Corporate Governance and Borrowing Powers of Directors - V

Company is an artificial juridical person. The company operates through directors who are its brain, eyes, ears etc.. They are entrusted with the job of managing the affairs of the company by its owners - shareholders. Thus the relationship between shareholders and directors are of principal and agent respectively, hence , the agency problem, agent may not perform his duties to the advantage of his principal. What should be done to eliminate such an eventuality? Here is an excerpt from "The Combined Code on Corporate Governance 2008".

A. DIRECTORS

A.1 The Board

Main Principle

Every company should be headed by an effective board, which is collectively responsible for the success of the company.

Supporting Principles

The board’s role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed. The board should set the company’s strategic aims, ensure that the necessary financial and human resources are in place for the company to meet its objectives and review management performance. The board should set the company’s values and standards and ensure that its obligations to its shareholders and others are understood and met.

All directors must take decisions objectively in the interests of the company.

As part of their role as members of a unitary board, non-executive directors should constructively challenge and help develop proposals on strategy. Non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible. They are responsible for determining appropriate levels of remuneration of executive directors and have a prime role in appointing, and where necessary removing, executive directors, and in succession planning.

A.3 Board balance and independence

Main Principle

The board should include a balance of executive and non-executive directors (and in particular independent non-executive directors) such that no individual or small group of individuals can dominate the board’s decision taking.

Supporting Principles

The board should not be so large as to be unwieldy. The board should be of sufficient size that the balance of skills and experience is appropriate for the requirements of the business and that changes to the board’s composition can be managed without undue disruption.

To ensure that power and information are not concentrated in one or two individuals, there should be a strong presence on the board of both executive and non-executive directors.

The value of ensuring that committee membership is refreshed and that undue reliance is not placed on particular individuals should be taken into account in deciding chairmanship and membership of committees.

No one other than the committee chairman and members is entitled to be present at a meeting of the nomination, audit or remuneration committee, but others may attend at the invitation of the committee.

A.4 Appointments to the Board

Main Principle

There should be a formal, rigorous and transparent procedure for the appointment of new directors to the board.

Supporting Principles

Appointments to the board should be made on merit and against objective criteria. Care should be taken to ensure that appointees have enough time available to devote to the job. This is particularly important in the case of chairmanships.

The board should satisfy itself that plans are in place for orderly succession for appointments to the board and to senior management, so as to maintain an appropriate balance of skills and experience within the company and on the board.

C.1 Financial Reporting

Main Principle

The board should present a balanced and understandable assessment of the company’s position and prospects.

Supporting Principle

The board’s responsibility to present a balanced and understandable assessment extends to interim and other price-sensitive public reports and reports to regulators as well as to information required to be presented by statutory requirements.

C.2 Internal Control

Main Principle

The board should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets.

C.3 Audit Committee and Auditors

Main Principle

The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the company’s auditors.

D.1 Dialogue with Institutional Shareholders

Main Principle

There should be a dialogue with shareholders based on the mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place.

Supporting Principles

Whilst recognising that most shareholder contact is with the chief executive and finance director, the chairman (and the senior independent director and other directors as appropriate) should maintain sufficient contact with major shareholders to understand their issues and concerns.

The board should keep in touch with shareholder opinion in whatever ways are most practical and efficient.

D.2 Constructive Use of the AGM

Main Principle

The board should use the AGM to communicate with investors and to encourage their participation.

E.2 Evaluation of Governance Disclosures

Main Principle

When evaluating companies’ governance arrangements, particularly those relating to board structure and composition, institutional shareholders should give due weight to all relevant factors drawn to their attention.

Supporting Principle

Institutional shareholders should consider carefully explanations given for departure from this Code and make reasoned judgements in each case. They should give an explanation to the company, in writing where appropriate, and be prepared to enter a dialogue if they do not accept the company’s position. They should avoid a box-ticking approach to assessing a company’s corporate governance. They should bear in mind in particular the size and complexity of the company and the nature of the risks and challenges it faces.

E.3 Shareholder Voting

Main Principle

Institutional shareholders have a responsibility to make considered use of their votes.

Supporting Principles

Institutional shareholders should take steps to ensure their voting intentions are being translated into practice.

