The Corporate Governance of Listed Companies A Manual for Investors second edition 2009 Corp Governance_2nd Ed.online.pdf 1 9/25/2009 11:24:38 AM ©2009 CFA Institute The mission of the CFA Institute Centre for Financial Market Integrity is to promote ethical conduct, professional standards, and integrity in financial markets on behalf of CFA Institute members around the world. CFA Institute, with more than 96,000 members worldwide, is the not-for-profit organization that awards the Chartered Financial Analyst® (CFA) and Certificate in Investment Performance Measurement® (CIPM) designations. ISBN 978-0-935015-99-7 Corp Governance_2nd Ed.online.pdf 2 9/25/2009 11:24:43 AM The Corporate Governance of Listed Companies: A Manual for Investors second edition 2009 CFA Institute Centre for Financial Market Integrity Corp Governance_2nd Ed.online.pdf 3 9/25/2009 11:24:43 AM Corp Governance_2nd Ed.online.pdf 4 9/25/2009 11:24:43 AM Contents Introduction The Importance of Corporate Governance to Investors. . . . . . . . . . . . . . . . . . . . . 2 Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Summary of Corporate Governance Considerations . . . . . . . . . . . . . . . . . . . . . . . 6 The Board Board Independence. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Board Member Qualifications and Ability to Serve as Shareowner Representative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Authority to Hire External Consultants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Other Board Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Board Member Terms and Board Composition. . . . . . . . . . . . . . . . . . . . . . . . . 12 Related-Party Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Board Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Audit Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Remuneration/Compensation Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Nominations Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Other Board Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Board Communications with Shareowners. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Management Implementation of Code of Ethics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Personal Use of Company Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Corporate Transparency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Share-Repurchase and Price-Stabilization Programs . . . . . . . . . . . . . . . . . . . 25 Management Communications with Shareowners . . . . . . . . . . . . . . . . . . . . 26 Shareowner Rights Shareowner Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Ownership Structure and Voting Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Proxy Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Confidential Voting and Vote Tabulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Cumulative Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Voting for Other Corporate Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Shareowner Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Shareowner-Sponsored Board Nominations . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Shareowner-Sponsored Resolutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Advisory or Binding Shareowner Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Corp Governance_2nd Ed.online.pdf 5 9/25/2009 11:24:43 AM Other Shareowner-Rights Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Shareowner Legal Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Takeover Defenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Actions of Other Shareowners. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Appendix A. Existing and Proposed Corporate Governance Codes . . . . . . . . . . 37 Appendix B. Corporate Governance Studies and Research . . . . . . . . . . . . . . . . . 45 Corp Governance_2nd Ed.online.pdf 6 9/25/2009 11:24:43 AM 1 Introduction The past decade of business around the world has highlighted the role that corporate governance practices play in maintaining viable entities and safeguarding investors’ interests. The governance failures at Enron Corporation, Worldcom, Parmalat, and others in the early 2000s and the more recent troubles at the Bear Stearns Companies, Lehman Brothers Holdings, and Northern Rock illustrate the risks posed by corporate governance breakdowns. The global governance problems in the early part of this decade were characterized by a lack of transparency and internal controls. Many have pointed to inadequate risk management systems and to remuneration systems disconnected from the long-term strategic interests of the company as the main governance issues of the recent financial crises. In both cases, a lack of understanding of the risks being taken and a lack of overall industry expertise by boards played a crucial role. Losses of trillions of dollars of investors’ capital around the world illustrated that the existing set of corporate checks and balances on insiders’ activities have not protected shareowners from the misplaced priorities of board members, the manipulation and misappropriation of company resources by management, or the misunderstanding of risk (or failure to adequately measure risk) by management and other groups that exercised significant influence over a company’s affairs. It was with the goal of educating and empowering the investor that this manual was first produced. It endeavors to provide investors a way of assessing a company’s corporate governance policies and the associated risks.1 Since the first edition of this manual in 2005, many countries, industry groups, and constituencies have proposed or created new or amended corporate governance codes in response to the wide-ranging effects of recent corporate failures on global markets.2 Many of these codes established internal controls or set an ethical tone that focused on investors’ interests. Although these government-mandated and voluntary industry codes helped restore a degree of investor confidence in the markets, they provided only part of the answer. As we have witnessed in subsequent years, investors also must take the initiative to evaluate the presence—or absence—of corporate governance safeguards, as well as corporate cultures, at the companies in which they invest. In many cases such initiatives were not adequately taken, and governance safeguards were not effectively installed at a number of institutions—mainly financial institutions—which contributed to the crisis that has enveloped the global financial system, destroying trillions of dollars of public company market capitalization and dealing another serious blow to investor confidence in the integrity of the markets. Therefore, the CFA Institute Centre for Financial Market Integrity, through the work of its Global Corporate Governance Task Force, has updated the original manual. We hope that all interested parties—existing shareowners, analysts, and investors—can use this information as part of their analysis of a company and make decisions about investing in that company, in light of their particular investment perspectives, objectives, and risk-tolerance levels. The manual does not provide a set of best practices, nor does it take positions on the best corporate governance structures for investors. Instead, its purpose is to alert investors to the primary corporate governance issues and risks affecting companies and to highlight some of the factors they should consider when making investment decisions. Issuers of financial securities may also find this manual useful as a reference tool for determining what corporate governance issues are important to investors. We hope that this manual will raise awareness of the governance standards within the investment community. 1 See these and other publications from the CFA Institute Centre related to corporate governance issues at www.cfainstitute.org: The Compensation of Senior Executives at Listed Companies; Environmental, Social, and Governance Factors at Listed Companies; Shareowner Rights across the Markets. 2 See a complete list of government-mandated corporate governance codes in Appendix A. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 7 9/25/2009 11:24:43 AM 2 The Importance of Corporate Governance to Investors The most effective and productive corporate governance structures rely on active and prudent shareowner engagement. Benjamin Graham and David Dodd recognized the direct correlation between active ownership and strong governance as early as the 1930s, advising that: The choice of a common stock is a single act, its ownership is a continuing process. Certainly there is just as much reason to exercise care and judgment in being a shareholder as in becoming one.3 A number of studies published in recent years reinforce the link between good corporate governance and strong profitability and investment performance. (Details for accessing the studies discussed here and additional studies are in Appendix B.) For example, a joint study by Institutional Shareholder Services (ISS) and Georgia State University4 found that the best- governed companies—as measured by the ISS Corporate Governance Quotient—had mean returns on investment and equity that were, respectively, 18.7 percent and 23.8 percent better than those of poorly governed companies during the year reviewed.5 Research carried out by employees of the California Public Employees Retirement System (CalPERS) on the effects of the system’s Focus List suggests that efforts by investment funds to improve the governance of companies that are considered poorly governed also produce returns in excess of market performance.6 For this reason, one would expect investors to reward companies that have superior governance with higher valuations. Indeed, a study of U.S. markets by Paul Gompers of Harvard University and colleagues from Harvard and the University of Pennsylvania7 found that portfolios of companies with strong shareowner-rights protections outperformed portfolios of companies with weaker protections by 8.5 percent per year. A similar study in Europe found annual disparities of 3.0 percent.8 Academics and investors have continued to probe the link between corporate governance and performance. Some recent studies delve into specialized areas of corporate governance and performance, such as the effects of hedge fund activism targeting companies in need of improved corporate governance.9 Some studies have found that the mixed results previously found in determining the link between governance and performance may have something to do with the difficulty of defining exactly what constitutes good corporate governance at a level that is measurable by researchers and investors.10 3 Benjamin Graham and David Dodd, Security Analysis, 6th ed. (New York: McGraw Hill, 2009):540. 4 Lawrence D. Brown and Marcus Caylor, “Corporate Governance Study: The Correlation between Corporate Governance and Company Performance” (Institutional Shareholder Services, 2004). 5 See also Sanjai Bhagat and Brian J. Bolton, “Corporate Governance and Firm Performance,” working paper (June 2007). 6 Mark Anson, Ted White, and Ho Ho, “Good Corporate Governance Works: More Evidence from CalPERS,” Journal of Asset Management (February 2004). Also see “The Shareholder Wealth Effects of CalPERS’ Focus List” by the same authors, published in the Journal of Applied Corporate Finance (Winter 2003):8–17. The authors found that between 1992 and 2002, publication of the CalPERS Focus List, which identifies underperforming companies, and efforts to improve the corporate governance of companies on that list generated one-year average cumulative excess returns of 59.4 percent. Cumulative excess return was defined as the cumulative “return earned over and above the risk-adjusted return required for each public corporation.” 7 Paul A. Gompers, Joy L. Ishii, and Andrew Metrick, “Corporate Governance and Equity Prices,” Quarterly Journal of Economics (revised January 2009). The authors compared the investment performance of some 1,500 U.S.-listed companies with a corporate governance index that the authors constructed from 24 distinct governance rules. Also see Lucian Bebchuk, Alma Cohen, and Allen Ferrell, “What Matters in Corporate Governance,” Review of Financial Studies (February 2009). 8 Rob Bauer and Nadja Guenster, “Good Corporate Governance Pays Off!” research report (2003). This study used Deminor ratings of corporate governance as the basis for determining which companies perform better on the stock market relative to corporate governance quality. 9 Alon Brave, Wei Jiang, Randall S. Thomas, and Frank Partnoy, “Hedge Fund Activism, Corporate Governance and Firm Performance,” Journal of Finance (May 2008). 10 David F. Larker, Scott A. Richardson, and A. Irem Tuna, “Corporate Governance, Accounting Outcomes, and Organizational Performance,” Accounting Review ( October 2007). cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 8 9/25/2009 11:24:43 AM 3 This search for the link between governance and performance is not limited to developed markets. Even before the collapse of Enron, Amar Gill, an analyst at Credit Lyonnais Securities Asia Group, found that investors in emerging markets overwhelmingly prefer companies with good governance.11 Of the 100 largest emerging market companies CLSA Group followed, those with the best governance—based on management discipline, transparency, independence, accountability, responsibility, fairness, and social responsibility—generated five-year returns well above average.12 CLSA Group continues to focus research on corporate governance in emerging markets because its clients are investors that believe strong corporate governance can add value in the markets in which they invest. Studies linking corporate governance to performance (and attempting to disprove the link of governance to performance) are continually being published. Recently, in the wake of the crisis in global markets, a number of authors have tried to look back and, using corporate governance practices as a lens through which to evaluate a company’s practices, draw lessons from the governance failures of past years. These authors urge investors to ask pertinent governance questions of the companies in which they invest.13 We believe good corporate governance leads to better results for companies and for investors. Corporate governance, therefore, is a factor that investors cannot ignore but should consider in seeking the best possible results for themselves and their clients. Definitions In this manual, we have used the following definitions: Corporate Governance Corporate governance is the system of internal controls and procedures by which individual companies are managed. It provides a framework that defines the rights, roles, and responsibilities of various groups—management, board, controlling shareowners, and minority or noncontrolling shareowners—within an organization. At its core, corporate governance is the arrangement of checks, balances, and incentives a company needs in order to minimize and manage the conflicting interests between insiders and external shareowners. Its purpose is to prevent one group from expropriating the cash flows and assets of one or more other groups. In general, good corporate governance practices seek to ensure that: • board members act in the best interests of shareowners, although in some jurisdictions, good corporate governance is tied to the interests of a broader stakeholder group (e.g., labor groups, society at large). • the company acts in a lawful and ethical manner in its dealings with all stakeholders and their representatives; • all shareowners have a right to participate in the governance of the company and receive fair treatment from the board and management and all rights of shareowners and other stakeholders are clearly delineated and communicated; • the board and its committees are structured to act independently from management and individuals or entities that have control over management and other nonshareowner groups; • appropriate controls and procedures are in place covering management’s activities in running the day-to-day operations of the company; 11 Amar Gill, “Corporate Governance in Emerging Markets—Saints and Sinners: Who’s Got Religion?” Credit Lyonnais Securities Asia (April 2001). Gill points out that CLSA assigned corporate governance ratings to 495 companies in 25 markets. 12 The five-year returns reported by Gill amounted to 930 percent for the well-governed large-cap companies in emerging markets, versus the total average return of 388 percent for large-cap companies in emerging markets during that period. 13 See, for example, Julie Hudson, “Corporate Governance and Capital Markets,” UBS (2008). ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 9 9/25/2009 11:24:44 AM 4 • the company’s governance activities, as well as its operating and financial activities, are consistently reported to shareowners in a fair, accurate, timely, reliable, relevant, complete, and verifiable manner. How well a company achieves these goals depends in large part on (1) the adequacy of the company’s corporate governance structure and (2) the strength of the shareowner’s voice in corporate governance matters through shareowner voting rights. This manual focuses on these two areas as the way to evaluate the corporate governance practices of companies. Independence A number of national corporate governance codes and stock exchange–based rules14 prescribe factors to consider in determining the independence of board and board committee members. Each company, each code of corporate governance, and each market will have its own definition of independence, so investors need to be able to define independence and its importance for themselves. Generally, to be considered independent, a board member must not have a material business or other relationship with the following individuals or groups: • the company or its subsidiaries or members of its group, including former employees and executives and their family members; • individuals, groups, or other entities that can exert significant influence on the company’s management, such as controlling individuals, controlling families, or governments; • executive managers, including family members; • company advisers (including external auditors) and their families; • any entity that has a cross-directorship relationship with the company. Shareowners also need to understand how other relationships a director may have with a company may compromise his/her independence. Shareowners should understand whether directors • have recently had material business relationships with a company or • represent a company with substantial voting rights in the company in question. Board Members The term “board member” (which in some jurisdictions is termed “director”) in this manual refers to all individuals who sit on the board (defined below), including executive board members, independent board members, and nonindependent board members. Executive Board Members This term refers to the members of executive management. In a unitary board (or “committee system”), executive board members also serve as members of the board. In a “two-tiered” board, these individuals are part of only the management board. These individuals are not considered independent. Independent Board Members An independent board member is an individual who meets the qualifications listed under “independence.” Nonindependent Board Members Individuals in this category may represent interests that conflict with those of the majority of shareowners. This category may include board members who are affiliated with individuals or entities that have control over management, who are part of a cross- directorship arrangement with another listed company, or who are representatives of labor organizations. 