit a company to insist that shareholders
wishing to vote at a general meeting of the company must attend the meeting and
cannot be represented by a proxy. This requirement in effect would remove the
right to vote of most foreign investors, who do not have the time to attend general
meetings in person in countries around the world.
Principle III: The equitable treatment of shareholders
‘The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should
have the opportunity to obtain effective redress for violation of their rights.’
Within the same class of shares, all shares should carry the same rights. Minority
investors should be protected against unfair actions by the majority shareholders.
Restrictions on cross-border voting should be eliminated. Insider trading should be
illegal. Directors should be required to notify their company of material personal
interests they have in transactions with the company.
These rights might also seem ‘obvious’. However, it is not uncommon in some
countries for majority shareholders negotiating the takeover of their company by a
buyer to arrange a higher price for their shares than the price that will later be
offered to the minority shareholders.
Principle IV: The role of stakeholders in corporate governance
The corporate governance framework should recognise the rights of stakeholders
that are established by law, or through mutual agreements. This will include, for
example, employment rights and agreements negotiated for employees with trade
union representatives.
There should also be active co-operation between companies and their stakeholders
‘in creating wealth, jobs and the sustainability of financially sound enterprises.’
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Principle V: Disclosure and transparency
‘The corporate governance framework should ensure that timely and accurate
disclosure is made on all material matters regarding the [company], including the
financial situation, performance, ownership and governance of the company.’
The disclosure of information to shareholders and investors is a critically important
aspect of corporate governance. This issue will be considered in more detail in a
later chapter.
Principle VI: The responsibilities of the board
‘The corporate governance framework should ensure the strategic guidance of the
company, the effective monitoring of management by the board and the board’s
accountability to the company and the shareholders.’
This principle relates to many of the functions of the board described in an earlier
chapter. It includes the requirement that ‘board members should act on a fully
informed basis, in good faith with due diligence and care, and in the best interests of
the company and the shareholders.’ The board should also apply high ethical
standards and take into account the interests of the company’s stakeholders.
3.4 Content of the ICGN Principles
The ICGN Principles are consistent with the OECD Principles, and deal with issues
such as disclosure and transparency, the rights and responsibilities of shareholders,
and the role and structure of boards of directors.
An important objective of the Principles is to encourage the removal of bad
corporate governance practices in countries where these still exist. Some of the
Principles are listed below. It is useful to remember that the purpose of stating a
principle is often to discourage different practices that are currently found in some
countries.
The objective of a company. The ICGN Principles begin with a statement that
the main objective of a company should be to ‘optimise’ over time the return to
its shareholders and that to achieve this, the board needs to develop a long-term
strategy that will improve the equity value.
Shareholder rights. The rights of all shareholders should be protected, including
the rights of minority shareholders and foreign shareholders. If a company
diverges from a ‘one share one vote’ standard of voting, so that some
shareholders have voting power that is disproportionate to the amount of shares
they hold, this should be explained and justified by the company. The voting
system should enable all shareholders to exercise their votes: the ICGN therefore
encourages initiatives to allow voting by telecommunications or other electronic
channels.
The board of directors. All directors must act in the best interests of the
company and should be accountable to the shareholders as a whole. A well-
governed company has independent-minded directors and there should be a
strong presence of independent non-executive directors on the board.
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Corporate citizenship and the ethical conduct of business. The ICGN
Principles support the concept of ‘corporate citizenship’ and also the ethical
conduct of business by companies. Companies should comply with the law and
the board of directors is responsible for maintaining a culture of integrity.
3.5 Limitations of international codes or statements of principles
International statements of principle about corporate governance establish
minimum acceptable standards of corporate governance, but they have several
limitations.
Because they apply to all countries, they can only state general principles. They
cannot give detailed guidelines, and so are not specific. Since they are not
specific, they are possibly of limited practical value.
Their main objective is to raise standards of corporate governance in the ‘worst’
countries. They have less relevance for countries where corporate governance
standards are above the minimum standard.
Unlike national laws and codes of corporate governance, there is no regulatory
authority for international statements of principle. The principles therefore lack
any ‘force’. In specific countries, by contrast, there may be a supervisory body or
regulatory body with specific responsibility for encouraging or enforcing
corporate governance practices.
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Governance,riskandethics
CHAPTER
7
Governance:
reporting and disclosure
Contents
1 General principles of disclosure
2 ‘Best practice’ disclosures about corporate
governance
3 Dialogue with shareholders: general meetings
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General principles of disclosure
The meaning of transparency and disclosure
Corporate governance: the need for transparency and disclosure
Principles of disclosure and communication
1 General principles of disclosure
1.1 The meaning of transparency and disclosure
Transparency in stock markets and other financial markets means that information
about conditions in the markets is clear and well understood. For example,
transparency exists when investors understand about the financial situation of
companies, and the future plans and prospects for those companies, so that they can
make well-informed investment decisions.