Institutional shareholders should, on request, make available to their clients information on the proportion of resolutions on which votes were cast and non-discretionary proxies lodged.

Major shareholders should attend AGMs where appropriate and practicable. Companies and registrars should facilitate this.

First Annual List of the 100 Top Global Thinkers | Foreign Policy

Foreign Policy's First Annual List of the 100 Top Global Thinkers | Foreign Policy

7. Cass Sunstein and Richard Thaler

Sunstein and Thaler describe themselves as "libertarian paternalists," but you probably know them more simply as the behavioralism gurus. Their big idea -- to use small policy tweaks to overcome human capriciousness -- has turned the field of economics upside down and, most recently, won them an ear at the Obama White House. Humans, the two men argue in their book, Nudge: Improving Decisions About Health, Wealth, and Happiness, tend to be emotional, rash, and uninformed, and value the present more than the future. They're far from the rational creatures upon which so much economic policy is based.

So what's a responsible government to do? Use free market policies that "nudge" citizens toward the smart options they wouldn't otherwise select, such as setting "opting in" as the default choice for retirement funds and organ donation. It's a quietly revolutionary idea from two brainy guys: Thaler is a University of Chicago-trained economist whose name has been mentioned along with "Nobel" more than a few times; Sunstein is a Harvard-trained lawyer who clerked for Thurgood Marshall and "seems to write a book about as often as most people run the dishwasher," as one 2008 profile put it. Clearly, people in power are reading: Thaler is reportedly advising the British Conservative Party on economic policy, and Sunstein, as the new head of the White House's Office of Information and Regulatory Affairs, is nudging Obama administration rules on everything from avian flu to student loans.

Corporate Governance and Borrowing Powers of Directors - IV

The Combined Code on Corporate Governance 2008 has something to say about directors role. Here is an excerpt:

Good corporate governance should contribute to better company performance by helping a board discharge its duties in the best interests of shareholders; if it is ignored, the consequence may well be vulnerability or poor performance. Good governance should facilitate efficient, effective and entrepreneurial management that can deliver shareholder value over the longer term.

The Code is not a rigid set of rules. Rather, it is a guide to the components of good board practice distilled from consultation and widespread experience over many years. While it is expected that companies will comply wholly or substantially with its provisions, it is recognised that noncompliance may be justified in particular circumstances if good governance can be achieved by other means. A condition of noncompliance is that the reasons for it should be explained to shareholders, who may wish to discuss the position with the company and whose voting intentions may be influenced as a result.

In relation to the requirement to state how it has applied the Code’s main principles, where a company has done so by complying with the associated provisions it should be sufficient simply to report that this is the case; copying out the principles in the annual report adds to its length

without adding to its value. But where a company has taken additional actions to apply the principles or otherwise improve its governance, it would be helpful to shareholders to describe these in the annual report.

If a company chooses not to comply with one or more provisions of the Code, it must give shareholders a careful and clear explanation which shareholders should evaluate on its merits. In providing an explanation, the company should aim to illustrate how its actual practices are consistent with the principle to which the particular provision relates and contribute to good governance.

In their turn, shareholders should pay due regard to companies’ individual circumstances and bear in mind in particular the size and complexity of the company and the nature of the risks and challenges it faces. Whilst shareholders have every right to challenge companies’ explanations if they are unconvincing, they should not be evaluated in a mechanistic way and departures from the Code should not be automatically treated as breaches. Institutional shareholders should be careful to respond to the statements from companies in a manner that supports the ‘comply or

explain’ principle and bearing in mind the purpose of good corporate governance. They should put their views to the company and be prepared to enter a dialogue if they do not accept the company’s position. Institutional shareholders should be prepared to put such views in writing

where appropriate.

Companies and shareholders have a shared responsibility for ensuring that ‘comply or explain’ remains an effective alternative to a rules-based system.

Companies can make a major contribution by spreading governance discussion with shareholders outside the two peak annual reporting periods around 31st December and 31st March and by raising further the general standard of their explanations justifying non- compliance. Shareholders for their part can still do more to satisfy companies that they devote adequate resources and scrutiny to engagement.

Corpoarte Governance and Borrowing Powers of Directors - III

Code of Corporate Governance issued by SECP in Pakistan provides guidelines regarding the responsibilities, powers and functions of board of directors. Here is a reproduction.