14 See Appendix A for a list of national and exchange-based governance codes. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 10 9/25/2009 11:24:44 AM 5 Shareowners should also be cognizant of any individual, government entity, or organization that may qualify as a “shadow director”—namely, any holder of a controlling share of the company who is not a named director but who has a great deal of influence over management and the board. These individuals may be large stakeholders, sovereign wealth funds, governments, or other interested parties who may have motivations that are different from those of shareowners. Board The term “board” in this manual refers to a “supervisory” type of board (or “board of corporate auditors” in Japan) in countries with the two-tiered board structure. In countries that use a unitary board, the term refers to the board of directors. In most jurisdictions, corporate structures take the form of one or the other of these types, but in some countries, such as France and Japan, companies have the option of choosing which of the two structures to use. Two-Tiered (Dual) Board Common in some parts of Europe—Germany, the Netherlands, Austria and Denmark—the two-tiered board structure has two elements, the management board and the supervisory board: Management Board The management board consists exclusively of executive managers. It is charged, in consultation with the supervisory board, with running the company on a daily basis and setting the corporate strategy for the company. Its members do not sit on the company’s supervisory board. Supervisory Board The supervisory board is charged with overseeing and advising the company’s management board. Corporate Auditors System In Japan, the two-tiered board structure is called the “corporate auditors system” and is used by most large Japanese companies. The system includes (1) directors who are elected by shareowners and are responsible for business decisions and (2) a board consisting of corporate auditors, including at least one full-time corporate auditor. At least half the members of the board of corporate auditors must be outside auditors. These corporate auditors are elected separately by shareowners and are charged with auditing the performance of the board. Unitary Board In a unitary board structure, the board may include executive, nonexecutive, and independent board members. The board oversees and advises management and helps set corporate strategy, although in many jurisdictions, it does not engage in corporate decision making except in such matters as mergers, acquisitions, divestitures, and sale of the company. Jurisdictions increasingly require independent board members to constitute at least a majority of the board. Committee System The committee system is most often used in unitary board structures to delegate specific tasks to committees of the board, such as audit, nominations, and compensation committees—all of which must have at least three members, and a majority of them must be either independent board members or nonexecutive board members. Committees are asked to look at particular matters in more detail than the whole board, but responsibility for decision making remains with the board as a whole. Company The “company” as used here is the corporate organization in which the shareowners have an ownership position and in which investors are considering an investment. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 11 9/25/2009 11:24:44 AM 6 Investors This term refers to all individuals or institutions considering investment opportunities in shares and other securities of the company. Shareowners The term “shareowners,” unlike the term “investors,” refers only to those individuals, institutions, or entities that own shares of common or ordinary stock in the company in question. Summary of Corporate Governance Considerations The Board Investors and shareowners should • determine whether a company’s board has, at a minimum, a majority of independent board members; • determine whether board members have the qualifications the company needs for the challenges it faces; • determine whether the board and its committees have budgetary authority to hire independent third-party consultants without having to receive approval from management; • determine whether board members are elected annually or whether the company has adopted an election process that staggers board member elections; • investigate whether the company engages in outside business relationships (related-party transactions) with management, board members, or individuals associated with management or board members for goods and services on behalf of the company; • determine whether the board has established a committee of independent board members, including those with recent and relevant experience in finance and accounting, to oversee the audit of the company’s financial reports; • determine whether the company has a committee of independent board members charged with setting executive remuneration/compensation; • determine whether the company has a nominations committee of independent board members that is responsible for recruiting board members; • determine whether the board has other committees that are responsible for overseeing management’s activities in select areas, such as corporate governance, mergers and acquisitions, legal matters, risk management, and environmental health and safety issues; • evaluate the communications the board has with shareowners and the ability shareowners have to meet with the board. Management Investors and shareowners should • determine whether the company has adopted a code of ethics and whether the company’s actions indicate a commitment to an appropriate ethical framework; • determine whether the company permits insiders (management or board members) or their family members to use company assets for personal reasons; • analyze both the amounts paid to key executives for managing the company’s affairs and the manner in which compensation is provided to determine whether the compensation paid to its executives (1) is commensurate with the executives’ responsibilities and performance and (2) provides appropriate incentives; • inquire into the size, purpose, means of financing, and duration of share-repurchase programs and price-stabilization efforts; • evaluate the level of communications that management has with shareowners and the ability shareowners have to meet with the management; cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 12 9/25/2009 11:24:44 AM 7 • determine whether management has adequately communicated its long-term strategic plans to investors and shareowners; • determine whether the incentive structures of management are aligned with the interests of shareowners and are tied to the execution of the long-term strategic plan, or whether they may encourage undue risk-taking that may be harmful to the interests of shareowners; • determine whether management adequately understands and communicates how nonfinancial key performance indicators and the environmental, social, and governance- related risks and opportunities are being handled by the company; • determine whether the company communicates and discloses management’s financial and nonfinancial performance in a consistent and transparent manner. Shareowner Rights Investors and shareowners should • examine the company’s ownership structure to determine whether it has different classes of common shares that separate the voting rights of those shares from their economic value; • determine whether the company permits shareowners to vote their shares prior to scheduled meetings of shareowners regardless of whether the shareowners are able to attend the meetings in person; • determine whether shareowners are able to cast confidential votes; • determine whether shareowners are allowed to cast the cumulative number of votes allotted to their shares for one or a limited number of board nominees (“cumulative voting”); • determine whether shareowners have the right to approve changes to corporate structures and policies that may alter the relationship between shareowners and the company; • determine whether the board must receive shareowner approval for important decisions, such as adoption of a poison pill and some merger agreements, and whether a simple majority or super-majority vote is required; • determine whether shareowners are allowed to elect directors according to a “majority voting” standard; • determine whether shareowners have either a binding or advisory “say on pay” concerning management remuneration; • determine whether shareowners enjoy preemption rights that guard against dilutive instruments such as new share issuances or convertible securities; • determine whether and in what circumstances shareowners are permitted to recommend director nominees to the board or place their own nominees on the proxy ballot; • determine whether and in what circumstances shareowners may submit proposals for consideration at the company’s annual general meeting; • determine whether the board and management are required to implement proposals that shareowners approve; • determine whether the corporate governance code and other legal statutes of the jurisdiction in which the company is headquartered permit shareowners to take legal action or seek regulatory action to protect and enforce their ownership rights; • carefully evaluate the structure of an existing or proposed takeover defense and analyze how it could affect the value of shares in a normal market environment and in the event of a takeover bid; • understand that the actions of other shareowners are governance issues they need to consider with the same degree of interest as they do the actions of the board and management. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 13 9/25/2009 11:24:44 AM 8 The Board Board members have a duty to make decisions based on what ultimately is best for the long- term interests of shareowners. There has been much discussion in recent years about the needs for boards and management to balance the short-term operations of a company with a long-term sustainable strategic outlook.15 Although shareowners with a short holding period may indeed be interested in corporate governance, long-term shareowners (those that hold shares for years) are more likely to incorporate corporate governance factors into their investment analyses. The reason is that governance aspects often affect company value over a long time frame. To act in the best interests of shareowners, board members need a combination of four things: independence, experience, resources, and accurate information about the company’s financial and operating position. First: A board should be composed of at least a majority of independent board members with the autonomy to act independently from management. Rather than simply voting with management, board members should bring with them a commitment to take an unbiased approach in making decisions that will benefit the company and shareowners. Second: Board members who have appropriate experience and expertise relevant to the company’s business are best able to evaluate what is in the best interests of shareowners. Depending on the nature of the business, specialized expertise by at least some board members may be required. Third: Internal mechanisms are needed to support the independent work of the board. Such mechanisms include the authority to hire the external auditor and other outside consultants without management’s intervention or approval. This mechanism alone provides the board with the ability to obtain expert help in specialized areas, helps it to circumvent potential areas of conflict with management, and overall, helps preserve the integrity of the board’s independent oversight function. Fourth: Directors must have access to complete and accurate information about the financial position of the company and its underlying value drivers to enable them to steer the company in the best long-term interests of shareowners. All of these points and how investors can evaluate them are discussed in more detail in the following subsections. Board Independence Investors should determine whether a company’s board has, at a minimum, a majority of independent board members. What Is Independence? Independence, as it relates to board members, refers to the degree to which they are not biased or otherwise controlled by company management or other groups who exert control over management. Factors to consider in determining whether a board member meets this definition are provided in the “Definitions” section of the “Introduction” to this manual. Implications for Investors A board that is not predominantly independent, or a committee that is not completely independent, may be more likely than independent individuals to make decisions that unfairly or improperly benefit the interests of management and those who have influence over management. These decisions may also be detrimental to the long-term interests of shareowners. 15 See Breaking the Short-Term Cycle, Charlottesville, VA: CFA Institute Centre (July 2006): www.cfapubs.org/loi/ccb. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 14 9/25/2009 11:24:44 AM 9 Things to Consider Investors should determine whether • independent board members constitute, at a minimum, a majority of the board. A board with this makeup is more likely to limit undue influence of management over the affairs of the board; • independent board members are meeting regularly without management present—ideally at least annually—and routinely reporting on their activities to shareowners. Such meetings permit board members to discuss issues facing the company without influence from executive board members; • the board chair also holds the title of chief executive. Combining the two positions may give undue influence to executive board members and impair the ability and willingness of board members to exercise their independent judgment. Several national corporate governance codes require the separation of these two positions. Many jurisdictions consider the separation of the chair and CEO positions a best practice because it ensures that the board agenda is set by an independent voice uninfluenced by the CEO; • independent board members have a lead member if the board chair is not independent. Some companies have kept the combined chair/CEO format but have named a “lead independent director” as a compromise. In such cases, shareowners must determine whether the lead director is able to set or influence the board agenda and is truly a chief spokesperson for shareowners; • the board chair is a former chief executive of the company. If so, this arrangement could impair the board’s ability to act independently of undue management influence and in the best interests of shareowners. Such a situation also increases the risk that the chair may hamper efforts to undo the mistakes made by him/her as chief executive; • members of the board are aligned with a company supplier or customer or are aligned with a manager or adviser to the company’s share-option or pension plan. In some cases, a company with a large number of suppliers, customers, and advisers may need to nominate individuals to the board who are aligned with these entities to ensure that it has the expertise it needs to make reasoned decisions. In such instance, investors should determine whether such board members recuse themselves on issues that may create a conflict. Where to find information about the independence of the board and its committees: In most jurisdictions, companies disclose the names, credentials, and company affiliations of existing board members either in their annual reports to shareowners or in their annual proxy statements to shareowners. Companies often devote a special section in their annual reports to a discussion of the issues confronted by the board and board committees during the previous year. In addition, the websites of many listed companies provide information about board members’ independence. Some specialty research providers focus exclusively on corporate governance issues and are a good source for such information as director independence and shareowner rights. Board Member Qualifications and Ability to Serve as Shareowner Representative Investors should determine whether board members have the qualifications the company needs for the challenges it faces. Implications for Investors Investors should assess whether individual board members have the knowledge and experience that is required to advise management in light of the particularities of the company, its businesses, and the competitive environment. Board members who lack the skills, knowledge, or expertise to conduct a meaningful review of the company’s activities are more likely to defer to management when making decisions. Such reliance on management ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 15 9/25/2009 11:24:44 AM 10 threatens the duty of board members to consider shareowner interests first. Moreover, having board members who are not capable of in-depth evaluation of the issues affecting the company’s business could threaten the company’s overall performance. (See also the subsection ”Nominations Committee” in this section.) Things to Consider Among the factors investors should consider when analyzing board members’ qualifications16 are whether the board members • are able to make informed decisions about the company’s future with regard to finance, accounting, business, and law; • are able to act with care and competence as a result of relevant expertise or understanding of ■ the principal technologies, products, or services offered in the company’s business, ■ financial operations, ■ legal matters, ■ accounting, ■ auditing, ■ strategic planning, and ■ the risks—financial risks and operational risks—that the company assumes as part of its business operations; • have made public statements that can provide an indication of their ethical perspectives; • have had legal or regulatory problems as a result of working for or serving on the board of another company; • have experience serving on other boards, particularly with companies known for having good corporate governance practices; • serve on boards for a number of other companies, which constrains the time needed to serve effectively on each board;17 • regularly attend board and committee meetings; • have committed to the needs of shareowners—for example, by making significant investments in the company or by avoiding situations or businesses that could create a conflict of interest with his/her position as a board member; • have the background, expertise, and knowledge in specific areas needed by the board; • have served individually on the board for more than 10 years. Such long-term participation may enhance the individual board member’s knowledge of the company, but it also may cause the board member to develop a cooperative relationship with management that could impair his/her willingness to act in the best interests of shareowners. Investors should also consider whether • the board and its committees have performed peer- or self-assessments and, if available, any information relating to these assessments. This review will help investors determine whether the board has the competence and independence to respond to the competitive and financial challenges facing the company; • the board requires ongoing training or continuing education for directors on particular committees so that those directors may properly execute their duties. An example would be training in enterprise risk management or valuing derivatives for the audit committee of a large financial firm. 16 The factors to consider are drawn from the CFA Institute textbook for the CFA Program titled Corporate Finance. 