Investors need information about companies to make their investment decisions.
Shareholders need information about the companies they have invested in, to assess
the financial performance of the company and its future prospects, and to decide
whether to hold on to their shares, sell them or buy more shares. Other investors
need information about companies in order to decide which companies they should
invest in, and how much to invest.
Disclosure means making information available, so that there is transparency.
Companies have the main responsibility for disclosure in the stock markets. They
provide regular reports to shareholders and other investors, and it is from these
reports that investors obtain most of their information.
Transparency and disclosure are key issues in corporate governance.
1.2 Corporate governance: the need for transparency and disclosure
The need for transparency and disclosures in the financial markets is recognised in
codes and statement of principles on corporate governance.
The UK Combined Code includes a principle about the disclosure of financial
information by companies, stating that the board has a responsibility to present
‘a balanced and understandable assessment’ of the company’s position and
prospects in its financial reporting.
The OECD Principles state the requirement with greater force. They state that
companies should provide ‘timely and accurate disclosure’ about their financial
performance and position, and also about the ownership of shares in the
company and also about other corporate governance issues.
The ICGN Principles emphasise the need for information so that investors can
make investment decisions, and state that companies should, on a timely basis,
disclose the relevant information about the company to enable informed
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decisions about the acquisition obligations and rights, ownership and sale of
shares to be made by investors.
What information should be disclosed?
There are three main categories of information that investors need from a company:
Financial information about the past performance of the company, its financial
position and its future prospects.
Information about the ownership of shares in the company, and voting rights
associated with the shares. This is important for global investors, who may have
problems with investing in companies where there is a majority shareholder, or
where there is a complex structure of share ownership, or where some
shareholders have more voting rights than other shareholders (for the same class
of shares).
Corporate governance information. This is explained in more detail later.
1.3 Principles of disclosure and communication
There are several basic principles for disclosure and communication of information.
The information should be reliable. Reliable information is information that is
sufficiently accurate for investors to trust it when making their investment
decisions. The OECD Principles, for example, state that information should be
prepared and disclosed with high quality standards of accounting and high
standards for both financial and non-financial disclosures.
Information should be understandable. One of the criticisms of international
financial standards (IFRSs) is that financial reporting in accordance with IFRSs
can be very complex, and some investors might not properly understand the
information that they provide. Many investors support the idea that companies
should provide information about themselves in a narrative form, in addition to
providing financial statements. Narrative statements are explained in more
detail later.
Information should be timely. In the financial markets, ‘timely’ often means
‘communicated as soon as possible’. Information should be made available to all
investors as soon as possible after it becomes ‘public’. Efficient stock markets
should ensure that information announced by companies is made available to
everyone quickly after the announcement. In the European Union, for example,
one of the aims of the Transparency Directive (introduced in 2007) is to
communicate information available quickly to investors as soon as companies
make announcements to the stock market.
When information is disclosed by companies, it should be equally available to all
investors. The OECD Principles state that the way information is distributed
should enable users to access relevant information in an equal, timely and cost-
efficient manner.
Information should be made available by convenient channels of
communication. Companies should be encouraged to make it available in
electronic form to investors who want to receive it in that form. For example,
companies should use their web sites for making disclosures.
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The opportunities for exploiting confidential information to make a personal
profit should be minimised. By making information available to investors
quickly, opportunities for insider dealing should be reduced.
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‘Best practice’ disclosures about corporate governance
Requirements for disclosures about corporate governance
The content of ‘best practice’ disclosures
Mandatory and voluntary disclosures
Narrative reports: business reviews and interim management statements
2 ‘Best practice’ disclosures about corporate
governance
2.1 Requirements for disclosures about corporate governance
Institutional investors expect to be given information about corporate governance
by companies, because this information helps them to make their investment
decisions.
In the European Union and in other countries, the principle of ‘comply or explain’ is
applied. Major companies are required to comply with a recognised code of
corporate governance, or explain their non-compliance. However, this on its own
does not provide all the corporate governance information that investors want.
In countries of the European Union, major companies are required to prepare a
corporate governance statement each year. This is included in their annual
report and accounts. In the UK for example, the Listing Rules require a
statement in the annual report and accounts (of listed companies) relating to
compliance with the Combined Code.
Similarly, the Singapore Exchange Listing Rules require similar disclosures from
listed companies, in relation to the Singapore Code of Corporate Governance.
The OECD Principles call for disclosures by companies about governance issues.
