Anglo-American Model of Corporate Governance - Example

Corporate Governance – Group Work Name Subject/Course Instructor Institution Date Issue 1 Unitary board structures provide better control over management decisions than do two-tiered board structures Introduction Corporations have remained the commonest business structures internationally since the 19th century, specifically in the Western nations. One reason for this is that ‘corporate structure’ is reputed for providing businesses with considerable levels of autonomy from the shareholders (Bezemer et al. 2014). Additionally, at the heart of a company’s operational procedures is the requirement that directors should take charge of managing a company. To this end, the directors form a crucial component of corporate governance, as they serve as a link between corporate management on one hand shareholders on the other. Board structure is essentially concerned with bringing a balance of power between the shareholders and the company’s management, and positions of organisational members (Maassen 2002). It also forms a basis for an effective board; hence, it is at the centre of accountability and performance. There are different board structures in existence, as companies operate on differently based on their business, corporate governance systems, and location contexts. At any rate, the most prevalent structures are unitary board (one-tier board) structures and two-tier board structure. Within the international context, the unitary structures are more likely to exist in an Anglo-Saxon context. On the other hand, a two-tier system is prevalent in continental Europe. This paper argues that unitary board structures offer better control over management decisions than two-tiered board structures. The unitary board structure is prevalent in nations associated with Anglo-Saxon corporate governance styles, such as the England, Belgium, Ireland, Spain, India, Sweden, United States, Portugal, Singapore and Greece. It is essentially a single board system consisting of executive and non-executive directors. It pulls together the two types of directors to form a unified unit, while still making it easy to distinguish between executive and non-executive directors. Despite this, the distinction is not necessarily as formal as the case for a two-tier board. The leadership of the board is left to the chairperson, who is often the company’s chief executive officer (Bezemer et al. 2014). On the other hand, a two-tier board structure is prevalently used in Asia and Continental Europe, including in Japan, Germany, and Italy. It is essentially a dual system, made up of the board’s management board and the supervisory board, which functions independently. Concurrent membership of the supervisory board and management board is prohibited. The management board is made up strictly of executive directors, although the supervisory board also comprises wholly of directors who have non-executive membership. The executive and non-executive directors are formally separated and have separate duties and responsibilities (Block & Gerstner 2016). Therefore, a unitary board structures provide better control over management decisions than do two-tiered board structures because it has a greater potential to make decisions that increase shareholder’s returns. For that reason, an additional approach that can be used to clarify the efficiency of each board structure in decision-making is by focusing on the economic intent of efficiency. For instance, based on the Agency Theory, it could be argued that shareholders would often attempt to maximize their profits and would therefore shun low quality corporate governance systems, such as an efficient board structure (Donaldson & Davis 1991). Unitary board structure offer better control over management decisions than a two-tier board structure. The reason for this is that it ensures a more efficient flow of information, hastens decision-making, as well as facilitates better participation and understanding in the board. It also ensures efficient flow of information across the members of the board, hence ensuring quality decisions are made. Compared to a two-tiered board, it ensures more meetings are carried out, where all board member attends. A unitary board also accommodates many committees. It also serves to import a wide range of information on the manager and independent monitors, as the board members must be in the same country. As the board accommodates the company’s chief executive and the independent monitors, it makes it easy to contact constantly the company’s executives. This potentially allows the members of the board to personally interrelate, promote better insights into the business and functioning of the board in overseeing decision-making process (Spisto 2005). According to Bezemer et al. (2014), as the directors with non-executive membership participate in making decisions, they maintain a greater motivation to furnish themselves with the necessary information, hence board members have no restricted access to information needed for controlling the organisation. A unitary board structure is also planned in a way that facilitates faster decision-making. Given that the supervisory and management board are integrated as one, this structure