17 Some corporate governance codes, including the code in Pakistan, put a limit on the number of company boards on which individuals may participate. In Pakistan, the limit is 10 board mandates for a board member. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 16 9/25/2009 11:24:44 AM 11 Where to find information about the qualifications of board members: Many listed companies post the names and qualifications of board members on their websites. In regions where this is not the practice, companies typically provide information about their board members in the annual reports to shareowners and, where applicable, in their annual proxy statements. In many countries, companies report on the number of board and board committee meetings, as well as attendance by individual board members, in their annual reports, on their websites, or where applicable, in their annual corporate governance reports. Some corporate governance codes in Australia, Canada, and the European Union require listed companies to disclose in their annual reports whether they failed to comply with the codes’ provisions and why they did not comply. The European Union has adopted a European Commission recommendation that the boards of listed companies annually discuss their internal organizations, their procedures, and the extent to which their self-assessments have led to material changes. In the United States, companies typically list the names and qualifications of board members in annual proxy statements and on their websites. The nominations committees also include their reports concerning members and activities in the annual proxy statements. In Pakistan, auditors are required to certify that a company has complied with the country’s Code of Corporate Governance. Authority to Hire External Consultants Investors should determine whether the board and its committees have budgetary authority to hire independent third-party consultants without having to receive approval from management. Implications for Investors This authority ensures that the board will receive specialized advice on technical decisions that could affect shareowner value. Independent board members typically have limited time to devote to their board duties. Consequently, board members need support in gathering and analyzing the large amount of information relevant to managing and overseeing the company. The board and its committees often need specialized and independent advice as they consider various corporate issues and risks, such as compensation; proposed mergers and acquisitions; legal, regulatory, and financial matters; and reputational concerns. The ability to hire external consultants without first having to seek management’s approval provides the board with an independent means of receiving advice uninfluenced by management’s interests. Remember, however, that responsibilities for decisions taken on the advice of consultants ultimately belong to the board. Things to Consider Among other issues, investors should determine whether • at relevant periods in the past, the board hired external financial consultants to help it consider mergers, acquisitions, divestitures, or risk management issues; • the nominations committee has used external advisers in the past to recruit qualified nominees for management or for the board; • the remuneration committee has hired external advisers in the past to help determine appropriate compensation for key executives. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 17 9/25/2009 11:24:45 AM 12 Where to find information about the authority of the board to hire external consultants: The three most likely places to find information relating to the board’s authority to hire external consultants are the corporate governance section of the company’s annual report, the annual corporate governance report to shareowners, and the corporate governance section of the company’s website. Other possible places to find this kind of information include the company’s articles of organization or by-laws, national corporate governance codes, stock exchange–mandated corporate governance requirements, and third-party corporate governance reports. Other Board Issues Board Member Terms and Board Composition Investors should determine whether board members are elected annually or whether the company has adopted an election process that staggers board member elections. Reasons for Reviewing Board Member Terms Investors need to understand the mechanisms that provide, limit, or eliminate altogether their ability to exercise their rights to vote on individual board members. Implications for Investors Companies that prevent shareowners from approving or rejecting board members on an annual basis limit shareowners’ ability to change the board’s composition when, for example, board members fail to act on behalf of shareowners and also limit their ability to elect individuals with needed expertise in response to a change in company strategy. Things to Consider When reviewing a company’s policy for the election of board members, investors should consider whether • shareowners elect board members every year or for staggered multiple-year terms (producing what is known as a “staggered” or “classified” board). An annually elected board may provide more flexibility to nominate new board members to meet changes in the marketplace, if needed, than a staggered board. On the one hand, staggered boards may also be used as antitakeover devices.18 On the other hand, a staggered board may provide better continuity of board expertise. In Japan, shareowners of a company that uses a corporate auditors system elect board members for two-year terms and elect members of the corporate auditors board for four-year terms. Shareowners of a company using a committees system elect board members every year; • the board has filled a vacancy for the remainder of a board member’s term without receiving shareowner approval at the next annual general meeting; • the board is the appropriate size for the circumstances of the company. A large board may have difficulty coordinating its members’ views, be slow to act, and defer more frequently to the chief executive. A small board may lack depth of experience and counsel and may not be able to adequately spread the workload among its members to operate effectively. Where to find information about the mechanisms related to board terms and composition: In most cases, the best place to find information about the election of board members is in the notice of the company’s annual general meeting. In the United States and Canada, this information is typically part of the annual proxy statement to shareowners. Investors should check also the company’s by-laws and articles of organization to determine whether management and the board are permitted to fill vacancies without shareowner approval. 18 See, especially, Lucian A. Bebchuk, John C. Coates IV, and Guhan Subramanian, “The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy,” Stanford Law Review (2002). The authors conclude that the ballot-box route to a takeover is illusory for a company with an effective staggered board because, in part, a bidder must foster interest and votes during two elections spread at least 14 months apart. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 18 9/25/2009 11:24:45 AM 13 Related-Party Transactions Investors should investigate whether the company engages in outside business relationships (related-party transactions) with management, board members, or individuals associated with management or board members for goods and services on behalf of the company.19 Reasons for Reviewing the Company’s Policies on Related-Party Transactions As they relate to board members, policies that cover related-party transactions attempt to ensure the independence of board members by discouraging them from engaging in the following practices, among others: • receiving consultancy fees for work performed on behalf of the company and • receiving finders’ fees for bringing merger, acquisition, or corporate sale partners to the company’s attention. Implications for Investors Receiving personal benefits from the company for which board members are supposed to make independent decisions poses an inherent conflict of interest if the benefits fall outside the role of a board member. Limitations on such transactions, through either the company’s ethical code or its board policies, reduce the likelihood that management can use company resources to sway board members’ allegiance away from shareowners. Things to Consider When reviewing a company’s policies regarding related-party transactions, investors should determine whether • the company has a policy for reviewing and approving related-party transactions. If the company has such a policy, consider whether interested directors (directors with financial interests in the transaction) are allowed to approve such transactions; • the company’s ethical code or the board’s policies and procedures limit the circumstances in which insiders, including board members and those associated with them, can accept remuneration or in-kind benefits from the company for consulting or other services outside the scope of their positions as board members. The intent of such provisions is not only to discourage actions that could compromise board members’ independence but also to discourage the company from entering into contracts that may not provide the best value to the company and its shareowners; • the company has disclosed any material related-party transactions or commercial relationships with existing board members or board nominees (see also the discussion of this issue in the preceding section titled “Board Independence”); • board members or executive officers have lent, leased, or otherwise provided property or equipment to the company; • the company has paid board members finders’ fees for their roles in acquisitions or other significant company transactions; • the company has provided to board members in-kind benefits/perquisites—e.g., the personal use of company facilities or resources, company donations to personal charities. Where to find information about related-party transactions: The annual reports of companies in many countries include a discussion of insider transactions and fees paid to board members and controlling shareowners, often under the heading of “Related-Party Transactions.” In the United States and Canada, listed companies are required to provide information relating to dealings with insiders in the annual proxy statement, often under the heading of “Related-Party Transactions.” 19 For more on related-party transactions in Hong Kong, see Related-Party Transactions: Cautionary Tales for Investors in Asia, Charlottesville, VA: CFA Institute Centre (January 2009): www.cfapubs.org/loi/ccb. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 19 9/25/2009 11:24:45 AM 14 Investors also should look for any disclosures of related-party transactions in the prospectus of a company preceding a public offering of securities. This document should inform investors about transactions that permit insiders to purchase shares at a discount prior to an offering at a higher price. Board Committees In this section, we consider separately the audit committee, the remuneration or compensation committee, the nominations committee, and other committees. Audit Committee Investors should determine whether the board has established a committee of independent board members, including those with recent and relevant experience in finance and accounting, to oversee the audit of the company’s financial reports. The Purpose of the Audit Committee The audit committee’s primary objective is to ensure that the financial information reported by the company to shareowners is complete, accurate, reliable, relevant, and timely. To this end, the audit committee is responsible for hiring and supervising the independent external auditors and ensuring that • the external auditors’ priorities are aligned with the best interests of shareowners, • the auditor is independent of management influences, • the information included in the financial reports to shareowners is complete, accurate, reliable, relevant, verifiable, and timely, • the financial statements are prepared in accordance with generally accepted accounting principles (GAAP) or international accounting standards (IAS) and regulatory disclosure requirements in the company’s jurisdiction, • the audit is conducted in accordance with generally accepted auditing standards (GAAS), • all conflicts of interest between the external auditor and the company are resolved in favor of the shareowners, and • the independent auditors have authority over the audit of the entire group, including foreign subsidiaries and affiliated companies. Implications for Investors If the independence of the audit committee is compromised, there could be doubts about the integrity of the financial reporting process and about the credibility of the company’s financial statements. Misrepresentations of, or other distortions about, the company’s performance and financial condition ultimately could have a detrimental effect on the company’s share valuation. Things to Consider Investors should determine whether • all of the board members serving on the audit committee are independent; • any of the board members serving on the audit committee are considered financial experts;20 20 Under U.S. SEC rules developed in response to the Sarbanes–Oxley Act of 2002, a financial expert is a director who (1) understands GAAP and financial statements; (2) can assess the application of GAAP for estimates, accruals, and reserves; (3) has prepared, audited, analyzed, or evaluated financial statements similar to those of the company or has experience supervising those who performed these functions; (4) understands internal controls and financial reporting procedures; and (5) understands audit committee functions. Directors may acquire these attributes through education and experience as (or by supervising) a principal financial officer, principal accounting officer, controller, public accountant, or auditor; by overseeing or assessing companies or public accountants in the preparation, auditing, or evaluation of financial statements; or from other relevant experience. See the SEC document at www.sec.gov/rules/final/ 33-8177.htm, under “Audit Committee Financial Experts.” cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 20 9/25/2009 11:24:45 AM 15 • the board submits the appointment of the external auditors to a vote of shareowners; • the audit committee has the authority to approve or reject other proposed nonaudit engagements with the external audit firm. This conclusion should be based on a review of the committee’s report on the services received from and fees paid to the external audit firm. Investors also should determine whether the audit committee has policies relating to any fees paid by the company to the external auditor for nonaudit consulting services and for resolving these types of potential conflicts of interest. Such nonaudit fees may influence the auditors in a way that leads them to resolve conflicts regarding financial reporting issues in favor of management rather than for the benefit of shareowners; • the company has procedures and provisions ensuring that the internal auditor reports directly to the audit committee in the case of concerns regarding the accuracy or integrity of the financial reports or accounting practices. Similarly, the audit committee should have unimpeded access to the internal auditor; • there were any discussions between the committee and the external auditors resulting in a change in the financial reports as a result of questionable interpretations of accounting rules, fraud, or other accounting problems and whether the company has fired its external auditors as a result of such issues; • the committee controls the audit budget to enable it to address unanticipated or complex issues; • the company has signed any agreement with the auditor limiting the auditor’s liability in the event of negligence, breach of duty, or breach of trust; • the committee undergoes or is required to undergo periodic training to stay educated about current financial issues. Where to find information about the audit committee: Australia Companies listed on the Australian Securities Exchange are required to disclose in their annual reports if they have not complied with the exchange’s recommendations relating to the audit committee, together with an explanation of why they did not comply. Canada Companies listed on the Toronto Stock Exchange are required to disclose in their annual reports whether • they have an audit committee, • its members are nonexecutive, • the board has defined its roles and responsibilities, • it communicates directly with internal and external auditors, and • it is responsible for overseeing management reporting and internal control systems. European Union All listed companies in the EU must have an audit committee or “body carrying out equivalent functions.” The committee has to have at least one independent member—although most national codes set a higher standard—and at least one member with “competence in accounting and/or auditing.” The audit committee is also required to report on the company’s system of internal controls in the annual director’s report. United States Companies must disclose whether they have at least one financial expert on their audit committees and the name of at least one of the committee’s financial experts. They also must disclose whether the named board members are independent. If they disclose that they do not have at least one financial expert, they must explain why. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 21 9/25/2009 11:24:45 AM 16 Companies also must disclose the following in their annual proxy statements: • whether they have a standing audit committee and, if so, the name of each committee member, the number of meetings held, and a description of the functions performed by the committee; • whether the board has adopted a written charter for the audit committee. If so, the company must include a copy of the charter as an appendix to the proxy statement at least once every three years. If this information is available, investors will most likely find it on the company’s website; • if the company’s shares are quoted on the NASDAQ or the American or New York stock exchanges, whether the audit committee members are independent as defined in the applicable listing standards (together with certain information regarding any audit committee member who is not independent); • whether the audit committee has reviewed and discussed the audited financial reports with management and the independent auditors and whether the auditors made appropriate disclosures regarding their independence; • a statement by the audit committee about whether it recommended to the board that the audited financial statements be included in the annual report. In some U.S. jurisdictions, the audit committee is the primary committee responsible for assessing and mitigating the risks a company faces. If the audit committee is charged with such a responsibility, shareowners need to determine whether the committee reviews all of the risks a company faces, including credit, market, fiduciary, liquidity, reputation, operational, strategic, and technology risks. Remuneration/Compensation Committee Investors should determine whether the company has a committee of independent board members charged with setting executive remuneration/compensation.21 The Purpose of the Remuneration/Compensation Committee The remuneration committee is responsible for ensuring that compensation and other awards encourage executive managers to act in ways that enhance the company’s long-term profitability and value. It is also responsible for ensuring that the remuneration packages offered to management are commensurate with the level of responsibilities of the executives and appropriate in light of the company’s performance. The committee can further these goals by • including only independent board members on the committee,22 • linking executive compensation to the long-term profitability of the company and long- term increases in share value relative to competitors and other comparably situated companies, • eliminating any potential conflicts of interests between the compensation committee and the company by, for instance, using only independent compensation consultants who report solely to the committee, • communicating regularly with the company’s shareowners about compensation philosophy and how it complements the company’s strategic goals, • establishing clear mechanisms in compensation packages for recouping incentive pay from management if the money was earned through fraud, • developing clear (that is, “plain language”) explanations of compensation philosophy and policies that are periodically communicated to all shareowners, and 21 For more on executive compensation in Asia, see It Pays to Disclose: Bridging the Information Gap in Executive- Compensation Disclosures in Asia, Charlottesville, VA: CFA Institute Centre (March 2008), and The Compensation of Senior Executives at Listed Companies: A Manual for Investors, Charlottesville, VA: CFA Institute Centre (December 2007): www.cfapubs.org/loi/ccb. 22 See a discussion of the independence of committees, particularly in Japan, in the earlier discussion titled “Audit Committee.” cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 22 9/25/2009 11:24:45 AM 17 • making sure that compensation committee members (or the board if the board sets compensation) understand all components of executive pay packages and are aware of what final payments may be made to executives in both best-case and worst-case scenarios. Implications for Investors The existence of the committee and its independence from executive management bias help to ensure that the rewards and incentives offered to management are consistent with the best long-term interests of shareowners. Committees that lack independence may be overly pressured by management to award compensation that is excessive when compared with other comparably situated companies or to provide incentives for actions that boost short- term share prices at the expense of long-term profitability and value. Things to Consider As part of their analyses relating to this committee, investors should determine whether • the overall composition of the compensation packages offered to senior management is appropriate; • the committee adequately articulates its compensation philosophy, policies, and procedures to shareowners; • executive compensation is linked to the long-term profitability of the company and long- term increases in share value relative to competitors and comparable companies. Shareowners should also determine whether incentive structures encourage management to take excessive risks in the short term that may prove detrimental to the company’s long-term viability; • compensation packages contain clear mechanisms for recouping incentive pay from management if it was earned through fraud or other activities deemed detrimental to the company’s sustainable performance or viability; • the compensation committee members understand all components of executive pay packages and are aware of what final payment may be made to executives in best-case and worst-case scenarios; • members of the committee regularly attended meetings during the previous year; • the company has provided detailed information to shareowners in public documents relating to the compensation paid during the previous year to the company’s five highest paid executives and its board members. Investors also should review any disclosures about the major components and amounts paid to these individuals. Some jurisdictions require companies to provide only summary information about the compensation of senior managers and the board; • the terms and conditions of options granted to management and employees are disclosed and whether the terms are reasonable; • the company intends to issue newly registered shares to fulfill its share-based remuneration obligations or it intends to settle these options with shares repurchased in the open market; • the company and the board are required to receive shareowner approval for any share- based remuneration plans. Such plans affect the number of shares outstanding and, consequently, current shareowners’ ownership interests, as well as the basis on which earnings per share are reported and the market valuations of the company’s securities; • the board receives variable remuneration instruments, such as stock options or restricted stock, and whether such awards adequately align the interests of the board with those of shareowners; • senior executives from other companies who have cross-directorship links with the company are members of the committee. Executive remuneration is often based on compensation of similarly positioned individuals at other companies, and if the committee has individuals who could benefit directly from reciprocal decisions on remuneration, those decisions may not be in the best interests of the company’s shareowners (also see the earlier discussion titled “Board Independence”); ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 23 9/25/2009 11:24:45 AM 18 • whether potential conflicts of interest exist between the compensation committee and the company. One way of avoiding such conflicts is to use only independent compensation consultants who report solely to the committee.23 Where to find information about the remuneration/compensation committee: Australia Companies that list on the Australian Securities Exchange are required to disclose in their annual reports if they did not comply with the exchange’s recommendations for remuneration committees and provide an explanation of why they did not comply. Canada The Toronto Stock Exchange requires TSE-listed companies to report in their annual reports or their management information and proxy circulars whether they have a compensation committee and, if so, whether it is composed of independent or nonexecutive board members and whether a majority are independent. New rules that came into force for annual reports after 31 December 2008, not unlike the SEC rules, require disclosure of total compensation in a “compensation disclosure & analysis” section.24 United Kingdom Listed U.K. companies are required to report in their annual reports on the frequency of and attendance by members at remuneration committee meetings. These companies also must disclose the responsibilities delegated to the committee. United States Listed U.S. companies report in their annual proxy statements on whether they have a standing compensation committee. These reports also include names of committee members, summaries of compensation strategies, and the policies and procedures of the committee. Nominations Committee Investors should determine whether the company has a nominations committee of independent board members that is responsible for recruiting board members. The Purpose of the Nominations Committee The nominations committee is responsible for • recruiting new board members with appropriate qualities and experience in light of the company’s business needs, • regularly examining the performance, independence, skills, and expertise of existing board members to determine whether they meet the current and future needs of the company and the board, • creating nominations policies and procedures, and • preparing for the succession of executive management and the board. Implications for Investors The slate of candidates offered by this committee will determine whether the board ultimately works for the benefit of shareowners. It is important for this committee to remain independent25 to ensure that it recruits individuals who can and will work on behalf of 23 For more discussion on this topic, see The Compensation of Senior Executives at Listed Companies: A Manual for Investors, Charlottesville, VA: CFA Institute Centre (December 2007): www.cfapubs.org/loi/ccb. 24 See the amendments to National Instrument 51-102, Continuous Disclosure Obligations, at www.osc.gov.on.ca/Regulation/Rulemaking/Current/Part5/rule_20081231_51-102_unofficial- consolidated.pdf. 25 See the discussion of the independence of committees, particularly in Japan, under the earlier discussion in the “Audit Committee.” cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 24 9/25/2009 11:24:45 AM 19 shareowners and to ensure that the performance assessment of current board members is fair and appropriate. (See also the section “Board Member Qualifications and Ability to Serve as Shareowner Representative.”) Things to Consider Investors may have to review company reports over several years to adequately assess whether this committee has recruited board members who act in the interests of shareowners. They also should review the following: • the criteria for new board members; • the composition, background, and areas of expertise of existing board members and whether new nominees complement the board’s current portfolio of talents; • how the committee finds potential new board members. Among the considerations is whether the committee engages in a search for candidates, such as by using an executive search firm, or whether its members rely on the advice of management or other board members; • the attendance records of board members at regular and special meetings; • whether the company has a succession plan for executive management in the event of unforeseen circumstances, such as the sudden incapacitation of the chief operating or finance officers. Investors should examine the information provided by the company about the plan and determine who is expected to lead and implement it; • the report of the committee, including any discussion of its actions and decisions during the previous year (including the number of meetings held, attendance by committee members, and the committee’s policies and procedures). Where to find information about the nominations committee: The annual reports of companies in many countries include a general discussion of the actions taken by the committee during the previous year. Moreover, the websites of many listed companies describe the activities and members of the committee and, in some countries, provide information about the committee’s charter. The annual reports of companies listed in some countries, such as Australia and the United Kingdom, are required to disclose and explain when a company fails to comply with applicable nominations committee rules. The corporate governance report, if there is one, often includes an explanation of the company’s nominations process and whether the company has a specially designated nominations committee. In some jurisdictions, such as the United States, investors should look in the annual proxy statement to shareowners for indications about the work of this committee, including the name of each committee member and the number of meetings held. Other Board Committees Investors should determine whether the board has other committees that are responsible for overseeing management’s activities in certain areas, such as corporate governance, mergers and acquisitions, legal matters, risk management, and environmental health and safety issues. Implications for Investors Because “other” committees are not covered by national corporate governance codes or exchange-mandated guidelines in the manner that audit, remuneration, or nominations committees are, they are more likely to have members who are part of executive management. Consequently, these committees may not, and possibly need not, achieve the levels of independence expected of the audit, nominations, and remuneration committees. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 25 9/25/2009 11:24:46 AM 20 Depending on each committee’s purpose, committees created by the board can provide additional insight into the goals, focus, and strategies of the company. For example, a committee dedicated to risk management may consider the identification and quantification of financial and operational risks faced by the company and determine its optimal risk exposure. In the wake of the recent global financial crisis, risk management committees—especially those at financial institutions—have heightened profiles and have taken on responsibilities now seen as important as those of other, traditionally more recognizable board committees (audit and compensation committees, for example). Risk management committees around the globe are now charged with a thorough review of the company’s financial risks, such as leverage, counterparty risks, and exposure concentrations. Things to Consider Investors should understand the amount of risk management and risk measurement expertise present on a committee charged with managing and measuring a company’s risk profile. Where to find information about other board committees: As in the case with the audit, compensation, and nominations committees, investors have four primary places to look for information about special-purpose committees—namely, the annual reports to shareowners; the annual corporate governance report, where available; the websites of listed companies; jurisdictions such as the United States and Canada, the annual proxy statement to shareowners; and on the websites of listed companies. Board Communications with Shareowners Investors should evaluate the communications the board has with shareowners and the ability shareowners have to meet with the board. Implications for Investors A corporate board does not have the time or resources to meet with all shareowners, but it should be open to talking with shareowners who hold a significant stake in the company or represent important stakeholders so that it can properly address legitimate investor concerns. A board should not breach its fiduciary duty to all shareowners by acting in the interests of a minority shareowner to the detriment of the company and shareowners as a whole or by disclosing material information to one group of shareowners while withholding it from others. A board should take care to establish ways for shareowners to communicate their concerns to the board in a way that helps the board understand legitimate concerns of shareowners that may not have been addressed by the board. Things to Consider Most jurisdictions do not set out formal rules governing the interaction of boards and shareowners; therefore, the culture of board–shareowner interaction and collegiality will vary from market to market. Also, because of a lack of time and resources, a board is likely to meet with only institutional shareowners that have significant holdings in the company. Information technology not available in past decades may, however, allow owners of smaller amounts of shares to communicate their concerns with the board, although face-to-face meetings between a board and individual investors are rare. Shareowners should consider whether they have a direct line to the board chair or lead independent director. Where to find information about board communications: A company’s corporate governance documents and websites will likely detail ways in which shareowners may communicate with the board if such communications are available. Institutional investors and analysts who meet with boards are likely to reach a board through its company investor relations contact, its corporate secretary, or a preexisting personal relationship with a member of the board. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 26 9/25/2009 11:24:46 AM 21 Management Although the board, in consultation with management, helps set the strategic, ethical, and financial course for a company, investors ultimately must rely on management to implement that course. Management also has the responsibility to communicate to directors, investors, and the public about the company’s performance, financial condition, and any changes in strategy or corporate initiatives in a complete, effective, and timely manner. Investors are generally familiar with the reports that management issues with regard to a company’s financial performance and condition. They may not be aware of other sources of information, however, that may provide insight into the corporate culture or the company’s governance practices. The company’s code of ethics, corporate governance principles, compensation policies, share-repurchase and price-stabilization programs, takeover defenses, and approach to shareowner communication—all provide valuable insights into whether management’s focus is on maximizing shareowner value. To help investors understand management’s role and responsibilities in corporate governance matters, the following section provides a general discussion of company codes of ethics and corporate culture, followed by specific discussions of aspects of corporate transparency. Implementation of Code of Ethics Investors should determine whether the company has adopted a code of ethics and whether the company’s actions indicate a commitment to an appropriate ethical framework. The Purpose of a Code of Ethics A company’s code of ethics sets standards for ethical conduct that are based on basic principles of integrity, trust, and honesty. It provides personnel with a framework for behavior while they are conducting the company’s business and guidance for addressing conflicts of interest. In effect, it represents a part of the company’s risk management policies, which are intended to prevent company representatives from engaging in practices that could harm the company, its products, or shareowners. Implications for Investors Reported breaches of ethics in a company often result in regulatory sanctions, fines, management turnover, and unwanted negative media coverage, all of which can adversely affect the company’s performance. Adoption of and adherence to an appropriate corporate code of ethics indicates a commitment on the part of management to establish and maintain ethical practices. The existence of such a code may also be a mitigating factor in regulatory actions when breaches do occur. Things to Consider As part of their analyses of the company’s ethical climate, investors should determine whether the company • gives the board access to relevant corporate information in a timely and comprehensive manner; • has an ethical code and whether that code prohibits any practice that would provide advantages to company insiders that are not also offered to shareowners. For example, a code might prohibit the company from offering shares at discounted prices to management, board members, and other insiders prior to a public offering of securities to prevent dilution of the value and interests of those who buy at the public offering price; • has an ethical code that the company promotes internally and requires training for employees on compliance with the code; • has designated someone who is responsible for corporate ethics; • has an ethical code that provides waivers from its prohibitions to certain levels of management and the reasons why; ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 27 9/25/2009 11:24:46 AM 22 • has waived any of its code’s provisions during recent periods and why; • is in compliance with the corporate governance code of the country where it is located or the governance requirements of the stock exchange that lists its securities. Typically, companies must disclose whether they have failed to adhere to such codes and, if so, give reasons for the failure. In some cases, noncompliance may result in fines or sanctions by regulators. The company also may face informal sanctions, such as product boycotting by customers or political groups; • regularly performs an audit of its ethical/governance policies and procedures to make improvements. Where to find information about a company’s code of ethics and other ethical matters: Companies with ethical codes typically post them on their public websites, in their annual reports to shareowners, or in countries that require them, in their annual corporate governance reports.26 The annual reports of companies listed in some countries, such as Australia, disclose when and why a company failed to meet applicable governance standards regarding the creation and implementation of a code of conduct. Investors may check on the requirements of a country’s national corporate governance code or exchange-mandated governance requirements. Personal Use of Company Assets Investors should determine whether the company permits insiders (management or board members) or their family members to use company assets for personal reasons. Reasons for Reviewing the Company’s Policies on the Personal Use of Company Assets As they relate to insiders, policies that limit or prohibit the use of company assets by insiders attempt to ensure that resources are used in the most efficient and productive manner for the purpose of generating returns for the company and all of its shareowners. Such policies and procedures also seek to preserve the independence of board members by attempting to prevent the conflicts of interest that may result when board members or their families use company assets. Implications for Investors When insiders—management, board members, or their families—use company assets for personal reasons, those resources are not available for investment in productive and income- generating activities. Such use also creates conflicts of interest for board members. Things to Consider When reviewing a company’s policies regarding the personal use of company assets, investors should determine whether the company • has an ethical code or policies and procedures that place limits on the ability of insiders to use company assets for personal benefit; • has lent or donated cash or other resources to insiders, their families, or other related parties; • has purchased property or other assets, such as houses or airplanes, for the personal use of management, board members, or their family members; • has leased assets, such as dwellings or transportation vehicles, to management, board members, or their family members and whether the terms of such contracts are appropriate in light of market conditions. 26 Proposed rules in Canada will not require codes to be filed with the securities regulators but will require only summaries of those codes and a description of where they can be obtained. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 28 9/25/2009 11:24:46 AM 23 Where to find information about insider transactions: Investors may find information about loans to company executives, board members, or their families in the “Related-Party Transactions” section of a company’s annual report, its annual corporate governance report, an annual proxy statement to shareowners, or its website. Investors also should review the prospectus of a company preceding a public offering of securities for any related-party transactions. This document should inform investors about transactions that permit insiders to purchase shares at a discount prior to an offering at a higher price. Corporate Transparency In this section, we review aspects of executive compensation, share-repurchase and price stabilization plans, and management communications with shareowners Executive Compensation Investors should analyze both the amounts paid to key executives for managing the company’s affairs and the manner in which compensation is provided to determine whether compensation paid to the company’s executives (1) is commensurate with the executives’ responsibilities and performance and (2) provides appropriate incentives. Reasons for Reviewing Executive Compensation Disclosures Disclosures of how much, in what manner, and on what basis executive management is paid shed light on a board’s stewardship of shareowner assets. Furthermore, these disclosures allow investors to evaluate whether the compensation is reasonable in light of the apparent return to the company in terms of performance. Implications for Shareowners The purpose of compensation is to reward managers for gains attributable directly to superior performance. An appropriately designed program should create incentives for company executives to generate sustainable value added for shareowners. A flawed compensation program may encourage executives to make decisions that generate additional compensation for themselves through short-term gains rather than decisions that implement an appropriate strategy focused on long-term growth. A flawed program may reward managers for excessive risk-taking or broad sector- or industry-wide trends. It may also dilute the ownership positions of existing shareowners. Compensation is often split between a basic salary and some form of bonus. Although there is no single model, best practice has moved toward (1) a bonus that reflects recent business performance against targeted indicators (e.g., “Key Performance Indicators” linked to the company’s strategy) and (2) a bonus based on a long-term incentive plan (LTIP), which uses forward-looking indicators of success. The LTIP is designed to capture how well the management is positioning the company for long-term growth. In general, the salary is not performance dependent but the bonus and LTIP are. Things to Consider When reviewing a company’s executive compensation disclosures, investors should examine the following: • Remuneration/compensation program. An examination of the terms and conditions of the company’s executive compensation program, together with an analysis of summaries of agreements with executives, will help investors determine whether the program rewards long-term growth or short-term increases in share value. This review should include a plain-language explanation of whether the remuneration/compensation committee uses consultants to set pay for company executives or relies on internal sources, which may be biased. Investors also should focus on whether the rewards offered to management are based on the performance of the company relative to its competitors or on some other metric. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 29 9/25/2009 11:24:46 AM 24 • Past executive compensation. Analysis of the actual compensation paid to the company’s top executives during recent years and the elements of the compensation packages offered to key employees can help shareowners determine whether the company is receiving adequate returns for the investment it has made in management and whether remuneration is aligned with shareowner interests. For example, the mix between fixed and variable compensation can indicate management’s risk appetite. • Whether compensation is variable or performance based. Investors should determine whether the compensation package is linked (throughout a normal business cycle) to the long- term profitability and share-price performance of the company relative to its competitors and peers. Best practices include disclosure of the targets the board uses to determine incentive-based compensation (both the bonus and LTIP). Key questions investors should ask include the following: ■ Is performance measured relative to peers, and are these peers the right comparison group? ■ Do targets require adequate stretching by executives in the current economic climate? ■ Are targets clearly linked to the company’s strategy? ■ Is performance measured over a reasonable time frame, ideally through a complete business cycle? ■ Does performance measurement take account of risk taken? • Use of external consultants. Investors should determine whether the remuneration/ compensation committee uses consultants to set pay for company executives or whether it relies on internal sources, which may be biased. • Share-based compensation terms. Examination of the terms of this type of remuneration program, including the total shares offered to key executives and other employees, should alert investors to how the program can affect shares outstanding, dilution of shareowner interests, and share values. Investors also should determine whether the company seeks shareowner approval for creation or amendments to such plans (see the upcoming section “Shareowner Rights” for other issues that may require a vote of shareowners). • Stock-option expensing. Compensation, regardless of whether it is paid in cash, shares, or share options, involves payment for services received and should appear as an expense on the income statement. International Financial Reporting Standards (IFRS) and U.S. GAAP both require companies to expense stock option grants.27 • Option repricing. Investors should remain aware of efforts by the company to reprice downward the strike prices of stock options previously granted. Changes in the strike price remove the incentives the original options created for management, and thus reduce the link of long-term profitability and performance of the company with management remuneration. • Equity award vesting schedules. Shareowners need to determine whether options, restricted stock, and other equity-based awards vest immediately, which may engender a short-term mindset, or vest over a series of years, which may better align the interests of management with those of shareowners. • Supplemental executive retirement plans (SERPs). Many companies have established SERPs or other retirement plans for their executives that provide benefits above and beyond those covered in the company’s ordinary retirement plans. Investors should understand the details of supplemental plans to determine what company resources are and will be devoted to these plans over the life of an executive’s contract. • Perquisites. Shareowners should understand the nonfinancial benefits given to executives and the outlays of company resources that are behind such benefits. Perquisites include automobiles, personal use of corporate aircraft, security systems, executive dining rooms, legal/tax/financial consulting services, and low-interest-rate loans. • Share ownership by management. Investors should determine whether members of management have share holdings other than those related to stock option grants. Such holdings should align the interests of company executives with those of shareowners. 27 This requirement is applicable for U.S.-listed companies with fiscal years that end after 15 June 2005. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 30 9/25/2009 11:24:46 AM 25 • The company’s peer group. Shareowners should note whether the peer group that is used to benchmark the company’s performance is disclosed by the company. If so, shareowners then need to determine whether this peer group is appropriate. Also important is whether the peer group has been relatively stable over the years. A compensation red flag may be raised if a peer group is not appropriate for comparison or is frequently changing.28 • Claw-back provisions. Investors need to understand whether the company has provisions for the return of money by managers in clear cases of fraud. Where to find information about executive compensation: In many jurisdictions, companies report information about executive compensation in their annual reports. In some cases, disclosures about amounts paid to individual executives is voluntary, although accounting standards setters and securities regulators are increasingly making such disclosures compulsory. In the United States and Canada, executive compensation strategies and reports of actual compensation paid to key executives are included in the company’s annual proxy statement to shareowners. Investors also may find such information posted on companies’ websites. Share-Repurchase and Price-Stabilization Programs Shareowners should inquire into the size, purpose, means of financing, and duration of share- repurchase programs and price-stabilization efforts. Reasons for Reviewing Disclosures of Share-Repurchase and Price-Stabilization Programs A company may use a share-repurchase program to buy its own shares that are already trading on a public stock exchange. In a stabilization program, the company has its investment bankers buy and sell shares following a public offering of shares as a means of reducing the price volatility of the shares. Implications for Investors Buying shares on the open market can have a positive effect on share values by reducing the number of shares available and increasing the value for the remaining shares outstanding. Price-stabilization programs may reduce the volatility of a security’s price following an offering and permit the market to achieve a balance between buyers and sellers, but such programs may provide insiders with an opportunity to trade at a higher price in anticipation that the share price will decline or buy at a lower price in anticipation of future price gains. Things to Consider When reviewing share-repurchase and price-stabilization programs, investors should determine the following: • The intention of the program. Investors should determine whether the board intends to use repurchased shares (1) to reduce the number of shares outstanding in order to increase long-term valuations, (2) to fund the future exercise of management share options, or (3) to prevent a hostile takeover. Depending on the perspective of the investor, the program may enhance or hurt long-term share value. Fixed-income investors, for example, may view the use of cash to repurchase shares as detrimental to the ability of the company to repay its outstanding debts.29 Equity investors, in contrast, may see such actions as beneficial to their valuations. 