2.2 The content of ‘best practice’ disclosures
Corporate governance statements by listed companies are often quite long.
Typically, they fill five or six pages in the annual report and accounts. (In addition,
UK listed companies include a lengthy directors’ remuneration report, in addition to
their corporate governance report.)
The specific content of a corporate governance statement may vary. In the UK,
statements by listed companies are required to contain the following information.
A statement of how the board operates, including a high level statement about
which matters are reserved for the board and which decisions are delegated to
management. For example, a report might state: ‘The Board has set out clearly
the Schedule of Matters Reserved for Board Decision in order to ensure overall
control of the Group’s affairs. These include the approval of financial statements,
major acquisitions and disposals, authority levels for expenditure, treasury
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policies, risk management, Group governance policies and succession plans for
senior executives.’
Names of the chairman, CEO, senior independent director and chairmen of the
nominations, audit and remuneration committees.
The number of board meetings and board committees during the year, and the
attendance record of each director at those meetings. This information might be
presented in a table, as follows.
Board
meetings
Nominations
committee
Remuneration
committee
Audit
committee
Number of meetings held
8 1 4 4
Attendance
Non-executive directors
Mr S Lee (Chairman) 8 1 n/a n/a
Mr J Glover 6 1 4 n/a
Mrs T Potter 8 1 4 4
Mr R Robinson 7 n/a 4 3
Mr A Timms 7 1 n/a 4
Executive directors
Mr D Watts (CEO) 8 1 n/a n/a
Ms G Hobbs 8 n/a n/a n/a
Mr B Lam 8 n/a n/a n/a
n/a = not applicable
The names of the non-executive directors that the board considers to be
independent. Reasons should be given where this is appropriate.
The other significant commitments of the chairman, and changes in these
commitments during the year.
A statement about the performance evaluation of the board, and how this has
been conducted.
A statement about the steps the board has taken to ensure that the directors
(especially the non-executive directors) are informed about the opinions of the
company’s major shareholders. This statement might be quite brief. For example:
‘Shareholders are offered the opportunity to meet with the Senior Independent
Non-Executive Director. The Board is kept informed of the view of major
shareholders through regular updates.’
Somewhere within the annual report and accounts, the following information
should also be provided.
A separate section describing the work of the nominations committee.
A description of the work of the remuneration committee. (In the UK this is
required as part of the Directors Remuneration Report Regulations, and is likely
to be contained within the Directors Remuneration Report.)
An explanation of the directors’ responsibility for preparing the financial
statements.
A statement by the directors that the company is a going concern.
A report that the board has carried out a review of the company’s system (and
group’s system) of internal controls.
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A separate section describing the work of the audit committee.
If the company does not have an internal audit department, the reasons why it
does not.
If the company’s auditors provide non-audit services to the company, an
explanation of how the auditors’ objectivity and independence are safeguarded.
Other information that should be provided by companies includes:
The terms of reference for the nominations committee, remuneration committee
and audit committee. These can be made available on the company’s website.
The terms and conditions of appointment of NEDs (which can also be made
available on the website).
When papers are sent to shareholders for a general meeting where there will be
a proposal to elect or re-elect a non-executive director, a statement by the board
of why the individual should be elected. When a NED is proposed for re-
election, the chairman should also confirm that the performance of the NED
continues to be effective and the individual continues to commit the necessary
amount of time to the company.
2.3 Mandatory and voluntary disclosures
Disclosures about corporate governance may be a mandatory requirement of the
law or other regulations, or they may be provided as voluntary disclosures by a
company. In practice, the disclosures by a company are likely to be a mixture of
mandatory and voluntary items.
The nature and amount of mandatory disclosures depends on the laws and
regulations of the country.
Some disclosures are required by law. For example, companies are required to
prepare an annual report and accounts, and present these to the shareholders.
Company law specifies what the directors’ report and the accounts must contain,
and in addition other regulations about content apply such as the requirements
of financial reporting standards. In the UK, there is a legal requirement for
quoted companies to include a directors’ remuneration report in their annual
report and accounts.
Some disclosures are required by stock market rules. For example, as mentioned
earlier, the UK Listing Rules require listed companies to provide information
relating to corporate governance in their annual report and accounts. There are
also stock market rules about other announcements by the company, such as
profit warnings and announcements of proposed takeovers.
In addition to the mandatory disclosures required by law or regulation, many
companies provide additional information, as part of their normal reporting cycle.
Typically, these include:
a chairman’s report describing the activities of the company and its different
operating divisions: alternatively, an operating and financial review by the CEO
a social and environmental report, or a corporate social responsibility report:
these reports are described later.