Concepts Description
Corporate Governance and ESG ‐ Introduction
Corporate Governance Definition:
‐ System of internal controls and procedures by which individual companies are managed
‐ Provide a framework that defines the rights, roles and responsibilities of various group within an organisation
‐ Is an arrangement of checks, balannces and incentives a company needs, to minimise and manage conflicts of interests between insiders and external shareholders
Shareholder theory:
Primary focus on the interests of shareholders ‐ maximise market value of firm's common equity
Corporate governance focuses on managers ‐ owners conflict
Stakeholder theory:
Consider conflict among groups that have interest in the firm's activities and performance (shareholders, employees, suppliers, customers)
Stakeholder groups and interests ‐ 1. Shareholders
Sharehoders Description:
‐ Have residual interest in the firm
‐ Have voting right → have effec ve control of the firm and its management
Interest: In the ongoing profitability and growth of firm, which can increase value of their shares
Stakeholder groups and interests ‐ 2. BOD
BOD Responsibility:
‐ protect the interest of shareholders
‐ Hire, fire and set the compensation of firm's senior managers
‐ Set strategic direction of the firm
‐ Monitor the financial performance and other aspect of the firm's ongoing activities
Stakeholder groups and interests ‐ 3. Senior managers
Senior managers Description: receive compensation made up of salary, bonus and perquisites
Interest:
‐ continued employment, maximise total value of compensation
‐ Bonus is tied to some measure of firm performance → interest in the financial success of the firm
Stakeholder groups and interests ‐ 4. Employees
Employees Interest:
‐ pay rate, opportunities for career advancement, training and working conditions
‐ Sustainability and success of the firm
Stakeholder groups and interests ‐ 5. Creditors
Creditors Definition:
‐ supply debt capital to the firm
‐ do not have vote in firm management, do not participate in firm growth
Interest:
‐ protected to varying degrees by covenants in their deb agreements with the firm
Stakeholder groups and interests ‐ Suppliers
Suppliers Definition: supply resources
Interest:
‐ preserve an ongoing relationship with the firm, profitability if their trade with the firm and the growth and ongoing stability of the firm
‐ firm's solvency and on‐going financial strength
Principal ‐ agent conflict Agent is hired to act in the interest of the principal, but agent's interest may not coincide exactly with principal's iinterest
Conflict of interest: shareholders Shareholders = Principal ; Director = agent
vs. Directors Reasons for conflict:
‐ Risk of directors (more dependent on firm performance)≠ Risk of shareholders (hold a diersified portfolio)
‐ Directors favor self‐iinterest at the expense of shareholders
‐ Directors favor a group of shareholders at the expense of another
‐ Information asymmertry: Directors have more and better information about the functioning of the firm and its trategic direction than shareholders
Conflict of interest: Group of A single shareholder / group of shareholders might hold a majority of votes and act against the interest of the minority shareholders. E.g.:
shareholders ‐ Acquisition: controlling shareholders may be in a position to get better term than minority shareholders
‐ Majority shareholders may cause the firm to enter RPTs that benefit entities in which they have a financial interesst, at the expense of minority shareholders
Conflict of interest: Creditors vs. ‐ Shareholders prefer more business risk than creditors, since creditors have limited upside from good results compared to shareholders
shareholders ‐ Shareholders could act against the interest of creditors by issuing new debt / paying greater dividend →↑ default risk faced by creditors
Conflict of interest: Shareholders ‐ ↑ price / ↓ quality to increase profit, at the expense of customers
vs. Other stakeholders ‐ Employ strategy to reduce taxes
Stakeholder management Manage the Company' relationship with stakeholders based on having a good understanding of stakeholder interest and maintaining communication with stakeholders
Based in 4 types of infrastructures:
1. Legal infrastructure: Identify relevant laws and legal recourse of stakeholders whien their rights are violated
2. Contractual infrastructure: contracts between the company and its stakeholders that specify the rights and responsibilities of the company and stakeholders
3. Organisational infrastructure: Company's corporate governance procedures, including internal systems and practices that address how to manage stakeholders relationships
4. Governmental infrastructure: regulations that the Company are subjected
Annual general meeting Hold at the end of the firm's fiscal year, to provide shareholders with audited financial statements, performance and significant indicators over the period, and answers to
shareholders
Extraordinary general meeting Hold at any time, to vote for special resolutions (e.g.: merger or takeover, amendment of corporate bylaws, etc.)