28 Seealso The Compensation of Senior Executives at Listed Companies: A Manual for Investors, Charlottesville, VA: CFA Institute Centre (December 2007): www.cfapubs.org/loi/ccb. 29 Bond indentures may require that the company repay outstanding debt securities or receive a waiver from bondholders prior to launching a share-repurchase program. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 31 9/25/2009 11:24:46 AM 26 • The size and financing of the program. This information, together with disclosures about whether the company plans to use internally generated cash from operations or issue debt to finance the purchases, can help equity investors determine how the program will affect the value of the company’s shares. In addition, investors should review the following: • Regular updates on the program’s progress. In particular, investors should review the prices at which open-market purchases of shares were made, the number of shares purchased, cumulative amounts of shares repurchased to date, and the average price paid to date. This information should help investors anticipate completion of the program and how that may affect share value. It also should help investors determine whether the program is proceeding as planned or exceeding original intentions for scope and cost. • Disclosures relating to stabilization activities. Investors should determine prior to investing in a public offering of securities whether the company intends to use such stabilization services and should subsequently review updates about the number of shares purchased and sold under the program, the average price paid and received, and when the activities concluded. This information will indicate whether the company and its advisers acted as proposed or whether they engaged in unintended or undisclosed activities. Where to find information about share-repurchase and price-stabilization programs: The annual and interim reports of a company will in most cases provide the information relating to a share-repurchase program. The prospectus for an offering should include initial information relating to stabilization activities. Annual and interim financial reports should provide final information about the activities of stabilization programs. Investors should look to the prospectus of an offering to determine whether at the time of the offering the company intended to use agents to perform price stabilization services following the issuance of the securities. Of particular interest are poststabilization disclosures. In the European Union, companies are required by the Market Abuse Directive to disclose (1) whether stabilization activities were undertaken and, if so, (2) the dates the program began and ended, and (3) the range of prices at which such activities were conducted. The ultimate disclosures will come from either the issuer or the lead underwriter. The SEC currently does not require poststabilization disclosures like those of the EU, although it is considering implementation of such a policy.30 Currently, NASDAQ requires market makers to attach a special symbol to an order for this purpose; other exchanges require underwriters to notify the exchange and provide disclosure to the recipient of the bid that such bids are part of a stabilization program. Poststabilization disclosures in many other jurisdictions are required to be made only to the company and the exchange. Management Communications with Shareowners Investors should evaluate the level of communications that management has with shareowners and the ability shareowners have to speak with management. Implications for Investors As was the case when discussing board–shareowner communications, investors need to understand that corporate management does not have the time or resources to meet with all shareowners, but as was the case with the board, management also should be open to listening to shareowners who hold a significant stake in the company or represent important 30 See “Amendments to Regulation M: Anti-Manipulation Rules Concerning Securities Offerings; Proposed Rule,” Federal Register, vol. 69, no. 242 (17 December 2004):75782, under the third question: “Should the Commission consider, in addition to the proposed disclosure, revising Rule 104 to require a general notification to the market (e.g., through a press release, a website posting, or an administrative message sent over the Tape) that [the] activity has commenced (and another notification when [the activity] has ceased)?” cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 32 9/25/2009 11:24:46 AM 27 stakeholders in order to properly address legitimate investor concerns. Management must not give information to certain shareowners that is not given to all shareowners, but management should be open to suggestions and concerns of their shareowners. Things to Consider Most large companies employ in-house investor relations teams or outsourced investor relations professionals to handle communications between management and individual shareowners. These avenues are probably the best way for investors to communicate with management. There is rarely a direct avenue for individual shareowners to contact management outside an annual meeting. To engender the kind of communications they want from management, shareowners should • encourage companies to provide frequent and meaningful communications about strategy and long-term vision, including transparent financial reporting that reflects a company’s progress toward its strategic goals and • encourage the inclusion of statements concerning long-term corporate strategy in all company communications. Where to find information about management communications: Much of the communication management has with shareowners comes through prescribed avenues, such as the company’s annual report, annual meetings, earnings press releases, earnings conference calls, and conference presentations. Institutional investors and analysts who meet with management are more likely than individual investors to reach management through a company investor relations contact, corporate secretary, or preexisting personal relationship with a member of the board management. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 33 9/25/2009 11:24:47 AM 28 Shareowner Rights The value of a financial security is determined not only by its claim on the company’s future earnings but also by the rights associated with that security. Among the rights associated with shares of common stock are the right to elect board members and the right to vote on matters that may affect the value of shareowner holdings, such as mergers or acquisitions. Other rights may include the right to apply the cumulative votes of one’s shares to one or a limited number of board nominees, the ability to nominate persons to the board, or the right to propose changes to company operations. Shareowners may not have all these rights in all cases, nor will they always find it easy to exercise those rights that are accessible. For example, companies in some regions can restrict voting to only those owners who are present at scheduled meetings of shareowners. Companies may also be able to prevent shareowners—in return for exercising their vote—from trading for a designated period prior to the annual general meeting. In other cases, individuals and institutions cannot confidentially cast their votes. In still other cases, founding-family members or government shareowners may exercise disproportionate influence over the companies’ affairs through the ownership of special classes of shares that grant them super voting rights. Shareowners may have the power to remedy situations in certain cases, but such remedies are not universal. Local laws and regulations also may provide legal or regulatory redress. Such issues are of interest not only to equity investors but also to investors interested in fixed- income investments—for example, companies that grant super voting rights to a certain class of stock and shareowners historically use debt financing more than equity financing to fund investments in new business opportunities.31 Such a strategy may raise the financial risk of a company and, ultimately, increase the possibility of default. Investors should recognize what specific rights are attached to the securities they are considering and factor that information into any investment decisions. Doing so may avoid situations that result in reduced valuations and poor investment performance. Shareowner- rights standards and the legal and regulatory environments that underpin those rights vary from market to market. Therefore, shareowners must seek out information to understand their rights in each market. For this reason, we have included a comprehensive list of corporate governance codes and resources in Appendix A.32 Following is a discussion of issues that investors should consider in evaluating the shareowner rights of various companies. Shareowner Voting Companies have all kinds of rules governing the way shareowners may vote their shares. We review in this section aspects of shareowner voting about which investors should be aware: ownership structure and voting rights, proxy voting, confidential voting and vote tabulation, cumulative voting, voting for other corporate changes, and shareowner proposals. Ownership Structure and Voting Rights Investors should examine the company’s ownership structure to determine whether it has different classes of common shares that separate the voting rights of those shares from their economic value. 31 A December 2003 study by Paul A. Gompers, Joy L. Ishii, and Andrew Metrick found that companies with two classes of common shares that separated the voting rights from the cash flow rights resulted in underinvestment and lower valuations. See Gompers et al., “Incentives vs. Control” (2003). 32 See also Shareowner Rights across the Markets: A Manual for Investors, Charlotteville, VA: CFA Institute Centre (April 2009): www.cfapubs.org/loi/ccb. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 34 9/25/2009 11:24:47 AM 29 Reasons for Examining the Ownership Structure of the Company A company that assigns one vote to each share is more likely to have a board that considers and acts in the best interests of all shareowners, and the one-share/one-vote standard is considered best practice by most international corporate governance professionals. Conversely, a company with different classes of common shares in which the majority, or all, of the voting rights are given to one class of shareowners may create a situation in which the management and board are disproportionately focused on the interests of those favored shareowners. It is usually in the shareowners’ best interests for cash flow rights and voting rights to be equivalent. Companies with dual classes or multiple classes of shares often have a separation of cash flow rights (to all shareowners) and voting rights (in favor of certain shareowners with higher voting rights). Implications for Investors Companies with dual classes of common equity could encourage potential acquirers to deal directly with those shareowners who own the shares with super voting rights. Moreover, studies have shown that companies that separate voting rights from economic rights (entitling a shareowner to a pro rata share of the earnings and residual asset value of the company) of their common shares have more difficult raising equity capital to invest in capital improvements and product development than companies that combine those rights. Things to Consider When analyzing the ownership structure of a company, investors should consider whether • there are different classes of shares and how voting rights differ between them; • the company has safeguards in its articles of organization or by-laws that protect the rights and interests of those shareowners whose shares have inferior voting rights; • the company was recently privatized by a government or governmental entity and whether the selling government has retained voting rights that could veto certain decisions of management and the board. If so, a government could prevent shareowners from receiving full value for their shares; • the super voting rights granted to certain classes of shareowners have impaired the company’s ability to raise equity capital for future investment. Investors may find the inferior class of shares unattractive, which could harm the company’s ability to finance future growth by means other than raising debt capital and increasing leverage.33 Where to find information about whether the company has more than one class of shares: In certain jurisdictions and in certain companies, investors may find information about the different classes of shares in the annual proxy statement to shareowners. The company’s website also is likely to describe the differences between shares of common stock and may provide hyperlinks to the company’s articles of organization, annual and interim financial reports, prospectuses, and proxy statements. The prospectus relating to the initial or follow-on offerings of common shares to the public is likely to include a discussion about different classes of common shares, including whether any entity or group of investors retains sufficient voting power to overrule certain management or board decisions. The notes to the financial statements, particularly in the annual report, will likely disclose the existence of different classes of common shares. Proxy Voting Investors should determine whether the company permits shareowners to vote their shares prior to scheduled meetings of shareowners regardless of whether they are able to attend the meetings in person. 33 See Shareowner Rights across the Markets, op cit. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 35 9/25/2009 11:24:47 AM 30 Reasons for Evaluating a Company’s Voting Rules The ability to vote one’s shares is a fundamental right of share ownership. In some jurisdictions, shareowners may find it difficult to vote their shares, however, because the company accepts only those votes cast at its annual general meeting and does not allow shareowners the right to vote by proxy or electronically. Implications for Investors By making it difficult for shareowners to vote their common shares, a company limits a shareowner’s ability to choose board members or otherwise express their views on initiatives that could alter the company’s course. Things to Consider In examining whether a company permits proxy voting, investors should consider whether the company • limits shareowners’ ability to cast votes by conditioning the exercise of their right to vote on their presence at the annual general meeting; • coordinates the timing of its annual general meeting with other companies in its region to ensure that all of them hold their meetings on the same day but in different locations. In some regions that require shareowners to attend such meetings to vote, such actions seek to prevent shareowners from attending all the meetings and, therefore, from exercising their voting rights. In Pakistan, to avoid companies bunching their annual meeting dates together and disenfranchising shareowners, companies must submit meeting dates to the securities regulator for approval; • permits proxy voting by means of paper ballot, electronic voting, proxy voting services, or some other remote mechanism; • is permitted under its national governance code to use share blocking, whereby the company prevents investors that wish to exercise their voting rights from trading their shares during a period prior to the annual general meeting to permit the company and various financial institutions to certify who owns the shares; • gives shareowners enough time between the release of the proxy and the actual annual meeting to thoughtfully review any voting decisions and vote their shares. In some markets shareowners are given only days or weeks to make such voting decisions, which renders voting especially difficult for foreign investors who may not be able to vote their shares as quickly as those investors in the local market. Where to find information about the company’s proxy voting rules: Investors can look to the company’s articles of organization and by-laws to determine the mechanisms shareowners can use to vote their shares. Investors can also examine the company’s corporate governance statement for information about whether proxy voting is permitted. In the United States and Canada, the proxy statement describes the mechanisms by which shareowners can cast their votes by proxy. Also, state corporation law in the United States and provincial securities legislation in Canada regulate issues relating to proxies. Consequently, investors may have to determine the locality in which a company is incorporated—typically found in the articles of incorporation—to review the proxy regulations governing the company. Confidential Voting and Vote Tabulation Investors should determine whether shareowners are able to cast confidential votes. Reasons for Determining Whether Shareowners Are Able to Cast Confidential Votes Shareowners are more likely to vote and to do so conscientiously if they are assured that board members and management will not find out how they voted. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 36 9/25/2009 11:24:47 AM 31 Implications for Investors Confidentiality of voting ensures that all votes are counted equally and that the board members and management cannot resolicit the votes of individuals and institutions who voted against the positions of these insiders until the votes are officially recorded.34 Things to Consider In examining whether shareowners can vote anonymously, investors should consider whether • the company uses a third-party entity to tabulate shareowner votes; • the company or its third-party agent retains voting records; • the company provides “timely disclosure” (immediate or a day or two after the vote) of annual meeting voting results; • the vote tabulation performed by the company or its third-party agent is subject to an audit to ensure accuracy; • shareowners are permitted to vote only if they are present at a scheduled company meeting. (See the previous section “Proxy Voting” for a discussion of this issue.) Where to find information concerning confidentiality of voting rights: Investors should look to the company’s by-laws or articles of organization to determine the procedures for counting and tabulating shareowner votes. Cumulative Voting Investors should determine whether shareowners are allowed to cast the cumulative number of votes allotted to their shares for one or a limited number of board nominees (which is cumulative voting). Implications for Investors The ability to use cumulative voting enables shareowners to vote in a manner that enhances the likelihood that their interests are represented on the board. Things to Consider In evaluating how a company handles cumulative voting, investors should consider whether the company has a significant minority shareowner group, such as a founding family, that might be able to use cumulative voting to elect board members who represent its specific interests at the expense of the interests of other shareowners. Where to find information about whether a company permits cumulative voting: The articles of organization and by-laws frequently provide information about how a company regards shareowner initiatives and rights. The prospectus that a listed company must file with the local regulator will typically describe the circumstances under which shareowners can exercise their voting rights. In the United States, investors also may look to Form 8-A, which listed companies must file with the SEC, for a description of the rights afforded a company’s common shares. Voting for Other Corporate Changes Investors should determine whether shareowners have the right to approve changes to corporate structures and policies that may alter the relationship between shareowners and the company. 