Corporate Governance and Financial Regulation - UK Coal Plc, Oxford BioMedica - Case Study Example

Corporate Governance and Financial Regulation Student’s Name Course Tutor’s Name Date: Introduction Although the term ‘corporate governance’ is used extensively in literature, scouring through the same literature reveals that the concept’s ramification on financial regulation has not been fully spelled out. The Organisation for Economic Co-operation and Development (OECD) has for example defined corporate governance as a “set of relationships between a company’s management, its board, its shareholders and other stakeholders” (OECD, 1999, p. 2 cited in Dyck, 2000, p. 2). Notably, this definition is value neutral and fails to indicate any objectives that corporate governance may have. On his part, Tirole (2001, p. 4) defines corporate governance as “the design of institutions that induce or force management to internalise the welfare of stakeholders”. Yet, a different definition states that “corporate governance is, to a large extent, a set of mechanisms through which outside investors protect themselves against expropriation by the insiders” (Dyck, 2000, p. 7). This discussion uses the latter definition. The importance of corporate governance mechanisms When financiers, management, suppliers and even labourers make their investments in firms, they do not receive simultaneous compensation; rather, they receive a promise that their investments would have good returns in the future (Dyck, 2000, p. 2). Yet, past experiences have shown the selfish interests of some insiders often violate the promises made to investors, and as the insiders’ grabbing hands amass wealth for personal gain, the firms accumulate debts, have difficulty raising the capital needed to fund future projects, and end up having a disenchanted workforce and an even more disenchanted investors. Gregory and Simms (1999, p. 1) have summed up the lack of effective corporate governance by arguing that it “distort[s] the efficient allocation of resources, undermine[s] opportunities to compete on a level playing field and ultimately hinder[s] investment and economic development”. In an analysis, Berle and Means (1932, cited by Ayuso & Argandona, 2007, p. 1) found that problems in corporate governance arose from “the separation of ownership and control in public corporations”. As such, the two authors argued that corporate governance should reduce or wipe away opportunistic behaviour that agents (managers) have towards their principals (shareholders). In developed economies, corporate governance is made up of laws, regulations, institutions, politics, codes of ethics and professional associations (Babic, 2003, p. 1). To effectively influence corporate governance, the World Bank (Cited by Babic, 2003, p. 6) indicates that internal and external corporate governance mechanisms need to be put in place. Figure 1 below is an illustration of the respective roles played by internal and external factors in enhancing corporate governance. Figure 1: Internal and external factors use in corporate governance Source: Babic (2003, p.6). Corporate Governance mechanisms – their nature and characteristics 1. Board Structure The structure of the board of directors is the most prominent corporate governance mechanism that an organisation can have (Gillan, Hartzell and Starks, 2007). According to Clarke (2007, p. 33), the board of directors is the “critical nexus in which the fortunes of the company are decided”. When firms are just starting up, the board provides the support and wisdom needed to grow and succeed, while in maturity, it becomes a source of objectives, values and direction in for purposes of sustaining the firm. Internally, the board offers the guidance and leadership needed in order to make the corporate entity successful, while on the external front, it is responsible first to the shareholders since it links them to the managers running the operations, and secondly, to the wider stakeholders (e.g. suppliers and customers) (Clarke, 2007, p. 33). According to Yermack (1996), the effectiveness of the board is affected by its size, composition and independence. For example, smaller boards were found to have better communication and hence fast and better decision-making abilities (Yermack, 1996); independent boards were found to have enhanced monitoring capabilities (Brickley, Coles and Terry, 1994); while independence of the boards was also found to have an effect on the regulatory bodies (e.g. the audit , nominating and compensation committees) (Gillan and Starks, 2000). Separating the positions of the chairman of the board and the chief executive officer (often known as CEO duality) has also been indicated as relevant especially in regard to increasing the monitoring capabilities of the board in relation to the management of the firm. 2. Charter provisions The agreements and by laws observed by different firms set out the rules and procedures under which the organisation operates. Under the charter provisions, different measures meant to enhance accountability and transparency are included (Lefort &Walker, 2003). The charter is used to indicate the separate functions that boards and management should take. Other inclusions in the charter often include voting rights (equal or unequal), cumulative voting, classified board, poison pill, blank-check preferred, written consent, special meeting, supermajority, and fair-price (Gillan et al., 2007). 3. National legal systems National legal systems provide corporate governance mechanisms, which provide “legal protections for financiers embodied in national laws” (Dyck, 2000, p. 9). Usually contained in state laws, the national legal systems provide varying antitakeover protections to different firms, and may act as an incentive to discourage firms from forming or including certain provisions in charters. Some of the prominent inclusions in the national legal systems/state laws as identified by Bebchuk and Cohen (2002) and include share-acquisition statute, freeze-out restrictions, director duty provisions, fair-price statute, poison pill endorsement, and short-term profit provision. In the United Kingdom, the Company Law Reform Bill 2005 (The Bill), and the UK Corporate Governance Code (The Code) are examples of the national legal system that dictate how companies exercise corporate governance. The Bill has designated seven duties to directors in companies namely: acting within powers conferred on them; promoting ‘the success of the company for benefit of its members’; exercising independent judgement; exercising ‘reasonable care, skill and diligence’; avoiding conflict of interest; turning down benefits advanced to them by third parties; and declaring their interests in any proposed transactions with the companies they lead (Clarke, 2007, p. 36). On its part, The Code has nine provisions that corporate organisations must meet as part of good corporate governance practices. In the UK, the corporate law system has been described as having fiduciary duties that are “wider and more developed” than those contained other European countries such as Germany (Clarke, 2007, p. 36). 