RESPONSIBILITIES, POWERS AND FUNCTIONS OF BOARD OF DIRECTORS

(vii) The directors of listed companies shall exercise their powers and carry out their fiduciary
duties with a sense of objective judgment and independence in the best interests of the listed company.
(viii) Every listed company shall ensure that:

(a) a ‘Statement of Ethics and Business Practices’ is prepared and circulated annually by its Board of Directors to establish a standard of conduct for directors and employees, which Statement shall be signed by each director and employee in acknowledgement of his understanding and acceptance of the standard of conduct;
(b) the Board of Directors adopt a vision/ mission statement and overall corporate strategy for the listed company and also formulate significant policies, having regard to the level of materiality, as may be determined it;

Explanation: Significant policies for this purpose may include:

• risk management;
• human resource management including preparation of a succession plan;
• procurement of goods and services;
• marketing;
• determination of terms of credit and discount to customers;
• write-off of bad/ doubtful debts, advances and receivables;
• acquisition/ disposal of fixed assets;
• investments;
• borrowing of moneys and the amount in excess of which borrowings shall be sanctioned/ ratified by a general meeting of shareholders;
• donations, charities, contributions and other payments of a similar nature;
• determination and delegation of financial powers;
• transactions or contracts with associated companies and related parties; and
• health, safety and environment

A complete record of particulars of the significant policies, as may be determined, along with the dates on which they were approved or amended by the Board of Directors shall be maintained.

The Board of Directors shall define the level of materiality, keeping in view the specific circumstances of the listed company and the recommendations of any technical or executive sub-committee of the Board that may be set up for the purpose;

(c) the Board of Directors establish a system of sound internal control, which is effectively implemented at all levels within the listed company;
(d) the following powers are exercised by the Board of Directors on behalf of the listed company and decisions on material transactions or significant matters are documented by a resolution passed at a meeting of the Board:

• investment and disinvestment of funds where the maturity period of such investments is six months or more, except in the case of banking companies, Non-Banking Financial Institutions, trusts and insurance companies;
• determination of the nature of loans and advances made by the listed company and fixing a monetary limit thereof;
• write-off of bad debts, advances and receivables and determination of a reasonable provision for doubtful debts;
• write-off of inventories and other assets; and
• determination of the terms of and the circumstances in which a law suit may be compromised and a claim/ right in favour of the listed company may be waived, released, extinguished or relinquished;

(e) appointment, remuneration and terms and conditions of employment of the Chief Executive Officer (CEO) and other executive directors of the listed company are determined and approved by the Board of Directors; and
(f) in the case of a modaraba or a Non-Banking Financial Institution, whose main business is investment in listed securities, the Board of Directors approve and adopt an investment policy, which is stated in each annual report of the modaraba / Non-Banking Financial Institution.

Explanation: The investment policy shall interalia state:

• that the modaraba / Non-Banking Financial Institution shall not invest in a connected person, as defined in the Asset Management Companies Rules, 1995, and shall provide a list of all such connected persons;
• that the modaraba / Non-Banking Financial Institution shall not invest in shares of unlisted companies; and
• the criteria for investment in listed securities.

The Net Asset Value of each modaraba / Non-Banking Financial Institution shall be provided for publication on a monthly basis to the stock exchange on which its shares/ certificates are listed.

(ix) The Chairman of a listed company shall preferably be elected from among the non-executive directors of the listed company. The Board of Directors shall clearly define the respective roles and responsibilities of the Chairman and Chief Executive, whether or not these offices

Corporate Governance and Borrowing Powers of Directors - II

The position in Company Law in Pakistan is that section 196 of Companies Ordinance 1984 describes the “Powers of Directors”, the section is being reproduced for reference.

“196. Powers of directors.- (l) The business of a company shall be managed by the directors, who may pay all expenses incurred in promoting and registering the
company, and may exercise all such powers of the company as are not by this Ordinance, or by the articles, or by a special resolution, required to be exercised by the company in general meeting.

