Title: Strengthening Corporate Governance with the OECD Principles: An Outcomeoriented Approach
1Strengthening Corporate Governance with the OECD
Principles An Outcome-oriented Approach
- Dr. William Witherell
- Director for Financial and Enterprise Affairs
- Organization for Economic Cooperation and
Development (OECD) - Academy of European Law Seminar
- Corporate Governance Legal Implications for
Europe and the United States - Trier, Germany 7-8 March, 2005
2BACKGROUND AND OVERVIEW
- After Asian Crisis, corporate governance reform
seen as a priority for emerging markets. - OECD Principles agreed in 1999 and soon became
the international benchmark. - More recent wave of corporate scandals and large
failures in major OECD advanced market economies
undermined investor confidence and has lead to
wide-spread governance reforms. - OECD in 2003-4 carried out a review and updating
of the Principles in light of recent experience.
3But why do national and international
policy-makers care about corporate governance??
- The dominance of the joint-stock corporation
- Institution building in less developed countries
- The growth of the private corporate sector
- The growth of equity markets
- The growth of international private capital flows
4Corporate Governance influences the outcomes at
all stages of the investment process
- The mobilization or raising of capital (in both
domestic and international markets) - The allocation of capital to its most effect uses
- The monitoring of how capital is employed
5Why core principles?
- Enormous variation in ownership and control
structures in the world - No single model of good corporate governance but
need for a global language - Detailed codes, best practices should be
established at national and regional levels - Objective to identify common elements or core
principles underlying good corporate governance
across the different systems a multilateral
policy framework
6Implications of core principles
outcome-oriented
- The Principles cover the general features or
functions to be in place, e.g. high level of
accounting standards, diligent and capable
directors. - These are termed outcomes.
- They involve functional equivalence they can be
achieved in many different ways and with
different institutions. - Principles need, therefore, to be adapted to the
legal and institutional environment of each
country.
7The OECD Principles are based on a wide
interpretation of corporate governance, which
emphasises resource inputs
-
- Corporate governance involves a set of
relationships between a companys management, its
board, its shareholders and other stakeholders.
Corporate governance also provides the structure
through which the objectives of the company are
set, and the means of attaining those objectives
and monitoring performance are determined.
8Moreover,
- Good corporate governance should provide proper
incentives for the board and management to pursue
objectives that are in the interests of the
company and shareholders and should facilitate
effective monitoring, thereby encouraging firms
to use resources more efficiently.
9Two implications for the desirable
characteristics (outcomes) of a corporate
governance system
- Checks and balances
- A structure of incentives that is compatible with
the checks and balances and with achieving the
objectives of the company
10Intended uses of the Principles
- Primarily aimed to provide a conceptual framework
for governments. - Guidance also for stock exchanges, investors,
corporations, commissions. - A benchmark that facilitates convergence.
11The Principles are the international benchmark
- Endorsed by the Financial Stability Forum as one
of 12 Key Standards for Sound Financial Systems - Used as the basis of the corporate governance
component of the World Bank/IMF Reports on the
Observance of Standards and Codes (ROSC) - Recommended by the Emerging Markets Committee of
the International Organization of Securities
Commissions (IOSCO) - Provide a basis for numerous national or
sector-specific codes and listing requirements.
12The objectives of international co-operation
under OECD-World Bank Corporate Governance
Partnership
- To build the rudiments of a global normative
framework - To build a corporate governance culture among
corporations and investors - To marshal human and financial resources at a
global level in order to help regional and local,
private and public efforts bear their fruits.
13OECD-World Bank Regional Corporate Governance
Roundtables
- Public-Private regional dialogue.
- Participants are senior policy- makers,
regulators, corporations, investor, professional
organizations, labor, and others. - OECD Principles are a framework for the dialogue.
