Discuss about the Role of Corporate Governance for Control and Management.
Strengths and Weaknesses of the Market-Based System of Corporate Governance
Corporate governance can be defined as the control and management system of organization based on some principles and best practices in this field. Corporate governance provides rules and proper framework of control by which both shareholders as well as partners can be managed. No corporate governance is perfect. There are many strengths and weaknesses in every country’s’ corporate governance (Jeffers, 2005). The strengths and weaknesses of Anglo countries such as the United Kingdom, the USA and New Zealand are as follows:
Strength and Weaknesses of Corporate Governance in Anglo Countries:
Strengths- The U.S. system has ability to fill the gaps in conditional contracts and resolve the agency problems. The management system of U.S. does a good job of policing efforts to switch corporate efforts to their own uses. The laws of U.S. have rules to protect minority shareholders from misuse. In UK, there is Cadbury model and report which ensures the quality of information provided by both of the parties. The guidance of UK has played important role for the investors to understand board structure and composition (Mallin, 2006).
Weakness- Although U.S. system is doing good job but it provides mixed result. Because of mixed policies, investors are facing problems in public companies. Along with this, U.S. system is working poorly in terms of controlling agency costs. The U.S. system is much depending on share market rather than banks and this is the reason of political issues. Succession issues may be a major problem. Sometimes corporate governance cannot be successful in some areas. The weakness of New Zealand and UK’s corporate governance is that it is failure to focus on the critical issues such as social and environmental issues (Martynova & Renneboog, 2011).
Comparison Between European and Asian Relationship-Based Insider Systems and the Market-Based System
European and Asian relationship-based System Vs Market-based System (advantage):
- There are wider group of stakeholders in European and Asian relationship-based System which are actively recognized. It includes customers, stakeholders, suppliers, banks and local communities. On the other hand, market based system has priority of market regulation (Maassen, 2002).
- European and Asian relationship-based System represents the diverse interests on the board of directors while market based system represents transitory interest of owner.
- European and Asian relationship-based System establishes close relationship with banks which provides stable finance while there is the absence of close relationship between shareholders and management in Market based system (FRANKS & MAYER, 2002).
- The European and Asian relationship-based System has inert-corporate shareholdings which provide stability of ownership. On the other hand, in the Market based system, there is an existence of an active market for corporate control. Shareholders have rights over the organizational group (The Institute of Chartered Accountants of New Zealand, 2003).
European and Asian Relationship-Based System Vs Market Based System (disadvantage) :
- The European and Asian relationship-based System is regulated by the securities market which is weak. While the Market based system is regulated by the banks and outsiders which is risky.
- Corporate control market is weak in European and Asian relationship-based System and there is a risk of takeover of poor performing companies. On the other hand, in the Market based model, the owners of the organizations are outsiders so there is a lack of direct monitoring (Hanson, L., Lorsch, W. J., & Wharton, C. R., 2016).
- There is a lack of development of institutional investors and financially stable banks in European and Asian relationship-based System and in Market- based system, there is low diversification opportunities because of outsider owners.
- There is a lack of public disclosure of information in European and Asian relationship-based System and there is less control of insider management on the organization.
- Minority groups are exercising control because of shareholders agreement and voting restrictions in European and Asian relationship-based System. On the other hand, there can be conflicts in the shareholders because of voting rights.
- The inter-locking business network can be the cause of complacency more than competitiveness in European and Asian relationship-based System and there can be competitiveness among the shareholders for the ownership in Market based System.
UK FRC Corporate Governance Code
The UK FRC Corporate Governance Code is valuable in that it demonstrates the way that governance has developed in most jurisdictions using the Anglo-American model, including New Zealand. There is a case given in the question. In the case, there are three points in the board composition of the company. Those points are as follows:
- The board chair is a non-executive director who holds a 25 percent shareholding in the company: This structure does not comply with components of the FRC Code because according to the UK FRC code, there should be at least two non-executive directors in the company. The board chair cannot be a non-executive director because he or she must be an independent person. Apart from this, according to the UK FRC code, they must be independent member of the company and they can hold any share in the company.
- Four of the board members are executive directors including the CEO and the CFO: According to the UK FRC code, there must be at least three to four executive directors. According to the UK FRC code, CEO and CFO can be the executive directors in the company (FMA, 2016).