eliminates a need for having separate means to approving decisions. Additionally, formal board meetings occur more frequently than in a two-tier board structure, hence encouraging decision-making processes that are more responsive (De Moore 2014). Because a company’s executive control is designated to managers rather than shareholders, the managers have a potential to exploit the shareholders, hence may lower shareholder’s return. Therefore, there has to be separation of interest that generates agency costs, as well as which may be reduced through control (De Moore 2014). Hence, it is considered more cost-efficient to allow people who are more specialized to carry out the supervision. As a result, direct corporate control is required that counterbalances inactivity and a separate specialized board that is unaffected by conflicts of interest linked to management (Bezemer et al. 2014). Additionally, integrating more recurrent board meetings encouraging a unified supervisory and management board encourages a greater level of grip into the strategies of the business and decision-making (Spisto 2005). Once the chief executive is allowed to be on the board and there exists a diverse variety of business backgrounds on the board, a greater possibility of understanding the complexities of the decisions made by business exist. It also positions the independent directors at a better place to confront any likely complexities in strategies that the management proposes. As this structure facilitates greater awareness of the business and its existing situations or complexities, the board is able to make more comprehensive decisions (De Moore 2014). In German, Volkswagen and Siemens have fallen victims to corporate financial scandals because of the inefficiency of a two-tier system, particularly is feature of promoting a less transparent supervisory board. In the two examples, a two-tier system has failed to unify supervisory and management board, hence leading to animosity between the supervisory board and the management board leading to poor grasp of business and its decision-making. At both Volkswagen and Siemens, the CEOs were ousted out of office by the supervisory board, despite being respected by shareholders and not having been implicated in the corporate scandals. Shareholders of both companies condemned the ousting, yet they could not overrule the decisions made by the supervisory board or engage the supervisory board in consultation due to fewer meetings. At Volkswagen, the CEO, called Bernd Pischetsrieder, was ousted by a divisive and overbearing chairman. This has led CEOs at German firms like Porsche to be highly critical of the supervisory boards and to argue that the German supervisory boards’ system of co-determination need to undergo reformation to enable employees to have some seats at the board and to play crucial role in making strategic decisions. At Volkswagen, while 81% of the car sales are outside the German market, yet the company has no single foreigner in its board. The main argument is that the board should be internationalised. Yet again, Volkswagen’s board underscores the challenge of possible conflicts of interest. For instance, Porsche, which is a major Volksagen competitor, is at the same time Volkswagen’s largest shareholder as well as controls the board, and holds the leadership. Conclusion A unitary board structure offer better control over management decisions than a two-tiered board structure. Within the international context, the unitary structures are more likely to exist in an Anglo-Saxon context, while a two-tier system is prevalent in continental Europe. Unitary board structure offer better control over management decisions than a two-tier board structure. The reason for this is that it ensures a more efficient flow of information, hastens decision-making, as well as facilitates better participation and understanding in the board. By ensuring efficient flow of information across the members of the board, it ensures quality decisions are made in the interest of the company and the shareholders. Additionally, as a unitary board accommodates the company’s chief executive and the independent monitors, it makes it easy to contact constantly the company’s executives. This has a potential to allow the members of the board to relate well, promote better insights into the business and functioning of the board in overseeing decision-making process. Additionally, formal board meetings occur more frequently than in a two-tier board structure, hence encouraging decision-making processes that are more responsive. As a unitary board accommodates the company’s chief executive and the independent monitors, it makes it easy to constantly contact the company’s executives. A unitary board structure is also planned in a way that facilitates faster decision-making. Therefore, a unitary board structures provide better control over management decisions than do two-tiered board structures because it has a greater potential to make decisions that increase shareholder’s returns. Issue 2 Do you think there is a role to be played by institutional investors in corporate governance? Discuss with reference to two corporate governance systems ie Anglo, Continental Europe, Asia. Introduction Institutional