34 In the case of pooled investment funds, CFA Institute has taken the position that the funds should disclose to investors how they voted the shares of each company on behalf of the fund’s beneficiaries. Such disclosures are different from disclosing those votes to management and the board, in that the investment fund is disclosing its voting record to the beneficiaries on whose behalf it is acting. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 37 9/25/2009 11:24:47 AM 32 Reasons for Considering Shareowner Input on Corporate Changes Changes to certain corporate structures have the ability to affect the value, ownership percentage, and rights associated with the company’s securities. Among the issues shareowners should review is the ability of shareowners to effect changes to the following company aspects: • articles of organization, • by-laws, • governance structures, • voting rights and mechanisms, • poison pills, • change-in-control provisions, and • board membership (by contesting board elections or recommending directors). Implications for Investors Certain changes to the company’s by-laws or articles of organization can affect the shareowner’s interests in the company. For example, the introduction or modification of an antitakeover mechanism might make a takeover too expensive for potential acquirers to consider, thereby denying shareowners full market value for their shares. Similarly, providing large quantities of stock options to management and employees may dilute the value of shares held by existing shareowners while redistributing company resources to insiders without shareowner approval. Shareowners should also consider whether such option grants put too much emphasis on short-term goals without regard to long-term risks. Things to Consider In reviewing what issues require shareowner approval, investors should determine whether shareowners • have an opportunity to vote on the sale of their company or a substantial portion of their company to a third-party buyer. Investors also may wish to consider whether shareowners have an opportunity to vote on significant acquisitions and divestitures that could increase or reduce annual revenues by 10 percent or more; • have the right to vote on certain aspects of executive compensation (see also the subsection “Executive Compensation” in the section “Corporate Transparency”); • have the right to vote against directors; • have the right to approve a new antitakeover measure and whether such measures are subject to periodic review and retention by shareowners (see the subsection “Takeover Defenses” in the section “Other Shareowner-Rights Issues”); • have the ability to periodically reconsider and revote on rules that require super-majority voting to revise the company’s by-laws, articles of organization, or other governance documents. Although these super-majority requirements may have been useful in making unwanted changes more difficult at a particular time in the company’s development, they may not serve the same purpose in light of the company’s evolution. Such provisions can make even changes overwhelmingly supported by shareowners difficult to enact; • have the ability to vote for changes to the following company elements: ■ articles of organization, ■ by-laws, ■ governance structures, and ■ voting rights and mechanisms; • may use their ownership of a limited number of shares to force a vote on special interests that are unrelated to the company’s operations. Such actions could cause the board to make it more difficult for other shareowners to propose resolutions that are relevant to the company’s operations. cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 38 9/25/2009 11:24:47 AM 33 Investors also should review the following issues to determine whether or in what conditions shareowners may vote on • share-repurchase programs, particularly if their purpose is to fund share-based compensation grants (see the section “Share-Repurchase and Price-Stabilization Programs”), • amendments, additions to, or revocation of corporate charters and by-laws, and • issuance of new capital stock, including common shares and instruments that convert into common shares. Where to find information about whether certain corporate changes require shareowner approval: • The company will often provide information to shareowners about specific issues requiring a vote as part of the company’s disclosures relating to the annual general meeting or as part of disclosures related to a special meeting of shareowners. A company typically will provide information on which issues require shareowner approval in the company’s by-laws and articles of organization. These documents will also provide information about whether management and the board can fill any vacancies without shareowner approval. Shareowner Proposals Shareowner proposals are generally of two types: board nominations and resolutions. In all cases of shareowner proposals, one issue is whether the proposal is binding or advisory only. Shareowner-Sponsored Board Nominations Investors should determine whether and in what circumstances shareowners are permitted to recommend director nominees to the board or place their own nominees on the proxy ballot. Reasons for Determining Whether Shareowners Can Propose Board Nominees The ability to nominate one or more individuals to the board can prevent erosion of shareowner value. When a board and management fail to remedy existing problems and improve the company’s financial performance, shareowners may use this power to ensure that at least one nominee is independent of the existing board and its nominations committee. Implications for Investors If shareowners have the right to nominate board members, they have the ability to force the board or management to take steps to address shareowner concerns. Things to Consider In evaluating whether shareowners can propose nominees to the board, investors should determine • in what circumstances shareowners have the right to nominate board members, such as when the board ignores a shareowner initiative; • how the company handles contested board elections. At some companies, particularly in the United States and Canada, a single vote cast in favor of a nominee is sufficient for an uncontested nominee to get elected to the board. In cases where the nominations are contested by shareowners, different rules for determining winners may apply. Where to find information about the ability of shareowners to nominate individuals for the board: The notice of the annual general meeting will provide information related to the election of board members. Also, the articles of organization and by-laws frequently provide information about how a company regards shareowner initiatives and rights. In the United States, investors may look to the company’s annual proxy statement. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 39 9/25/2009 11:24:47 AM 34 Shareowner-Sponsored Resolutions Investors should determine whether and in what circumstances shareowners may submit proposals for consideration at the company’s annual general meeting. Reasons for Determining Whether Shareowners Can Propose Corporate Initiatives Investors need to understand what they can do if the board and management fail to remedy existing problems or improve the company’s financial performance. Investors also need to understand the extent to which outside institutions or individuals with specific interests or biases are able to influence company activity. The ability to propose needed changes can prevent erosion of shareowner value. Implications for Investors The right to propose initiatives for consideration at the company’s annual general meeting is one way for shareowners to send a message that they do not like the way the board and/or management is handling one or more company matters. If the proposal receives an overwhelming number of votes, it could pressure the board and management either to make the changes called for or, if they fail to do so, to justify their inaction. Things to Consider In evaluating the ability of shareowners to propose changes for the company, investors should determine whether • the company requires a simple majority, a two-thirds majority, or some other super- majority vote for passing a shareowner resolution. The company may require a simple majority vote to pass board- or management-sponsored initiatives; • initiatives proposed by shareowners benefit the long-term interests of all shareowners or whether they represent the narrow interests of those making the proposals; • any “advance notice provision” exists in the jurisdiction that would require a shareowner to give notice of a proposal a certain amount of time before an annual meeting. Often such advance notice has to do with the nomination of directors, and such notice requirements call on a shareowner to give notice of such proposals to the company months before the annual meeting. Where to find information about shareowner authority to propose voting initiatives: A company’s articles of organization and by-laws frequently provide information about how a company regards shareowner-sponsored proposals. In the United States, shareowners may look to the annual proxy statement for information about how to submit proxy initiatives. Advisory or Binding Shareowner Proposals Investors should determine whether the board and management are required to implement proposals that shareowners approve. Reasons for Determining Whether Shareowner Proposals Are Binding Unless the company is required to implement an initiative that shareowners have approved, the board and management may ignore those and other shareowner concerns. Implications for Investors Requirements that the board and management implement approved shareowner-sponsored initiatives could pressure the board and management to act on behalf of shareowners. Things to Consider When reviewing the company’s rules regarding shareowner initiatives, investors should determine whether • the company has implemented or ignored approved shareowner-sponsored proposals in the past; • the company requires a super majority of votes to approve changes to its by-laws and articles of organization; cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 40 9/25/2009 11:24:47 AM 35 • national regulatory agencies have pressured companies to act on the terms of approved shareowner initiatives. Where to find information about the enforceability of shareowner-sponsored proposals: The articles of organization and by-laws typically provide information about whether shareowner initiatives are binding and, if so, the size of the majority vote needed to enforce the measure. Investors also may look to the regulatory agency in the jurisdiction where the company is headquartered to determine whether the agency has taken steps to enforce shareowner initiatives in other cases. Other Shareowner-Rights Issues Issues discussed here include shareowners’ legal rights, takeover defenses, and the actions of other shareowners. Shareowner Legal Rights Investors should determine whether the corporate governance code and other legal statutes of the jurisdiction in which the company is headquartered permit shareowners to take legal action or seek regulatory action to protect and enforce their ownership rights. Reasons for Determining the Legal Remedies Available to Shareowners In situations where the company has failed to fully recognize shareowner rights, shareowners may have to turn to the courts or national regulators to enforce their rights of ownership. Things to Consider When reviewing the local governance code and statutes regarding legal and regulatory actions, investors should determine whether • local legal statutes permit shareowners to take derivative legal actions, which permit shareowners to initiate legal actions against management or board members on behalf of the company and, if so, what conditions must be met for them to take such actions; • the regulator in the local jurisdiction where the company is headquartered has taken action in other cases to enforce shareowner rights or to prevent the denial of shareowner rights; • shareowners, either individually or as a class, are permitted to take legal action or seek regulatory action to enforce fraud charges against management or the board. Where to find information about legal and regulatory relief for shareowners: The regulator in the local market of the company’s headquarters may provide information about the remedies available to shareowners in a variety of legal and regulatory matters. Takeover Defenses Shareowners should carefully evaluate the structure of an existing or proposed takeover defense and analyze how it could affect the value of shares in a normal market environment and in the event of a takeover bid. Reasons for Reviewing Disclosures Relating to Takeover Defenses Such disclosures should provide shareowners with information about the situations in which takeover defenses could be used to counter a hostile bid. Examples of takeover defenses include golden parachutes, cross-shareholdings, caps on voting rights, poison pills, and greenmail.35 Implications for Investors By forcing an acquiring entity to deal directly with management and the board, takeover defenses may reduce the potential for the acquirer to succeed, even in situations that would benefit shareowners. Defenses against takeovers also may cause investors to discount the value of the company’s shares in normal trading because of the conditions and barriers they create. 35 Greenmail is a premium paid by the object of a hostile takeover bid to the entity making that bid in return for an agreement that the bidding entity will halt its takeover bid for a certain period. ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 41 9/25/2009 11:24:48 AM 36 Things to Consider When reviewing a company’s antitakeover measures, investors should • inquire whether the company is required to receive shareowner approval for such measures prior to implementation. Each company is likely to structure antitakeover measures differently. In some cases, investors may find that the board is permitted to implement an antitakeover measure subject to approval by shareowners within a set period of time. Others may not require shareowner approval at all; • inquire whether the company has received any formal acquisition overtures during the past two years and whether takeover defenses were used; • consider the possibility that the board and management will use the company’s cash and available credit lines to pay a hostile bidder to forgo a takeover. In general, shareowners should take steps to prevent the board from carrying out such actions. If the company agrees to such payments, shareowners should review any publicly available information about the terms of such greenmail payments; • consider whether in some cases change-in-control issues are likely to invoke the interest of a national or local government, which might then pressure the seller to change the terms of a proposed acquisition or merger. In such cases, the investor is unlikely to find specific government directives decreeing such defenses, although investors may find indications about the likelihood of such actions by examining the government’s past actions relating to the company or relating to other companies in similar situations; • consider whether change-in-control provisions will trigger large severance packages and other payments to company executives; • understand whether the company is involved in any cross-shareholding arrangements with other companies that may function as a defense against hostile takeover bids from unwanted third parties. Where to find information about takeover provisions: A company’s articles of organization are the most likely places to find information about existing takeover defenses. Newly created antitakeover provisions may or may not require shareowner approval. In any case, the company may have to provide information to its shareowners about amendments to existing defenses. Actions of Other Shareowners Investors should understand that the actions of other shareowners are governance issues they need to consider with the same degree of interest as they do the actions of the board and management. Reasons for Reviewing Disclosures Relating to Other Shareowner Actions The actions of other shareowners may have a great deal of influence on the value of a company’s shares. Activist investors or investor groups with significant stakes in companies often have the power to influence corporate decisions and sometimes to replace board members and even management. Shareowners should pay attention to the actions of the owners of large amounts of the company’s shares to determine whether their actions are consistent with the creation of long-term shareowner value. Implications for Investors Investors may see their shareholdings diluted, may see a shareowner push for changes they do not agree would be in the best interests of the company, or may get ideas from activists about strategies that investors may want to apply at other companies in which they are invested. Things to Consider When reviewing the activities of other shareowners, investors should understand the motivations behind the actions of any activist investor: Are the motivations short term in nature or intended to enhance the creation of long-term value? cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 42 9/25/2009 11:24:48 AM 37 Appendix A. Existing and Proposed Corporate Governance Codes Global Organizations International Corporate Governance Network, Global Corporate Governance Principles, 2005: www.ecgi.org/codes/documents/revised_principles_jul2005.pdf Organization for Economic Cooperation and Development, OECD Principles of Corporate Governance, January 2004: www.oecd.org/dataoecd/32/18/31557724.pdf Argentina Instituto Argentino para el Gobierno de las Organizaciones (IAGO), Código de Mejores Prácticas de Gobierno de las Organizaciones para la República Argentina, 2004: www.ecgi.org/ codes/documents/argentina_2004_es.pdf Australia Australian Stock Exchange, ASX Corporate Governance Council, Corporate Governance Principles and Recommendations: Principles of Good Corporate Governance and Best Practice Recommendations, 2nd edition, 2007: http://asx.ice4.interactiveinvestor.com.au/ ASX0701/Corporate%20Governance%20Principles/EN/body.aspx?z=1&p= -1&v=1&uid= Investment and Financial Services Association, Blue Book Corporate Governance: A Guide for Fund Managers and Corporations, 2004: www.ifsa.com.au/documents/ IFSA%20Guidance%20Note%20No%202.pdf Austria Austrian Working Group for Corporate Governance, Austrian Code of Corporate Governance, 2009: www.corporate-governance.at/(English version). Bangladesh Bangladesh Enterprise Institute (BEI), The Code of Corporate Governance for Bangladesh, March 2004: www.ecgi.org/codes/documents/code.pdf Belgium Corporate Governance Committee, Belgian Corporate Governance Code, 2009: www.corporategovernancecommittee.be/library/documents/final%20code/ CorporateGovUKCode2009.pdf (English version). Brazil Comissão de Valores Mobiliários, Recomendações sobre Governança Corporativa, 2002 : www.cvm.gov.br/ingl/indexing.asp (English version). Instituto Brasileiro de Governança Corporativa (IBGC), Code of Best Practice of Corporate Governance, 2009: www.ibgc.org.br/Download.aspx?Ref=Arquivos&CodArquivo=315 (Portuguese version). Novo Mercado, Listing Rules, March, 2008: www.bovespa.com.br/pdf/regulamento.pdf ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 43 9/25/2009 11:24:48 AM 38 Bulgaria The Bulgarian Stock Exchange, Bulgarian National Code for Corporate Governance, October 2007: http://download.bse-sofia.bg/pdf/CodeksEN.pdf Canada Canadian Coalition for Good Governance, Corporate Governance Guidelines for Building High Performance Boards (Version 1.0), September 2005: www.ccgg.ca/media/files/ guidelines-and-policies/guidelines/CCGG%20Guidelines%20v1%20-%20November %202005.pdf Expert Panel on Securities Regulation, Final Report and Recommendations, January 2009: www.expertpanel.ca/eng/documents/Expert_Panel_Final_Report_And_ Recommendations.pdf Ontario Teachers Pension Plan, Corporate Governance Policies and Proxy Voting Guidelines: Good Governance Is Good Business, 2009: http://docs.otpp.com/TeachersCorpGovE.pdf Toronto Stock Exchange, Corporate Governance: A Guide to Good Disclosure, 2006: www.tsx.com/en/pdf/TSXGuideToGoodDisclosure.pdf Canadian Multilateral Agreements Amendments to Multilateral Instrument 52-110, Audit Committees, 2004: www.osc.gov.on.ca/ Regulation/Rulemaking/Current/Part5/rule_20041029_52-110_amend-audit-com.jsp Multilateral Instrument 52-110, Audit Committees, 2004: www.osc.gov.on.ca/Regulation/ Rulemaking/Current/Part5/rule_20050617_52-110_audit-com-cp.pdf National Instrument (NI) 51-102 (Continuous Disclosure Obligations), NI 71-102 (Continuous Disclosure and Other Exemptions Relating to Foreign Issuers), and NI 52-107: www.osc.gov.on.ca/Regulation/Rulemaking/Current/Part5/rule_20071221_51- 102_cont-disc-ob.pdf Proposed repeal and replacement of NP 58-201 (Corporate Governance Guidelines), NI 58-101 (Disclosure of Corporate Governance Practices), and NI 52-110 (Audit Committees,) and Companion Policy 52-110CP (Audit Committees) (these would replace 52-110): www.osc.gov.on.ca/ Regulation/Rulemaking/Current/Part5/rule_20081219_58-201_rfc.pdf China China Securities Regulatory Commission, The Code of Corporate Governance for Listed Companies in China, 2001: www.ecgi.org/codes/documents/code_en.pdf (English version). Cyprus Cyprus Stock Exchange, Cyprus Corporate Governance Code, 2nd edition, March 2006: www.ecgi.org/codes/documents/cgc_cyprus_march2006_en.pdf Czech Republic Czech Securities Commission, Corporate Governance Code Based on the OECD Principles, 2004; www.ecgi.org/codes/documents/czech_code_2004_en.pdf Denmark Committee on Corporate Governance, Recommendations for Corporate Governance, 2008: www.corporategovernance.dk/ cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 44 9/25/2009 11:24:48 AM 39 Egypt General Authority of Investment and Free Zones; Alexandria Stock Exchange, Guide to Corporate Governance Principles in Egypt: www.hawkamah.org/publications/codes/files/ egyptiancodeofcorporategovernance_eng.pdf Ministry of Investment, The Code of Corporate Governance for the Public Enterprise Sector, July 2006: www.ecgi.org/codes/documents/egyptsoecodeofcg_en.pdf Estonia Financial Supervision Authority; Tallinn Stock Exchange, Corporate Governance Recommendations, January 2006: www.ecgi.org/codes/documents/cg_recommendations_ 2005_en.pdf European Commission Directive 2007/36/EC (on the exercise of certain rights of shareholders in listed companies), 2007: http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2007: 184:0017:0024:EN:PDF Eighth Council Directive 84/253/EEC (on the approval of persons responsible for carrying out the statutory audits of accounting documents [audit committees]), 2006: http:// eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:31984L0253:EN:NOT Finland Securities Market Association, Finnish Corporate Governance Code, 2008: www.cgfinland.fi/images/stories/pdf/cg-koodi_2008_eng.pdf France MEDEF/AFEP, Recommendations Concerning Compensation of Executive Corporate Officers of Listed Companies, October 2008: www.medef.fr/medias/files/ 132856_FICHIER_0.pdf Germany German Government Commission, Amendment to the German Corporate Governance Code (Cromme Commission Code), June 2008: www.corporate-governance-code.de/eng/ kodex/index.html (English version). Greece Federation of Greek Industries, Principles of Corporate Governance, 2001: www.ecgi.org/ codes/documents/fge_july2001_en.pdf (English version). Hong Kong Hong Kong Exchanges and Clearing, Ltd., Governance Practices and Corporate Governance Report, November 2004: www.ecgi.org/codes/documents/hk_cg_codes_conclusions.pdf Hong Kong Society of Accountants, Corporate Governance for Public Bodies, 2004: www.hkicpa.org.hk/publications/corporategovernanceguides/eframework_guide.pdf (English version). Hungary Budapest Stock Exchange, Corporate Governance Recommendations, March 2008: www.bse.hu/data/cms61401/CGR_080516.doc (English version). ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 45 9/25/2009 11:24:48 AM 40 Iceland Iceland Stock Exchange, Guidelines on Corporate Governance, 2nd edition, 2005: www.ecgi.org/codes/documents/iceland_2005_en.pdf India Securities and Exchange Board of India, Report of the Kumar Mangalam Birla Committee on Corporate Governance, 2002: www.ecgi.org/codes/documents/corpgov.pdf Indonesia The National Committee on Corporate Governance, Code for Good Corporate Governance, 2006: www.ecgi.org/codes/documents/indonesia_cg_2006_en.pdf Ireland Irish Association of Investment Managers, Corporate Governance, Share Option and Other Incentive Schemes, 1999: www.iaim.ie/Guideline1.htm Italy Associazione fra le Società Italiane per Azioni (Assonime), Handbook on Corporate Governance Reports, 2004: www.ecgi.org/codes/documents/cg_guide.pdf (Italian and English versions). Borsa Italiana S.p.A., Committee for the Corporate Governance of Listed Companies, Corporate Governance Code, 2006: www.borsaitaliana.it/documenti/regolamenti/corporate governance/corporategovernance.en.htm (English version). Jamaica Private Sector Organisation of Jamaica, Code of Corporate Governance, 2006: www.ecgi.org/ codes/documents/jamaica_code_final_25oct2006.pdf Japan Tokyo Stock Exchange, Principles of Corporate Governance for Listed Companies, 2004: www.ecgi.org/codes/documents/principles.pdf (English version). Jordan Central Bank of Jordan, Corporate Governance Code for Banks in Jordan, 2007: www.cbj.gov.jo/uploads/code_book__e.pdf Kenya Private Sector Corporate Governance Trust, Principles for Corporate Governance in Kenya, 2002: www.ecgi.org/codes/documents/principles_2.pdf Latvia Riga Stock Exchange, Principles of Corporate Governance and Recommendations on Their Implementation, December 2005: www.ecgi.org/codes/documents/cg_latvia_2005_en.pdf Lebanon The Lebanese Transparency Association, The Lebanese Code of Corporate Governance, 2006: www.hawkamah.org/publications/codes/files/lebanon_cg_2006.pdf cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 46 9/25/2009 11:24:48 AM 41 Luxembourg The Luxembourg Stock Exchange, The Ten Principles of Corporate Governance of the Luxembourg Stock Exchange, April 2006: www.ecgi.org/codes/documents/ luxembourg_en.pdf Malaysia Securities Commission Malaysia, Malaysian Code on Corporate Governance, 2007: www.ecgi.org/codes/documents/cg_code_malaysia_2007_en.pdf Malta Malta Financial Services Authority (MFSA), Principles of Good Corporate Governance: Revised Code for Issuers of Listed Securities, October 2005: www.ecgi.org/codes/documents/ cg_principles_malta_lc_nov2005_en.pdf Malta Financial Services Authority (MFSA), Principles of Good Corporate Governance for Public Interest Companies, November 2005: www.ecgi.org/codes/documents/cg_principles_ malta_pic_nov2005_en.pdf Mexico Mexican Stock Exchange, Mexican Bankers’ Association, Mexican Institute of Finance Executives; Mexican Institute of Public Accountants, Código de Mejores Prácticas Corporativas, 1999: www.ecgi.org/codes/documents/mexico_code_en.pdf Morocco Commission Nationale Gouvernance d’Entreprise, Moroccan Code of Good Corporate Governance Practices, March 2008: www.ecgi.org/codes/documents/morocco_code_ march2008_en.pdf The Netherlands Dutch Corporate Governance Code Monitoring Committee, Corporate Governance Codes and Principles—The Netherlands, 2008: www.ecgi.org/codes/documents/cg_code_ netherlands_dec2008_en.pdf Stichting Corporate Governance Onderzoek voor Pensioenfondsen, Manual Corporate Governance SCGOP, 2004; www.ecgi.org/codes/documents/scgop_handbook_2004_ en.pdf (English version). New Zealand New Zealand Securities Commission, Corporate Governance in New Zealand: Principles and Guidelines—A Handbook for Directors, Executives and Advisers, 2004: www.ecgi.org/codes/ documents/cg_handbook2004.pdf Corporate Governance in New Zealand: Principles and Guidelines, 2004: www.ecgi.org/codes/ documents/cg_nz2004.pdf Nigeria Central Bank of Nigeria, Code of Corporate Governance for Banks in Nigeria Post Consolidation, March 2006: www.ecgi.org/codes/documents/cg_code_nigeria_2006_en.pdf ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 47 9/25/2009 11:24:48 AM 42 Norway Norwegian Corporate Governance Board (Norsk Utvalg for Eierstyring og Selskapsle- delse), The Norwegian Code of Practice for Corporate Governance, 2007: www.ecgi.org/codes/ documents/norway_code_4dec2007_en.pdf (English version). Oman Capital Market Authority, Code of Corporate Governance for MSM Listed Companies: www.omancma.org/documents/bef0f8d9-5521-4881-9067-07abd74ae337.pdf Pakistan Securities and Exchange Commission of Pakistan, Code of Corporate Governance, 2002: www.ecgi.org/codes/documents/code_corporate(revised).pdf (English version). Securities and Exchange Commission of Pakistan, Manual of Corporate Governance, 2002: www.secp.gov.pk/dp/pdf/manual-CG.pdf (English version). Peru Comisión Nacional Supervisora de Empresas y Valores, Principos de Buen Gobierno para las Sociedades Peruanas, 2002: www.ecgi.org/codes/documents/code_jul2002_en.pdf (English version). The Philippines Philippines Securities and Exchange Commission, Code of Corporate Governance, Memorandum Circular No. 6, 2009: www.sec.gov.ph/circulars/cy,2009/sec-memo-06,s2009.pdf Poland Warsaw Stock Exchange, Code of Best Practice for Warsaw Stock Exchange Listed Companies, 2007: www.ecgi.org/codes/documents/code_wse_2007_en.pdf Portugal Comissão do Mercado de Valores Mobiliários (CNMV), CMVM Regulation No. 11/2003: Corporate Governance, 2007: www.cmvm.pt/NR/exeres/11DE7CAE-FDB8-42D7-8A54- DB95FCB470D5.htm (English version). Romania Bucharest Stock Exchange, Bucharest Stock Exchange Corporate Governance Code, 2009: www.ecgi.org/codes/documents/bucharest_se_code_jan2009_en.pdf Russia Coordination Council for Corporate Governance, The Russian Code of Corporate Governance, 2002: www.ecgi.org/codes/documents/final_code_english.pdf Saudi Arabia Capital Market Authority, Corporate Governance Regulations in the Kingdom of Saudi Arabia, 2006: www.cma.org.sa/cma_cms/upload_sec_content/dwfile19/convE.pdf Central European Corporate Governance Association, Corporate Governance Code for Slovakia, January 2008: www.ecgi.org/codes/documents/cega_code_slovakia_jan2008_en.pdf Singapore Council on Corporate Disclosure and Governance (CCDG), Code of Corporate Governance, 2001: www.ecgi.org/codes/documents/cg_code.pdf (English version). Slovakia cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 48 9/25/2009 11:24:48 AM 43 Slovenia Ljubljana Stock Exchange, Association of Supervisory Board Members; Managers’ Association of Slovenia, Corporate Governance Code, February 2007: www.ecgi.org/codes/ documents/cg_code_slovenia_feb2007_en.pdf South Africa Institute of Directors in Southern Africa, King Report on Corporate Governance for South Africa (King III Report), 2009: www.iodsa.co.za/products_services.asp?CatID=268(code order form and summary). South Korea Committee on Corporate Governance, Code of Best Practice for Corporate Governance, 1999: www.ecgi.org/codes/documents/code_korea.pdf (English version). Spain Comision Nacional del Mercado de Valores, Unified Good Governance Code of Listed Companies, 2006: www.ecgi.org/codes/documents/unified_code_may2006_en.pdf Sri Lanka Institute of Chartered Accountants of Sri Lanka (ICASL); Securities and Exchange Commission of Sri Lanka (SEC), Draft Rules on Corporate Governance for Listed Companies, July 2006: www.ecgi.org/codes/documents/sri_lanka_draftcode_july2006.pdf Sweden Swedish Corporate Governance Board, Swedish Code of Corporate Governance, 2008: www.ecgi.org/codes/documents/swedish_cgc_jul2008_en.pdf (English version). Switzerland Economiesuisse, Swiss Code of Best Practice for Corporate Governance, February 2008: www.ecgi.org/codes/documents/swiss_code_feb2008_en.pdf (English version). Vereinigung der Privaten Aktiengesellschaften (VPAG), Prager Dreifuss, Continuum AG, Governance in Family Firms, December 2006: www.ecgi.org/codes/documents/ swisscode_family_firms_de.pdf (German version). Taiwan Taiwan Stock Exchange, GreTai Securities Market, Taiwan Corporate Governance Best- Practice Principles, 2002: www.ecgi.org/codes/documents/taiwan_cg_principles.pdf Thailand Stock Exchange of Thailand, The Principles of Good Corporate Governance for Listed Companies, March 2006: www.ecgi.org/codes/documents/cg_principles_thailand_2006_en.pdf Trinidad and Tobago Central Bank of Trinidad and Tobago, Corporate Governance Guideline, May 2006: www.ecgi.org/codes/documents/trinidad_may2006.pdf ©2009 cfa institute the corporate governance of listed companies, 2nd ed. Corp Governance_2nd Ed.online.pdf 49 9/25/2009 11:24:48 AM 44 Tunisia L’Institut Arabe des Chefs d’Entreprises, Guide de Bonnes Pratiques de Gouvernance des Entreprises Tunisiennes, June 2008: www.ecgi.org/codes/documents/guide_tunisia_ 2008_en.pdf Turkey Capital Markets Board of Turkey, Corporate Governance Principles, June 2003: www.ecgi.org/codes/documents/cmb_principles_2004.pdf Ukraine Ukrainian Securities Commission, Ukrainian Corporate Governance Principles, June 2003: www.ecgi.org/codes/documents/ukraine_cg_en.pdf United Arab Emirates Securities & Commodities Authority, Chairperson Decision No. (r/32) of the Year 2007 on Corporate Governance Code for Joint-Stock Companies and Institutional Discipline Criteria: http://sca-mo1.sca.ae/English/legalaffairs/LegalLaws/2007-32.pdf United Kingdom Financial Reporting Council, The Combined Code on Corporate Governance, 2008: www.frc.org.uk/corporate/combinedcode.cfm Financial Reporting Council, Guidance on Audit Committees, 2008: www.frc.org.uk/ corporate/auditcommittees.cfm NAPF, Pension Scheme Governance—Fit for the 21st Century: A Discussion Paper from the NAPF, July 2005: www.ecgi.org/codes/documents/napf_discussion_paper_jul2005.pdf United States Council of Institutional Investors, Corporate Governance Policies, 2009: www.cii.org/ UserFiles/file/council%20policies/CII%20Full%20Corp%20Gov%20Policies%205-7- 09.pdf NASDAQ Stock Market, Nasdaq Rule 4200, revised 2006: http://nasdaq. cchwallstreet.com/nasdaqtools/platformviewer.asp?selectednode=chp_1_1_4_1_5_9& manual=/nasdaq/main/nasdaq-equityrules/ New York Stock Exchange, Final Corporate Governance Listing Standards, Section 303A: Final Rules, November 2004: www.nyse.com/pdfs/section303A_final_rules.pdf State of Delaware, Division of Corporations, Delaware Corporation and Business Entity Laws (current): www.state.de.us/corp/DElaw.shtml Teachers Insurance and Annuity Association–College Retirement Equities Fund, TIAA- CREF Policy Statement on Corporate Governance, March 2007: www.ecgi.org/codes/ documents/tiaa_cref_governance_policy_2007.pdf cfa institute centre for financial market integrity ©2009 cfa institute Corp Governance_2nd Ed.online.pdf 50 9/25/2009 11:24:49 AM 45 Appendix B. Corporate Governance Studies and Research “2009 U.S. Proxy Season Trends,” RiskMetrics Group (June 2009): www.riskmetrics.com/ docs/2009_us_proxy_season_trends (site login required) “Accounting Choice in Troubled Companies,” by H. DeAngelo, Linda DeAngelo, and Douglas J. Skinner, Journal of Accounting and Economics, vol. 17, nos. 1-2 (January 1994):113–143: http://deepblue.lib.umich.edu/bitstream/2027.42/31888/1/0000840.pdf “Additional Evidence on Equity Ownership and Corporate Value,” by J.J. McConnell and H. Servaes, Journal of Financial Economics, vol. 27, no. 2 (October 1990): 595–612: www.sciencedirect.com/science/article/B6VBX-45N4YYX-2S/2/cdf77497e3b 230b0bc11fcc412eb48b3 (abstract and paid version). “Agency Problems and the Theory of the Firm,” by Eugene F. Fama, Journal of Political Economy, vol. 88, no. 2 (April 1980):288–307: http://astro.temple.edu/~tub06197/ Wk5FamaAgency Problemsandthetheoryofthefirm.pdf “Agency Problems at Dual-Class Companies,” Ronald W. 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