14Non-OECD Countries in the Roundtables
- Asia Bangladesh, China, HK (China), India,
Indonesia, Malaysia, Pakistan, Philippines,
Singapore, Sri Lanka, Chinese Taipei, Thailand,
Viet Nam - Latin America Argentina, Bolivia, Brazil, Chile,
Columbia, El Salvador, Peru, Uruguay, Venezuela - Eurasia Armenia, Azerbaijan, Georgia,
Kazakhstan, Kyrgyz Rep., Mongolia, Ukraine,
Uzbekistan - South Eastern Europe Albania, Bosnia-Herzegovina,
Bulgaria, Croatia, FYR of Macedonia, Serbia and
Montenegro, Romania - Russia
15Objectives of the Roundtables
- Improve understanding through peer discussion and
exchange - Identify areas for improvement and formulate
reform agenda the White Papers - Facilitate regional participation in global
dialogue on corporate governance - Identify needs and facilitate provision of
technical assistance.
16Core Elements of the OECD Principles
- Assuring an effective framework(1)
- The rights of shareholders
- The equitable treatment of shareholders
- The role of stakeholders
- Disclosure and transparency
- The responsibility of the boards
(1) This chapter added in 2004
17Setting the new Chapter 1 aside until later, let
us look briefly at chapters II to VI in reverse
order to better understand the overall logic of
the original Principles.
18VI. The responsibilities of the boardThe
corporate governance framework should ensure the
strategic guidance of the company, the effective
monitoring of management by the board, and the
boards accountability to the company and the
shareholders.
- Thus the board serves as the fulcrum, balancing
the ownership rights enjoyed by shareholders with
the discretion granted to managers to run the
business.
19V. Disclosure and transparencyThe corporate
governance framework should ensure that timely
and accurate disclosure is made on all material
matters regarding the corporation, including the
financial situation, performance, ownership, and
governance of the company.
- The process of disclosure and the integrity of
the accounting and financial reporting systems
should be overseen by the board. - Disclosure should include information about the
control structures and ownership of the firm
which should make potential conflicts of interest
(i.e. the incentive structure) transparent.
20Principles II, III and IV concern shareholders
and stakeholders, who have an important role in
effecting checks and balances
- II. The rights of shareholders
- The corporate governance framework should
protect shareholders rights. - 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.
21Stakeholders include employees, creditors,
depositors, pensioners
- IV. The role of stakeholders in corporate
governance - The corporate governance framework should
recognize the rights of stakeholders as
established by law and encourage active
co-operation between corporations and
stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises.
22In sum,
- The Principles thus comprise checks and balances
the board oversees management and is in turn
overseen by shareholders, creditors and
stakeholders who must be sufficiently informed to
do this. - Information should also make it possible to
understand the incentive structure facing the
board and management and thus make the checks and
balances effective.
23The 2002 call by OECD Ministers for an
assessment/review of the Principles
24Policy concerns and driving forces
- Corporate scandals and large failures.
- New awareness of links between corporate
governance arrangements and growth - Revealed need for improving
- Implementation and enforcement
- Transparency and disclosure
- Alignment of incentives
- Monitoring by boards
- Shareholder rights
-
25Recent Legal or Regulatory Changes in G-7
26OECD Ministers at their 2002 Annual Meeting
- Observed that the integrity of corporations,
financial institutions and markets is essential
to maintain confidence and economic activity and
to protect the interests of stockholders. - Agreed to implement best practices in corporate
and financial governance which entails an
appropriate mix of incentives, balanced between
government regulations and self regulation,
backed by effective enforcement. - Agreed to survey recent experience and assess the
Principles of Corporate Governance.
27The Review Process
- OECDs Steering Group on Corporate Governance
carried out the Review (30 OECD Governments,
World Bank, IMF, IOSCO, BIS, Basel Banking
Committee, BIAC, and TUAC) - Consultations held with a wider group of
interested parties, with non-OECD countries, and
with several high-level roundtables chaired by
the Secretary-General - A survey of corporate governance developments in
OECD countries since 1999, and a summary of
experiences in non-OECD countries were produced. - Draft revisions placed on web for comment.