Board structure One‐tier board: Single BOD, with both internal directors (EDs) and external directors (NEDs)
Two‐tier board: Includes supervisory board (NEDs only) and management board (EDs only). Supervisory and management board operate independently
, Board's duties ‐ Selecting senior management, setting their compensation, evaluating their performance
‐ Setting the strategic direction for the company
‐ Approving capital structure changes, significant acquisitions, and large investment expenditures
‐ Reviewing company performance and implementing any neccessary corrective steps
‐ Planning for coninuity of management and the suceession of the CEO
‐ Establishing, monitoring and overseeing the firm's internal controls and risk management
‐ Ensuring the quality of the firm's financial reporting and internal audit
Board committees 1. Audit committee
‐ Oversight of the FR function and implementation of accounting policies
‐ Effectiveness of the company's IS and internal audit function
‐ Recommending external auditor and its compensation
‐ Proposing remedies based on their review of internal and external audits
2. Governance committee
‐ Oversight of the company's corporate governance code
‐ Implementing code of ethics and policies regarding conflicts of interest
‐ Monitoring changes in relevant laws and regulation
‐ Ensuring compliance with laws, regulations and governance policies
3. Nomination committee
‐ Proposed candidates for board election
‐ Manage the search process
‐ Align board composition with corporate governance policies
4. Compensation committee
‐ Recommend the amounts and types of compensation paid to directors and senior manager
‐ Oversight benefit plan and evaluation of senior managers
5. Risk committee
‐ Inform appropriate risk policy and risk tolerance of the organisation
‐ oversee risk management process of the organisation
6. Investment committee
‐ review and reports proposals for large acquisitions or projects, sale or other disposal of company assets/segments
‐ reviews and reports the performance of acquired assets and other large capital expenditure
Factors affect stakeholder 1. Communication and engagement with shareholders to support management in the negative events
relationship and corporate 2. Shareholder activism pressure companies in which they hold significant number of shares for changes by initiating lawsuit, seeking presentation on BOD, proposing resolution for a
governance vore, raising issues to gain wider support
3. Threat of hostile takeover (management pursue policies more in allignment with the interest of shareholders) and existence of anti‐hostile takeover provisions (↑issues of
corporate governance and conflicts of interest)
4. Company legal environment shareholders are better protected in countries with common‐law system, rather than civil law system
5. Proxy fight a group of shareholders may seek proxies to vote in favor of their proposals and policies
Risks of poor corporate Risks of porr corporate governance Benefits of effective corporate governance
governance / Benefits of effective ‐ Some stakeholders could gain advantage, at the costs of others (e.g.: accounting fraud, ‐ Align managers' interest with shareholders' interest → ↑ opera onal efficiency
corporate governance poor recordkeeping) ‐ Avoid legal and regulatory risks
‐ Manager may choose lowe‐than‐optima risk →lower company's value ‐ Better operating results
‐ Managers might have incentive that causes them to pursue their own interest, rather ‐ ↓ risk of debt default and bankruptcy → ↓ cost of debt financing
than the company's benefit ‐ Better performance, ↑ company value
‐ Legal risks: stakeholders lawsuits
‐ Reputation risks: failure to comply with Government's regulations
‐ Failure to manage creditors' rights →debt default and bankruptcy
Factors relevant to analysis of 1. Ownership and voting structure
corporate governance and Dual class share structure: one class of share might be entitled to several votes per share, while other classes are entitled to 1 vote / share
stakeholder management Companies with dual‐class share structure are traded at a discount to comparable companies with single class of shares
2. Composition of board
Consideratons on whether directors:
‐ are ED, NED or independent directors
‐ involve in RPTs with the company
‐ have diversified of expertise that suits the company's strategy and challenges
‐ have served for too long and may become too close to the company's management
3. Management incentives
‐ Offer cash incentives to achieve ST goals, at the expense of building LT value using equity incentives
‐ Performance‐based incentive is fairly stable overtime → performance targets are easy toachieve
‐ Management remuneration is too high compared to the industry
‐ Management incentives are not aligned with company's strategy and objectives
4. Composition of shareholders
Affiliate company holds a significant portion of shares → able to dictate company's policy and direc on, hinder change by protec ng from poten al hos le takeovers and ac vist
shareholders
5. Relative strength of shareholders' rights
Weak shareholders' rights → difficult to realise increase in shareholder returns from being acquired or from significant chanes in corporate strategy
6. Management of LT risks
Failure to manage stakeholder issues / Failure to manage other LT risks to company's sustainability → bad consequences for shareholders
Environmental and social ESG integration / ESG investing: making investment decisions with the use of environmental, social and governance factors
considerations in investment Considered issues: harm to the environment, risk of loss due to environment accidents, changing in demographics of workforce changing in work preference