(2) The directors of a company shall exercise the following powers on behalf of the company, and shall do so by means of a resolution passed at their meeting, namely. —
(a) to make calls on shareholders in respect of moneys unpaid on their shares;
(b) to issue shares;
(c) to issue debentures or 1[participation term certificate, any instrument in the nature of redeemable capital];
(d) to borrow moneys otherwise than on debentures;
(e) to invest the funds of the company;
(f ) to make loans;
(g) to authorise a director or the firm of which he is a partner or any partner of such firm or a private company of which he is a member or director to enter into any contract with the company for making sale, purchase or supply of goods or rendering services with the company;
(h) to approve annual or half-yearly or other periodical accounts as are required to be circulated to the members;
(i) to approve bonus to employees;
(j) to incur capital expenditure on any single item or dispose of a fixed asset in accordance with the limits as prescribed by the Commission from time to time;

(k) to undertake obligations under leasing contracts exceeding one million rupees;

(l) to declare interim dividend; and
(m) having regard to such amount as may be determined to be material (as construed in Generally Accepted Accounting Principles) by the Board-
(i) to write off bad debts, advances and receivables;
(ii) to write off inventories and other assets of the company; and
(iii) to determine the terms of and the circumstances in which a law suit may be compromised and a claim or right in favour of a company may be released, extinguished or relinquished:

Provided that the acceptance by a banking company in the ordinary course of its business of deposits of money from the public repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise, or the placing of moneys or deposit by a banking company with another banking company on such conditions as the directors may prescribe, shall not be deemed to be a borrowing of moneys or, as the case may be, a making of loan by a banking company within the meaning of this section.

(3) The directors of a public company or of a subsidiary of a public company shall not except with the consent of the general meeting either specifically or by way of an authorisation, do any of the following things, namely.-
(a) sell, lease or otherwise dispose of the undertakings or a sizeable part thereof unless the main business of the company comprises of such selling or leasing; and
(b) remit, give any relief or give extension of time for the repayment of any debt outstanding against any person specified in sub-section (1) of section 195.

(4) Whosoever contravenes any provision of this section shall be punishable with a fine which may extend to 1[one hundred thousand] rupees and shall be individually
and severally liable for losses or damages arising out of such action.”

Table “A” of First Schedule to Companies Ord. 1984 contains a sample of “REGULATIONS FOR MANAGEMENT OF A COMPANY LIMITED BY SHARES”. Following is a reproduction of clauses that deal with “Powers of Director”.

“44. The business of the company shall be managed by the directors, who may pay all expenses incurred in promoting and registering the company, and may exercise all such powers of the company as are not by the Ordinance or any statutory modification thereof for the time being in force, or by these regulations, required to be exercised by the company in general meeting, subject nevertheless to the provisions of the Ordinance or to any of these regulations, and such regulations being not inconsistent with the aforesaid provisions, as may be prescribed by the company in general meeting but no regulation made by the company in general meeting shall in-radiate any prior act of the directors which would have been valid if that regulation had not been made.

45. The directors shall appoint a chief executive in accordance with the provisions of sections 198 and 199.

46. The amount for the time being remaining undercharged of moneys borrowed or raised by the directors for the purposes of the company (otherwise than by the issue of share capital) shall not at any time, without the sanction of the company in general meeting, exceed the issued share capital of the company.

47. The directors shall duly comply with the provisions of the Ordinance or any statutory modification thereof for the time being in force, and in particular with the provisions in regard to the registration of the particulars of mortgages and charges affecting the property of the company or created by it, to the keeping of a register of the directors, and to the sending to the registrar of an annual list of members, and a summary of particulars relating thereto and notice of any consolidation or increase of share capital, or sub-division of shares, and copies of special resolutions and a copy of the register of directors and notifications of any changes therein.

48. The directors shall cause minutes to be made in books provided for the purpose—
(a) of all appointments of officers made by the directors;
(b) of the names of the directors present at each meeting of the directors and any committee of the directors;
(c) of all resolutions and proceedings at all meetings of the company and of the directors and of committees of directors:

and every director present at any meeting of directors or committee of directors shall sign his name in a book to be kept for that purpose.”