- 2004 Revision of the Principles endorsed by OECD
Ministers in May 2004
28The key reference
- OECD PRINCIPLES OF CORPORATE GOVERNANCE - 2004
- Available for free download at www.oecd.org/corpor
ate
29And for developments in the OECD and non-OECD
countries
- CORPORATE GOVERNANCE A SURVEY OF OECD COUNTRIES
2004 - EXPERIENCE FROM THE REGIONAL CORPORATE GOVERNANCE
ROUNDTABLES 2003 - Also available at WWW.OECD.ORG/CORPORATE
30Five sets of issues at the forefront of
discussions
- Ensuring an adequate regulatory framework for
corporate governance, taking account of costs - The effective exercise of share ownership and the
increasing role of institutional investors - The changing nature and role of the board
- Dealing with conflicts of interest
- Stakeholder concerns
31Issue 1 Ensuring an adequate regulatory
framework for corporate governance, taking
account of costs
32Implementation and enforcement of laws,
regulations and codes
- Enacting laws, regulations and codes that meet
international standards is the easy step
effective implementation and enforcement is much
more difficult. - Scope and content of self regulation is under
scrutiny incentives facing the professions may
conflict with their integrity and credibility to
uphold and enforce expected standards. - Capacity and independence of regulatory and
enforcement authorities are a serious concern,
especially in emerging market and transition
countries. - Legal and regulatory framework should provide
shareholders opportunity for effective legal
redress.
33Key elements of disclosure and transparency
- Major share ownership and voting rights
- Material foreseeable risk factors
- Full financial disclosure
- Governance structure and policies
- Information should be prepared audited and
disclosed in accordance with high standards of
accounting, audit and non-financial disclosure - Regular disclosure
34The integrity of the disclosure process and of
transparency have been called into question
- Rules-based accounting leads to show me I cant
do it mentality. - Holes such as derivative, pension and options
accounting are too wide. - Audit independence called into question. They
think they are employed by management. - Standards of the big 4 not what they were
expected. Peer review failed.
35Reactions
- Auditor independence strengthened both
structurally and by rules. - Move effective responsibility to another organ
than management - Convergence of accounting standards -- but
implementation an issue. - Greater consideration of disclosure of material
information - More calls for non-financial disclosure
36Auditors in G-7
37- IOSCO released (Oct. 2002) principles for
national standards covering auditor independence
and auditor oversight. - Reflect a growing international consensus.
- Many in OECD consider these principles to be
minimum requirements. - Importance of audit firms establishing internal
monitoring and control systems. - Auditors should be subject to an independent
auditor oversight body, or if a professional body
plays that role, it should be overseen by an
independent body.
38The Financial Stability Forum has underscored
the importance of progress towards a single set
of high quality principles-based accounting
standards, with due regard to financial stability
concerns.
- US moving closer to a principles-based system.
- Process in place to work towards convergence of
IAS and US GAP. - EU (including its candidate states), Australia,
NZ, Hong Kong, Russia, Singapore to adopt IAS. - Indeed, GAAP Convergence 2002 survey of 59
countries indicated that all but three ( Japan,
Saudi Arabia and Iceland) intend to converge
with IAS.
39- A number of countries have moved to require
better disclosure of board and executive
compensation - Nomination and appointment of the board is a key
corporate governance decision transparent and
even-handed nomination and recruitment process is
needed. - Remuneration including information on the
structure of compensation schemes and termination
conditions relevant not only for financial
implications but also for assessing incentives
and performance. - Some countries call for disclosure of individual
remuneration others ask for only aggregate board
compensation. - NYSE and NASDAQ have proposed independent
compensation committees codes and principles in
other countries go in same direction.
40- Ensuring that corporate service providers work
in the interests of shareholders - In exercising ownership rights, shareholders have
to rely on agents (brokers, investment advisors,
analysts, rating agencies) for information. - Recently a number of cases of serious conflicts
of interest and inappropriate incentives have
come to light. - Responses include changes in stock exchange rules
and professional codes of conduct, structural
changes such as firewalls, and increased
disclosure, e.g., of material conflicts of
interest.