analysis
ESG integration method 1. Negative screening: Exclude certain companies / industries (e.g.: mining and oil production)
2. Positive screening: identify companies with best practices across environmental sustainability, employee right and safety, and overall governance practices
3. Impact investing: investing to promote specific social / environmental goals
4. Thematic investing: investing based on single goal (e.g.: development of alternative energy sources; clean water resoruces)
Corporate Governance and ESG ‐ Introduction
Corporate Governance Definition:
‐ System of internal controls and procedures by which individual companies are managed
‐ Provide a framework that defines the rights, roles and responsibilities of various group within an organisation
‐ Is an arrangement of checks, balannces and incentives a company needs, to minimise and manage conflicts of interests between insiders and external shareholders
Shareholder theory:
Primary focus on the interests of shareholders ‐ maximise market value of firm's common equity
Corporate governance focuses on managers ‐ owners conflict
Stakeholder theory:
Consider conflict among groups that have interest in the firm's activities and performance (shareholders, employees, suppliers, customers)
Stakeholder groups and interests ‐ 1. Shareholders
Sharehoders Description:
‐ Have residual interest in the firm
‐ Have voting right → have effec ve control of the firm and its management
Interest: In the ongoing profitability and growth of firm, which can increase value of their shares
Stakeholder groups and interests ‐ 2. BOD
BOD Responsibility:
‐ protect the interest of shareholders
‐ Hire, fire and set the compensation of firm's senior managers
‐ Set strategic direction of the firm
‐ Monitor the financial performance and other aspect of the firm's ongoing activities
Stakeholder groups and interests ‐ 3. Senior managers
Senior managers Description: receive compensation made up of salary, bonus and perquisites
Interest:
‐ continued employment, maximise total value of compensation
‐ Bonus is tied to some measure of firm performance → interest in the financial success of the firm
Stakeholder groups and interests ‐ 4. Employees
Employees Interest:
‐ pay rate, opportunities for career advancement, training and working conditions
‐ Sustainability and success of the firm
Stakeholder groups and interests ‐ 5. Creditors
Creditors Definition:
‐ supply debt capital to the firm
‐ do not have vote in firm management, do not participate in firm growth
Interest:
‐ protected to varying degrees by covenants in their deb agreements with the firm
Stakeholder groups and interests ‐ Suppliers
Suppliers Definition: supply resources
Interest:
‐ preserve an ongoing relationship with the firm, profitability if their trade with the firm and the growth and ongoing stability of the firm
‐ firm's solvency and on‐going financial strength
Principal ‐ agent conflict Agent is hired to act in the interest of the principal, but agent's interest may not coincide exactly with principal's iinterest
Conflict of interest: shareholders Shareholders = Principal ; Director = agent
vs. Directors Reasons for conflict:
‐ Risk of directors (more dependent on firm performance)≠ Risk of shareholders (hold a diersified portfolio)
‐ Directors favor self‐iinterest at the expense of shareholders
‐ Directors favor a group of shareholders at the expense of another
‐ Information asymmertry: Directors have more and better information about the functioning of the firm and its trategic direction than shareholders
Conflict of interest: Group of A single shareholder / group of shareholders might hold a majority of votes and act against the interest of the minority shareholders. E.g.:
shareholders ‐ Acquisition: controlling shareholders may be in a position to get better term than minority shareholders
‐ Majority shareholders may cause the firm to enter RPTs that benefit entities in which they have a financial interesst, at the expense of minority shareholders
Conflict of interest: Creditors vs. ‐ Shareholders prefer more business risk than creditors, since creditors have limited upside from good results compared to shareholders
shareholders ‐ Shareholders could act against the interest of creditors by issuing new debt / paying greater dividend →↑ default risk faced by creditors
Conflict of interest: Shareholders ‐ ↑ price / ↓ quality to increase profit, at the expense of customers
vs. Other stakeholders ‐ Employ strategy to reduce taxes
Stakeholder management Manage the Company' relationship with stakeholders based on having a good understanding of stakeholder interest and maintaining communication with stakeholders
Based in 4 types of infrastructures:
1. Legal infrastructure: Identify relevant laws and legal recourse of stakeholders whien their rights are violated
2. Contractual infrastructure: contracts between the company and its stakeholders that specify the rights and responsibilities of the company and stakeholders
3. Organisational infrastructure: Company's corporate governance procedures, including internal systems and practices that address how to manage stakeholders relationships
4. Governmental infrastructure: regulations that the Company are subjected
Annual general meeting Hold at the end of the firm's fiscal year, to provide shareholders with audited financial statements, performance and significant indicators over the period, and answers to
shareholders
Extraordinary general meeting Hold at any time, to vote for special resolutions (e.g.: merger or takeover, amendment of corporate bylaws, etc.)