- The board has one sub-committee – an audit committee with three members. This includes the board chair, an independent director and the CFO, who is able to provide specific information about the company: The Company is using defined and described structure of auditing committee. It is not mentioned in the FRC code i.e. the board should establish an audit committee of at least three, or in the case of smaller companies1 two, members. The company chairman may be a member of, but not chair, the committee in addition to the independent non-executive directors. Along with this, the board should satisfy itself that at least one member of the audit committee has recent and relevant financial experience.
Comparison Between UK FRC Code with the New Zealand FMA Principles and Guidelines
The UK FRC code is based on the expected actions and behavior of the board of directors within an organization. The FRC code sets out the best practices for some issues such as leadership, effectiveness, accountability, remuneration, and relation with the shareholders. This FRC code is based on the behavior of the board of directors of the company. On the other hand, FMA Principles and Guidelines are based on the ethical standard. The aim of the FMA Principles and Guidelines is that directors should set high standards of ethical behavior and hold the management ethically. Both the principles and practices can be compared on some points and those are as follows:
Board Composition and Performance:
- According to the UK FRC, there should be a clear vision by the head of the company. There should be executive responsibilities for the running of the business. On the other hand, according to the FMA Principles and Guidelines, there should be ethical standards which have to be set by the directors of the company.
- In the FRC code, the chairman is responsible for leadership of the board and ensuring its effectiveness on all aspects of its role. On the other hand, in FMA Principles and Guidelines director should be responsible for the business operation of the company.
- The board in the FRC code should meet sufficiently regularly to discharge its duties effectively. There should be a formal schedule of matters specifically reserved for its decision. While in FMA Principles and Guidelines, every issuer’s board should have an appropriate balance of executive and non-executive directors, and should include directors who meet formal criteria for ‘independent directors’.
- In the FRC code, the roles of chairman and chief executive should not be exercised by the same individual. The division of responsibilities between the chairman and chief executive should be clearly established, set out in writing and agreed by the board and in the FMA Principles and Guidelines, all directors should, except as permitted by law and disclosed to shareholders, act in the best interests of the entity (Stephen layburn, 2015).
- Deloitte, (2016). FRC consults on changes to the UK corporate Governance code. Retrieved on 3rd November 2016 https://www2.deloitte.com/content/dam/Deloitte/uk/Documents/audit/deloitte-uk-audit-governance-in-brief-frc-consults-april-2014.pdf
- (2016). Corporate Governance in new zealand. Retrieved on 3rd November 2016 from https://fma.govt.nz/assets/Reports/141201-FMA-Corporate-Governance-Handbook-Principles-and-Guidelines2014.pdf
- J., & MAYER, C., (2002). Corporate Governance in the UK – Contrasted with the us system. Retrieved on 3rd November 2016 from file:///C:/Users/Guest/Downloads/Forum302-focus3.pdf
- FRC News. (2016). UK Corporate Governance Code. Retrieved on 3rd November 2016 from https://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspx
- Hanson, L., Lorsch, W. J., & Wharton, C. R., (2016). Rating the corporate governance compact. Retrieved on 3rd November 2016 from https://hbr.org/1991/11/advice-and-dissent-rating-the-corporate-governance-compact
- Jeffers, E. (2005). Corporate governance: Toward converging models?, Global Finance Journal. Volume 16, Issue 2, p. 225.
- Lockhart, J., & Crow, , (2014). Corporate Governance issues in New Zealand and Australia. Retrieved on 3rd November 2016 from https://ethicalboardroom.com/global-news/corporate-governance-issues-new-zealand-australia/
- Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. Retrieved on 3rd November 2016 from file:///C:/Users/Guest/Downloads/Maassen_9789090125916.pdf
- Mallin, C. (2006). International corporative governance: a case study approach, Northampton, Massachusetts. USA: Edward Eldar Publishing Ltd.
- Martynova, M., Renneboog, L. (2011). Evidence on the international evolution and convergence of corporate governance regulations,:Journal of Corporate Finance. Volume 17, Issue 5, p. 1542.
- Stephen layburn. (2015). Corporate Governance in New Zealand – Revised Principles and Guidelines from the FMA. Retrieved on 3rd November 2016 from https://stephenlayburn.co.nz/corporate-governance-in-new-zealand-principles-and-guidelines
- The Institute of Chartered Accountants of New Zealand. (2003). Submission to the securities commission corporate governance principles. Retrieved on 3rd November 2016 from https://www.ecgi.org/codes/documents/grsccgr.pdf