investors are crucial components of corporate governance in the United Kingdom and the United States due to their proactive roles in monitoring the decisions reached by the Board of directors and in facilitating the creation of efficient corporate governance practices in companies. In large institutions, they also pass private information they have acquired from the management to the rest of the shareholders. It is argued that institutional investors, by virtue of their large shareholding, have the capacity to participate in ensuring that companies have effective corporate governance practices in place. According to Lonien (2003), the public has trusted institutional investors who must therefore act in fiduciary capacity. They have an obligation to make decisions they consider as best fit for serving the interests of the companies while steering the companies ethically. Examples of institution investors include insurance firms, banks, mutual funds, development finance companies, and foreign institutional investors. Therefore, because of their huge size of shareholdings, I believe that institutional investors play crucial roles in corporate governance, which cannot be underestimated. In the United Kingdom, three key committees that reported on corporate governance underscore the indispensable roles of institutional investors. In 1992, the Cadbury Committee considered institutional investors as performing crucial roles as shareholders of ensuring that that the companies they have invested in adhere to the ethical code of conduct. The same observation was made in 1995 on the Greenbury Report, where it was highlighted that investor institutions can use their influence to make sure that organisations come up with sound ethical codes that they can comply with. Later in 1998, the Hampel Report (1998) highlighted that institutional investors have crucial roles in corporate governance as they are important shareholders. As a consequence, in 2002, a UK institutional investor called Hermes came up with Hermes Principles. The first stipulated how firms should consider having dialogue with their shareholders. Despite this, the role of institutional investors is not solely a trend in the UK. In the United States, the concept of ‘investor capitalism’ emerged in 1996 to enable institutional investors to confront openly companies’ management on matters they consider of need to be addressed. According to Lonien (2003), ‘global investors’ are the private as well as public pension funds of the United Kingdom, United States, Canada, Japan, Australia, and Netherlands. In these countries, when the particular holding of their largest pension schemes, Majocchi et al (2013) concluded that the level of ownership in nearly all public firms is sufficiently huge to allow for effective participation of owners in corporation governance. In the case of Australia, which relies on a hybrid system that combines Anglo-Saxon, German, and Asian corporate governance system, the increased influence of institutional investors due to their large size and huge investment makes them significant components of corporate governance (Milne 2007). On the other hand, Italy just like many other nations in Continental Europe, possess a governance system that is rooted in concentrated ownership or controlled by families. The institutional investors are, therefore, less prominent (Clarke 2009). The Anglo-Saxon countries, on the other hand, have a significantly concentrated share ownership to the institutional investors. According to Clarke and Chanlat (2009), UK and US pension funds, which embody some 72 percent of overall pension fund assets within the Western world, have been instrumental in altering corporate governance standards because of their active stand on investment as required by local regulations and codes. In the United States, the extensive fraction of institutional share ownership, where institution investors own some 55 percent of US equities as well as make 80 percent of all share trades, and the United Kingdom where institutional investment is estimated at between 65 and 80 percent, imply that the role of institutional investors in corporate governance cannot be ignored. Therefore, the institutional investors have a crucial role to play in corporate governance (Clarke 2009). The idea of bring in institutional investors to safeguard stakeholder’s interests reflects the stewardship theory, which argues that shareholders’ interests would be maximised once the roles of the management (agents) are with the shareholders (principals) (Donaldson & Davis 1991). In which case, managers would not automatically maximize shareholder returns except for when appropriate governance structures, including oversight by the institutional investors, are implemented to protect shareholders’ interests. Within the context of an organisation, stewardship describes the roles of the management in ensuring proper use and development of a company’s resources in a manner that can generate long-term value to a company sustainably (Clarke & Chanlat 2009). Within the context of institutional investors, it is, therefore, reasoned that stewardship consists of an ongoing duty of the institutional investors to act in a manner that can be considered to be to the best interests of