Governance and Responsibility: Approaches to Corporate

Governance

Rule vs. Principle based approaches

• Rule-based: instills the code into law with appropriate penalty for transgression. US model (SOX)• Principle-based: require the company to adhere to the spirit

rather than the letter of the code. • Comply or explain: principle-based approach require the

company to state that it has complied with the requirement of the codes or to explain why it could not do so in its annual report. This will leave shareholders to draw their own conclusion with regards to corporate governance. UK model.

Factors affecting choices of governance regime

• Dominant ownership structure• Legal system and its power/ability • Government structure and policies• State of the economy• Culture and history• Levels of capital inflow or investment coming into the country• Global economic and political climate

Arguments in-favour of rules-based approach

• Clarity in terms of what the company must do; the rules are legal requirements hence no interpretation needed• Standardisation for all companies; there is no choice as to

complying or explaining. Level playing field is created• Binding requirements; the criminal nature makes it very clear

that the rules must be complied with• Greater confidence in regulatory compliance

Arguments against rules-based approach

• Exploitation of loopholes; the exacting nature of the law lends itself to the seeking of loopholes• Flexibility is lost; there is no choice in compliance to reflect the

nature of the organization, its size or stage of development• Box-ticking approach; just for the sake of complying with all

aspects of the rules. Does not lead to well-governed organization.• Regulation overload; the volume of rules and amount of

legislation may give rise to increasing costs for businesses and for regulators• Legal costs: to enact new legislations to close loopholes• There is no room to improve or go beyond the minimum level

Sarbanes Oxley Act 2002 (SOX)

• SOX:• Rule-based approach to governance• Extremely detailed and carries the full force of the law• Security Exchange Commission (SEC) to issue certain rules of corporate

governance• Relevant to US companies, directors of subsidiaries of US listed

businesses and auditors who are working on US listed businesses

Sarbanes Oxley Act 2002 (SOX)

• SOX key points:• Auditor independence: auditors are restricted in the additional services

they can provide to an audit client• Audit committee: company must have audit committee, will be

disallowed from trading if it does not have one• Internal control report: Annual reports must include statements

concerning internal control system • Accuracy of financial statements: must be vouched for by CEO and CFO• Increased financial disclosures: financial reports to detail off balance

sheet financing• Restrictions on dealing: directors are prohibited from dealing in shares

at sensitive times• Audit partner: senior partner must be changed every five years

Sarbanes Oxley Act 2002 (SOX)

• SOX positive effects• Personal liability of directors for mismanagement and criminal

punishment• Improved communication of material issues to shareholders• Improved investors and public confidence in US companies• Improved internal control and external audit of companies• Greater arm’s length relationship between companies and audit firms• Improved governance through audit committee

Sarbanes Oxley Act 2002 (SOX)

• SOX negative effects• Doubling of audit fee costs to organisations• Onerous documentation and internal control costs• Reduced flexibility and responsiveness of companies• Reduced risk taking and competitiveness of organisations • Limited impact on the ability to stop corporate abuse

International convergence

• 2 organisations have published corporate governance codes intended to apply to multiple jurisdictions• The Organisation for Economic Cooperation and Development (OECD)• The International Corporate Governance Network (ICGN)

• OECD: Estabished in 1961. International organization composed of industrialised market economy countries and some developing countries. Provide a forum to establish and co-ordinate policies

International convergence

• Contents of OECD principles:• ensuring the basis for an effective corporate governance framework• the rights of shareholders and key ownership functions• the equitable treatment of shareholders• the role of stakeholders in corporate governance• disclosure and transparency• the responsibilities of the board.

International convergence

• ICGN: Established in 1995. The instigation of major institutional shareholders, represents investors, companies, financial intermediaries, academics and other parties interested in the development of global corporate governance practices • Contents of ICGN:

• Corporate objective: shareholder returns• Disclosure and transparency• Shareholders’ ownership, responsibilities, voting rights and remedy • Corporate boards• Corporate remuneration policies • Corporate citizenship, stakeholders relations and the ethical conduct of

business