41The Principles Ensuring an adequate regulatory
framework for corporate governance, taking
account of costs ( A new Chapter 1)
- Clear objectives for policy in establishing a
system leading to transparent and efficient
markets. - Legal and regulatory instruments to be
transparent and enforceable. - Clear division of responsibilities between
domestic authorities - Supervisory, regulatory and enforcement
authorities should have authority, integrity and
resources to fulfil duties. - Greater role for shareholders and improved
transparency - Improved financial market integrity (see next
slide)
42Also assuring financial market integrity
- Better disclosure by the company including
related party transactions - Boards to focus on overseeing internal controls
and major accounting assumptions through
independent audit committee. - More emphasis on auditor independence and
reference to IOSCO standards. - Accountability of external auditors to
shareholders and duty of professional care to the
company - Those providing analysis and advice to be free of
conflicts of interest
43Issue 2 The effective exercise of share
ownership and the increasing role of
institutional investors
44The corporate governance framework should protect
shareholders rights
- Right to have shares registered and secure
- Should be able to take part in shareholder
meetings and in major decisions concerning the
firm - Equitable treatment of all shareholders, foreign
and minority especially - Should not be abused by insiders
45But in practice the rights are often weak and
redress is difficult
- Need for greater voice through strengthened
voting rights and information - More active institutional investors and
disclosure of their conflicts of interest - In presence of major shareholders improve
protection of minority shareholders - Takeovers often blocked
46Improving Shareholder voice
- The ability of shareholders to elect board
members of their choice, to table proposals and
ask questions of directors is, in reality, very
limited in a number of countries. - Should shareholders be given more decision rights
with respect to board and executive compensation? - Need to avoid shareholders second guessing
management
47Ownership and shareholding structures
- The transparency of ownership and shareholding
structures, including pyramids that result in
control rights being greater than cash flow
rights, is limited in many cases. - The Regional Roundtables have called for
improvements in the disclosure of beneficial
ownership to assist in efforts to curb abusive
related party transactions. - Beneficial ownership information also is
important for the battle against international
financial crime
48- Regional Roundtables on shareholder rights and
equitable treatment - Typically high degree of concentrated ownership,
with control through pyramids and cross-holdings,
combined with weak shareholder protection and
insufficient disclosure equitable treatment of
shareholders is a pivotal issue. - Need to facilitate the exercise of shareholder
rights. - Minority shareholder rights in relation to
changes in capital structure, in corporate
control and delisting a concern (lack of
pre-emptive or tag-along rights, etc.) - Voting of depository receipts.
- Frequent abuse of related party transactions
improved disclosure needed.
49- Improving and facilitating the exercise of
voting rights - Exercise of voting rights varies widely
- VOTES CAST BY INVESTORS AS A OF TOTAL
- U.S. Japan
U.K. - 83 71-80
50 - Greater use of electronic communications?
- Institutional investors that act as fiduciaries
being pressed to be more active. - Legal and practical problems to cross-border
voting widespread among the OECD countries.
50Over The Past Two Decades Institutional
Investors Have Grown Significantly In Size and
Importance
Source OECD Institutional Investors Statistical
Yearbook 2003
51Financial assets of institutional investors as a
per cent of GDP Some individual countries
Source OECD Institutional Investor Yearbook 2003
52The rights and responsibilities of institutional
investors.
- While institutional ownership is growing in size
and importance, institutional investors typically
play a limited role in corporate governance. - The issue is not always to add to their already
established rights as shareholders. The problem
is that they do not make use of them. - This is partly due to a lack of proper incentives
and sometimes due to restrictions on their
ability to set aside sufficient resources to
carry out key ownership functions in an informed
way.
53Should those who act as fiduciaries disclose
their voting policies? If they do, it would also
be natural to ask that they disclose how they, in
practice, will implement these policies for
example what resources will they set aside to
carry out their ownership functions
54The Principles The effective exercise of share
ownership and the increasing role of
institutional investors
- Call for effective shareholder participation in
key decisions such as the nomination and election
of board members, proposing resolutions and
making views known on compensation policy - Improved possibilities for shareholders to
consult with each other on key governance issues.