the individual considered the end beneficiaries of the resources they have been entrusted to. The idea of stewardship is at the centre of a debate on corporate governance, particularly whether the management should strictly be concerned with generating value to shareholders (Rosa et al. 2014). The institutional investors hold the management to account. This can be ensured through a voting process. Although the boards of directors in the United States and United Kingdom possess the power of appointment, institutional investors should direct how the board renews itself as well as make sure that the board is diversely constituted, in term of having a mix of talents and leadership expertise. In the United States and the United Kingdom, companies can be held into account through an audit process. The shareholders, including the institutional investors, vote to appoint an auditor (ICAEW 2006). The institutional investors play a crucial role of monitoring company’s performance. The process of monitoring performance should however be regular. It consists of making review of annual reports or even attendance at company meetings. According to the Davis (1996), institutional investors should make effort to confirm that the board of the investee company as well as the sub-committee structures function effectively, as well as that sufficient oversight is provided by independent directors. The institutional investors intervene whenever necessary whenever there are issues of concerns. As Lonien (2003) explains, institutional investors arbitrate whenever they deem it necessary, specifically when they are concerned about various issues that touch on the strategy of the company, the company’s performance, and improper remuneration packages. Majocchi et al (2013) also argue that the Board should be provided with an opportunity to provide constructive response yet if they are not allowed, then they may opt to raise their actions such as by intervening alongside other institutions on certain matters of concern, or even calling for an unexpected general meeting to change the board. They should as well assess and makes reports on the implications of their shareholder activism. Recently, several corporate failures such as the collapse of Enron in the United States and the financial scandal at RBS in the United Kingdom have pointed to a need to entrust institutional investors with the role of overseeing how companies they have invested in are managed (Clarke 2009). While the Enron and RBS scandals eliminated equity and wealth for shareholders, they also created systemic risks in financial structures worldwide. In response to the Enron scandal, the United States have selected to use a direct legislative intervention under the “Sarbanes Oxley” legislation, which seeks to address the matter of accountability and transparency of the senior management and the Board. Consequently, the Dodd-Frank Wall Street Reform and Consumer Protection Act was established to strengthen board accountability and to promote greater level of oversight by shareholders, including the institutional investors (Clarke 2009). In 2010, the UK updated the Combined Code after the UK Corporate Governance Code was published to introduce alterations encouraging diversity in the boards. Shareholders and their agents did not escape scrutiny. The UK also introduced the UK Stewardship Code, which requires that institutional investors should proclaim their engagement with investee companies, strategies for addressing conflicts of interest, and voting policies (Department for Business, Innovation and Skills 2011). It is recommended that institutional investors should develop a comprehensible statement of policies on activism in addition to how they would assume their roles and responsibilities in corporate governance. The policy may consist of a public document that addresses how to carry out the monitoring of investee companies, meetings with the board and executive management, addressing conflicts, voting mechanism as well as strategies on intervention. Conclusion Because of their huge size of shareholdings, institutional investors play crucial roles in corporate governance that aim to ensure that shareholder’s interests are well taken care of by the management. In which case, managers would not automatically maximize shareholder returns except for when appropriate governance structures, including oversight by the institutional investors, are implemented to protect shareholders’ interests. The institutional investors hold the management to account. This can be ensured through a voting process. The institutional investors play a crucial role of monitoring company’s performance. The institutional investors intervene whenever necessary whenever there are issues of concerns. Issue 3 In Anglo governance systems the CEO and director remuneration has risen dramatically in the last few decades. Is this beneficial for companies and investors? Discuss. Compare remuneration across 2 corporate governance systems. Introduction Directors’ remuneration refers to the payment made to company directors for their services. It consists of basic salary in addition to financial and non-monetary awards given to company CEOs and directors during their tenure (Oakley 2016). On average, it consists