Board structure One‐tier board: Single BOD, with both internal directors (EDs) and external directors (NEDs)
Two‐tier board: Includes supervisory board (NEDs only) and management board (EDs only). Supervisory and management board operate independently
, Board's duties ‐ Selecting senior management, setting their compensation, evaluating their performance
‐ Setting the strategic direction for the company
‐ Approving capital structure changes, significant acquisitions, and large investment expenditures
‐ Reviewing company performance and implementing any neccessary corrective steps
‐ Planning for coninuity of management and the suceession of the CEO
‐ Establishing, monitoring and overseeing the firm's internal controls and risk management
‐ Ensuring the quality of the firm's financial reporting and internal audit
Board committees 1. Audit committee
‐ Oversight of the FR function and implementation of accounting policies
‐ Effectiveness of the company's IS and internal audit function
‐ Recommending external auditor and its compensation
‐ Proposing remedies based on their review of internal and external audits
2. Governance committee
‐ Oversight of the company's corporate governance code
‐ Implementing code of ethics and policies regarding conflicts of interest
‐ Monitoring changes in relevant laws and regulation
‐ Ensuring compliance with laws, regulations and governance policies
3. Nomination committee
‐ Proposed candidates for board election
‐ Manage the search process
‐ Align board composition with corporate governance policies
4. Compensation committee
‐ Recommend the amounts and types of compensation paid to directors and senior manager
‐ Oversight benefit plan and evaluation of senior managers
5. Risk committee
‐ Inform appropriate risk policy and risk tolerance of the organisation
‐ oversee risk management process of the organisation
6. Investment committee
‐ review and reports proposals for large acquisitions or projects, sale or other disposal of company assets/segments
‐ reviews and reports the performance of acquired assets and other large capital expenditure
Factors affect stakeholder 1. Communication and engagement with shareholders to support management in the negative events
relationship and corporate 2. Shareholder activism pressure companies in which they hold significant number of shares for changes by initiating lawsuit, seeking presentation on BOD, proposing resolution for a
governance vore, raising issues to gain wider support
3. Threat of hostile takeover (management pursue policies more in allignment with the interest of shareholders) and existence of anti‐hostile takeover provisions (↑issues of
corporate governance and conflicts of interest)
4. Company legal environment shareholders are better protected in countries with common‐law system, rather than civil law system
5. Proxy fight a group of shareholders may seek proxies to vote in favor of their proposals and policies
Risks of poor corporate Risks of porr corporate governance Benefits of effective corporate governance
governance / Benefits of effective ‐ Some stakeholders could gain advantage, at the costs of others (e.g.: accounting fraud, ‐ Align managers' interest with shareholders' interest → ↑ opera onal efficiency
corporate governance poor recordkeeping) ‐ Avoid legal and regulatory risks
‐ Manager may choose lowe‐than‐optima risk →lower company's value ‐ Better operating results
‐ Managers might have incentive that causes them to pursue their own interest, rather ‐ ↓ risk of debt default and bankruptcy → ↓ cost of debt financing
than the company's benefit ‐ Better performance, ↑ company value
‐ Legal risks: stakeholders lawsuits
‐ Reputation risks: failure to comply with Government's regulations
‐ Failure to manage creditors' rights →debt default and bankruptcy
Factors relevant to analysis of 1. Ownership and voting structure
corporate governance and Dual class share structure: one class of share might be entitled to several votes per share, while other classes are entitled to 1 vote / share
stakeholder management Companies with dual‐class share structure are traded at a discount to comparable companies with single class of shares
2. Composition of board
Consideratons on whether directors:
‐ are ED, NED or independent directors
‐ involve in RPTs with the company
‐ have diversified of expertise that suits the company's strategy and challenges
‐ have served for too long and may become too close to the company's management
3. Management incentives
‐ Offer cash incentives to achieve ST goals, at the expense of building LT value using equity incentives
‐ Performance‐based incentive is fairly stable overtime → performance targets are easy toachieve
‐ Management remuneration is too high compared to the industry
‐ Management incentives are not aligned with company's strategy and objectives
4. Composition of shareholders
Affiliate company holds a significant portion of shares → able to dictate company's policy and direc on, hinder change by protec ng from poten al hos le takeovers and ac vist
shareholders
5. Relative strength of shareholders' rights
Weak shareholders' rights → difficult to realise increase in shareholder returns from being acquired or from significant chanes in corporate strategy
6. Management of LT risks
Failure to manage stakeholder issues / Failure to manage other LT risks to company's sustainability → bad consequences for shareholders
Environmental and social ESG integration / ESG investing: making investment decisions with the use of environmental, social and governance factors
considerations in investment Considered issues: harm to the environment, risk of loss due to environment accidents, changing in demographics of workforce changing in work preference
analysis
ESG integration method 1. Negative screening: Exclude certain companies / industries (e.g.: mining and oil production)
2. Positive screening: identify companies with best practices across environmental sustainability, employee right and safety, and overall governance practices
3. Impact investing: investing to promote specific social / environmental goals
4. Thematic investing: investing based on single goal (e.g.: development of alternative energy sources; clean water resoruces)