- Eliminating impediments to cross border voting
- Call for institutional investors acting in a
fiduciary capacity to declare voting policies and
how they are handling conflict of interests
55Also control abuse between related companies
- Clear statement on fiduciary duties of board
members to the company and not to the company
group. - Explicit statement that boards to review related
party transactions using independent directors - Stronger annotations on disclosure of related
party transactions - Stronger principle on board and executive
disclosure of material interests - Stronger call for protection of minority
shareholders
56Issue 3 The changing nature and role of the board
57Hes becoming insufferably More transparent than
thou!
58- Towards independent and more effective boards
- Moves towards increasing not only the number of
non-executive directors but also ensuring they
are independent - 1. UK - Higgs Report
- 2. Japan new company law
- 3. US
- Commission on Public Trust and Private
Enterprise NYSE - Sarbanes-Oxley
- Independence of judgement and independence from
management.
59Board Integrity Issues
- Responsibility to Whom? Is it Clear?
- Duty of Loyalty / Duty of Care
- Status of Independent Directors
- Legal Status of Committees
- Alternate / Supplementary Directors
60Legal requirements for boards in the G-7
61The Principles The changing nature and role of
the board
- More general statement of board independence to
cover those in a position to influence the
company and not just management - Greater possibilities for shareholders to
question boards and to participate - Tightening of fiduciary responsibility of boards
- Strengthened principle calling for boards to
establish ethical guidelines and effective
compliance procedures
62The board (continued)
- Boards to oversee internal controls and provide
confidential access to whistleblowers - Disclosure of mandate, working procedures and
composition of board committees - Boards to align key executive and board
remuneration with the longer terms interests of
company and shareholders and establish a
remuneration policy
63Issue 4Dealing with conflicts of interest
64The Principles Dealing with conflicts of
interest
- Institutional investors called on to disclose
conflicts of interest and how they manage them. - Providers of advice to investors, such as
analysts and brokers, should provide advice free
from conflicts of interest - Tighter conditions specified to ensure no
material conflict of interest by auditors and
thereby guard auditor independence - Tightened disclosure standards to the board and
to the market
65Issue 5 Stakeholder Concerns
66The role of stakeholders in corporate governance
- Stakeholders include creditors, depositors and
employees - Encourage active co-operation between between
company and stakeholders - Performance enhancing mechanisms should be
available - Redress for violation of legal rights
- Access to relevant information
67Stakeholders Issues are complex and difficult.
Best to consider two major groups- creditors and
employees separately
- Creditor rights are important for the terms and
conditions of finance - These rights arise from bankruptcy and other
laws, but in some countries these rights are
deficient and/or the courts are poorly structured
to enforce them. - Recent reforms in Germany, Japan and Italy.
- Reorganization procedures and the rights of
creditors to remove management vary widely. - World Bank and UNCITRAL developing principles.
68- Regional Roundtables have stressed their
concerns about corporate practices that impede
the opportunities for employees - to seek redress for violation of their rights.
- To communicate their concerns about illegal or
unethical transactions they have observed or
asked to undertake. - Such complaints can provide important
information to shareholders.
69The Principles The role of stakeholders
- Recognise the role of stakeholders to creating
value and therefore corporate governance
framework should recognise their interests. - Whistleblower protection is now a principle
covering individuals and their organisations - Better disclosure to stakeholders and of company
policy towards them. - Improved powers for shareholders and greater
pressure for institutions to disclose voting
policies important for pensions. - Principle that board should set company ethics
and establish a compliance policy will benefit
employees
70Summary of steps toward implementing more robust
corporate governance regimes
- Review regulatory costs of any proposed measure
and whether there are any more effective
instruments at hand. - Strengthen market disciplines as they are the
most effective continuing discipline on
management. Give emphasis to getting incentives
aligned properly. - Strengthen the ownership function of
shareholders. - Monitor the governance system particularly the
effects of new measures.