of a combination of bonuses, shares, perquisites, benefits, and stock options (Graziano & Rondi 2016). This paper argues that in the Anglo-American governance systems, the executive remuneration has increased radically during the last few decades. However, this has not been beneficial to shareholders and companies. Since the 1980s, there has been a radical rise in executive compensation compared with that of an average employee in the United Kingdom and United States, both of which use the Anglo-American governance system (Buchanan et al. 2003). According to Oakley (2016), the rise has naturally and resulted from competition for the limited business talents that potentially add great value to shareholders as well as socially detrimental trends resulting from political and social transformations that have provided executives with greater say over what they should be paid. Within this context, it is conceivable that the Anglo-Saxon countries (particularly the United States and United Kingdom) have a dispersed ownership and a market-based compensation system that determine the executives’ remuneration. In Asia and some parts of Continental Europe that use a different governance system, the policies on CEOs and director’s remuneration differ across countries, and to a considerable degree influenced by the broader cultural and national practices. In the case of Japan for instance, companies, by tradition, pay the workers depending on their rank rather than performance (Graziano & Rondi 2016). At the same time, the discrepancy between the CEOs, directors and the average employees is less distinct. Despite this, as compensation has risen relative to the decline in shareholder returns, new regulations were enacted in March 2010 that compel companies to make full disclosure of details of the executive's compensation, particularly when the total compensation goes beyond US$1 million (Department for Business, Innovation and Skills 2011). In the UK, between 1998 and 2010, executive remuneration in largest listed companies, particularly FTSE100, rose by 13.6 percent -- from an average of £1 million to £4.2 million during the period (Department for Business, Innovation and Skills 2011). The same trend has been witnessed in the United States, which also relies on the Anglo-American corporate governance system. Since the early 1990s, executive’s remuneration in the United States has surpassed corporate profits, in addition to the average salaries and benefits paid to the rest of the workers. For instance, in the period 1980-2004, the executive compensation rose by 8.5 percent each year, relative to the growth in corporate profit of merely 2.9 percent each year. At the end of 2006, executives were paid by up to 400 times what an average worker was paid. In 2012, the median executive compensation pay was $9.6 million (Department for Business, Innovation and Skills 2011). Incidentally, the company executives that rely on the Anglo-Saxon governance system are paid higher than those in Continental Europe and Asia. In 2006 for instance, the highest paid CEO in the United States was Terry Semel of Yahoo Inc, whose total compensations was US$71.4 million. In Continental Europe, the highest paid was Carlos Ghosn of Renault in France, whose total compensations was US$45 million (Clarke 2009). The Italian case provides an interesting case for analysing the relationship between competitive pressures, shareholding, and executive compensation. On the other hand, Italy just like many other nations in Continental Europe, possess a governance system that is rooted in concentrated ownership or controlled by families (Graziano & Rondi 2016). They also have a comparatively small stock market. In which case, unlike in Anglo-Saxon countries, the executive compensation is less transparent, yet proportionate to the shareholder returns. Buchanan’s et al. (2003) study on Italian firms revealed that in Italy, the larger companies may have a severe agency problem among minority shareholders and the controlling shareholder, instead of shareholders and managers as it happens in Anglo-Saxon countries which have a dispersed ownership environments. The rise in executive compensations is not beneficial to shareholders and companies. Indeed, current studies have indicated that executive remuneration should be in line with the social goals. The rise in the compensation is suggestive of two likely scenarios: the remuneration structure does not automatically motivate directors to act in the best interests of the shareholders or the company (Graziano & Rondi 201. Additionally, the degree of remuneration may signify disproportionate rewards for the observable performance of the executives. In comparison to the rise in pay for the executives, shareholders have witnessed relatively slower growth in returns. The employees have also witnessed relatively slower growth in earnings (Buchanan et al. 2003). This leads to an increase in the disparity among senior executives, shareholders, and workers, with company chief executives in the UK earning up to 120 times what an average employee earns. This has raised issues regarding reward distribution in firms as well as whether concentrating rewards for those in the higher hierarchy is really the most efficient means to