How the tax code encourages debt: newyorker.com

How the tax code encourages debt: newyorker.com

John Kenneth Galbraith wrote that all financial crises are the result of “debt that, in one fashion or another, has become dangerously out of scale.” The recent financial crisis was no exception, with everyone—homeowners, private-equity investors, our biggest banks—taking on enormous amounts of debt. If it’s frustrating that the government is footing the bill to clean up the mess, it’s even worse that the government helped pay for the debt binge that created the mess in the first place, thanks to a tax system that actually subsidizes borrowing. Debt didn’t get dangerously out of scale because the system was broken. It got out of scale, in part, because the system worked

Read more: http://www.newyorker.com/talk/financial/2009/11/23/091123ta_talk_surowiecki#ixzz0XfTASpak

Corporate Governance and Borrowing Powers of Directors

Corporate governance is to ensure that a system is in place to protect the individual as well as collective interests of all the stakeholders in a company. In this respect the role of Board of Directors becomes very important because by its very nature a company is an artificial juridical person in the sense that it can sue and can be sued. But it works through its directors who are its eyes, brain and muscle. Directors are the persons who run day to day affairs of the company and possess the first hand information about every aspects of its operations. Directors are also in the best of position to determine its future course i-e set objectives, formulate strategy, devise operational plans etc. Shareholders are the owners of the company who provide capital to the company for its operations but are not supposed to run its affairs and delegate this function to professional managers. These professional managers may also be shareholders of the company. This separation of brain and capital poses agency problem and dual role of directors, shareholders as well as directors creates conflict of interest with other stakeholders such as outside shareholders.

In the wake of recent financial crises and recent past failure of Enron, Worldcom and Parmalat, a heated debate is going on the role of directors and the board in the governance of corporate world. Much of the debate is centered round the structure of the board, integrity of the financial reports, auditing, shareholder activism, corporate governance rules and regulations etc. A very little attention has been given to the concept of borrowing powers of the directors. One of the elements of the powers enjoyed by the directors is that these may be misused and abused as well. If these are being misused, it means due care and necessary diligence has not been taken care of and if these are being abused, it means these are used for the purposes other than the benefit of the company. In both the cases, the tendency or some inclination to misuse and /or abuse powers can lead to disaster. As a precautionary measure, there is a need to put some checks on the use of powers enjoyed by the directors. One of the powers given to directors or used by the directors on behalf of the company is borrowing power. There is no restriction on the borrowing powers of the directors in Articles of Association and neither there is any law that restricts this power. However, there are rules and regulations for the lenders that prohibit them to lend in case of borrowing beyond a certain percentage of equity but generally there is no restriction on borrowers.

As directors manage a corporation for and on behalf of the shareholders who own it, it is critical that any regulatory and legal requirements placed on directors do not seriously compromise their goal of maximizing shareholder wealth. Directors’ behavior influences the efficient operation of corporations. If directors are subject to undue transaction costs in protecting themselves from personal liability, these costs will ultimately be passed onto, and borne by, the corporation itself. On the other hand, if directors are permitted to operate completely unfettered by regulation and a degree of shareholder control, investor confidence in the corporate may potentially be undermined. In this regard, it is clear from past experience, particularly in relation to the corporate collapses as mentioned above, that the conduct of directors through corporations can have a significant impact on public perceptions and market confidence.

While regulatory requirements are usually placed on directors as a means of protecting investors, or the general public, such protection may well be achieved at the expense of investors themselves. Accordingly, it is vitally important that any measures put in place as a means of promoting investor protection are properly assessed from an economic perspective to ensure that they do not ultimately act to the detriment of shareholders as a whole. To promote investor confidence and thereby facilitate expansion of capital market, investors need to be satisfied that they have sufficient opportunity for redress against a corporation and its directors in clear cases of negligent, reckless or fraudulent conduct. However, directors who effectively control the corporation, must not feel so over-burdened with a fear of responsibility that their decision-making is seriously constrained. Regulation in the area of directors’ duties and shareholders’ rights invariably involves a fine balance between maintaining investor confidence and encouraging commercial enterprise. In the interests of maximizing shareholder wealth and economic growth, directors need to be encouraged to take enterprising decisions. However, these decisions must be taken in the interests of the company and be challengeable if they are not bona fides and well informed.

In the backdrop of above deliberations, it is important to thoroughly evaluate the possibility of check on the borrowing powers of the directors. This paper shall examine the all possible ways in which such a check can be placed and a critical analysis of each alternative shall be put forward. Finally, a recommendation shall be made whether such a check is required or not and if required what necessary amendments in Company Law are required.