incentivise employees and to sustain long-term organisational performance (Tomasic 2011). Therefore, the rise in executive compensation has been unfair to the shareholders, hence indicating poor corporate governance as the shareholder’s value is disparaged. The relationship between directors’ remuneration and corporate governance can be clarified further using the agency theory. The Agency theory describes the relationship between a company’s management and its shareholders, where the management is designated as an agent entrusted with the role of making sure that the best interests of the shareholders are given due consideration (Graziano & Rondi 2016). According to Buchanan et al. (2003), the management (as the agent) should operate the company specifically for the ‘best interest’ of shareholder (as the principal). Therefore, based on the agency theory, it is clear that by allowing the board to decide executive compensation and for the executive to be paid excessively, as for the case of companies in the Anglo-American governance system, the agents are acting in their best interest rather than the interest of the shareholders. This denotes a conflict of interests on the part of the agents. The agency affiliation that arises from the separating shareholding from management is often considered an agency problem. There is a potential for conflict of interest to occur. This is because the CEOs and directors are given higher salaries, stock option and bonuses, which are relatively higher than what the shareholders get as dividends (Graziano & Rondi 2016). In the Anglo-American system, unlike the Asian system, where the board decides executive remuneration, the management is bound to use their influence to reward themselves excessively (Graziano & Rondi 2016). This implies that they would opt to retain profits instead of giving out dividends to minimise financial risk. According to Clarkson and Olsson (2010), the shareholders and management have divergent views on risk avoidance because the outcomes of the operation potentially influence their rewards. For this reason, the management are only likely to strive to improve a company’s performance once they perceive that the pay relates to profitability or size of the company. Therefore, it is clear that the Anglo-Saxon countries (particularly the United States and United Kingdom) have a dispersed ownership in addition to a market-based compensation system. Recently, some incidents have happened that indicate how higher executive compensation is unfair and can lead to business collapse. In Australia, which relies on hybrid of Anglo-Saxon, German, and Asian corporate governance system, the collapse of HIH Insurance in 2001shows the disadvantages of paying company executive excessively -- at the expense of the company or shareholder’s interest. Before its collapses, the company’s deficiency was estimated at around $5.3 billion. Its collapse is greatly attributed to its last major acquisition and higher executive compensation (Buchanan et al. 2003). Indeed, in spite of its losses, the CEO was still given a multimillion-dollar severance package after resigning a year before the company was declared bankrupt. In the United States, WorldCom’s collapse in 2002 can also be blamed on paying executives excessively, among other issues like major acquisitions, and deceptive accounting practices. A few months before WorldCom was declared bankrupt, the CEO was also given a multimillion-dollar severance package after he resigned. The parallels between the histories and failures of HIH and WorldCom are striking, especially given that the companies were located in countries with differing corporate governance systems. In this paper we analyse the corporate governance failures that aided the collapse of HIH and their similarities to the same failures at WorldCom (Buchanan et al. 2003). Conclusion In the Anglo-American governance systems, the executive remuneration has increased radically during the last few decades. However, this has not been beneficial to shareholders and companies. As established, the Anglo-Saxon countries (particularly the United States and United Kingdom) have a dispersed ownership and a market-based compensation system that determines the executives’ remuneration. The company executives that rely on the Anglo-Saxon governance system are paid higher than those in Continental Europe and Asia. At any rate, rise in executive compensations is not beneficial to shareholders and companies. Indeed, current studies have indicated that executive remuneration should be in line with the social goals. The rise in the compensation is suggestive of two likely scenarios: the remuneration structure does not automatically motivate directors to act in the best interests of the shareholders or the company. Additionally, the degree of remuneration may signify disproportionate rewards for the observable performance of the executives. In comparison to the rise in pay for the executives, shareholders have witnessed relatively slower growth in returns. Therefore, the rise in executive compensation has been unfair to the shareholders, hence indicating poor corporate governance as the shareholders are given relatively little reward. 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