4. Ownership concentration Ownership concentration refers to at least 5 percent stocks ownership by large-block shareholders or individual investors (Financial Times Lexicon, 2012). Ownership concentration enables the large-block shareholders or individual investors to have stronger monitoring powers over the managerial decisions. This mainly stems from the fact that large investors are willing to safeguard their investments through aggressive actions that limit management’s powers. According to Financial Times Lexicon (2012), ownership concentration is a vital internal governance mechanism due to its ability to reduce managerial opportunism. Companies in Focus 1. UK Coal Plc UK Coal is among the largest coal producing companies in the UK. The company has been in a loss making streak since 2006, and only recorded its first pre-tax profits of £ 58.0 million after four years in the 2010-2011 financial year (UK Coal PLC, 2011, p. 4). Although UK Coal’s core business is in coal mining, it has business interests in the property sector through Harworth Estates (ibid.). In its 2011 annual report, UK Coal has clearly stipulated that it abides by the provisions “set out in the UK Corporate Governance Code, save for its development of “two distinct principal businesses within the Group” (i.e. coal mining and property dealing) (UK Coal PLC, 2011, p. 36). Among the major issues arising from the sort of arrangement that UK Coal maintains by tying two separate but principal businesses within the same group is that the risks of the two businesses are shared. As such, problems (in cash flow or operational performance) will be construed to mean that the entire group has problems hence affecting such things like the stock prices of the larger group. To reduce such risks, the UK Coal’s chairman announced that plans are underway to separate the distinct businesses by 2014. In the meantime, UK Coal has restructured it board through appointing four non-executive directors, which the company says has renewed the determination of the board to improve the company’s performance (UK Coal PLC, 2011, p. 4). Three internal governance mechanisms identified by Hitt, Ireland and Hoskisson (2008, p. 299), i.e. the company has used the board of directors, executive compensation, ownership concentration as internal corporate governance mechanisms, are utilised at UK Coal. Notably, the company still maintains the CEO-board chairman duality, and that one of its four non-executive directors is not independent owing to his connection with one of the single largest shareholders (i.e. Peel Holdings) as indicated in UK Coal PLC (2011, p. 36). The non-independence of one of the non-executive directors hence undermines the possibility that all non-executive directors would bring objective, non partisan judgement, experience and knowledge to the board during its deliberations. Ownership concentration is evident in UK Coal’s engagement with three of its major shareholders namely Goodweather Holdings Ltd (owns 29.09 % share capital), UBS Investment bank (owns 8.52% share capital), and Pelham Capital (owns 7.48% share capital) (UK Coal PLC, 2011, p. 38). In regard to executive compensation, UK Coal has stated that it has in the recent past aligned “executive reward to challenges facing the group” (p. 41). Justifying its approach, the 2011 annual report states that the remuneration committee “has acted to incentivise key executives to meet operational targets and deliver the restructuring plan, thereby aligning executive reward to the challenges facing the group”. The report does not however state how the company has quantified the challenges facing it, or how the executive reward was determined in light of the quantifying problems that may arise when trying to quantify the challenges facing the company. 2. Oxford BioMedica Oxford BioMedica Plc – a public limited company – designs and develops gene-based medicines for use is gene therapy and immunotherapy, and is listed on the London Stock Exchange. Its profit and loss account for the 2011 reveals that the company made pre-tax loss of £11.302 million. In the 2011 annual report however, Oxford BioMedica has revealed its compliance with the UK Corporate Governance Code, with several exceptions which include the fact that its chairman chairs the audit committee – which is against the Code’s recommendations (Oxford BioMedica Plc., 2011, p. 45). The composition of Oxford BioMedica’s board is relatively non-independent considering that only 2 of the 5 directors have non-executive position. The chairman also serves as the CEO hence meaning the board cannot be considered independent. Notably, there is a probability of shareholder concentration owing to the fact that 13.26% of the share capital is owned by Cubana Investments Ltd, closely followed by M&G Investment Management Ltd owning 11.91% share capital and JP Morgan Asset Management Ltd owning 9.93% of the company’s share capital. Although the company states that “no person holds shares carrying special rights with regard to control of the company”, there is no doubt that the block-shareholders in the company can affect decisions made by the management (Oxford Biomedica, 2011, p. 50). The executive compensation strategy in Oxford BioMedica is, according to the 2011 annual report, “intended to be competitive and comprise a mix of performance-related elements” (2011, p. 53). Such measures include progress of new and existing clinical trials, product – related deals, and an unspecified other goals. Understandably, Oxford BioMedica does not engage in aggressive marketing of its products, and this perhaps forms the compensation strategy that does not seem to consider the profitability (or lack thereof) in the company. Abbey Plc Abbey Plc is one of the few companies that paid dividends to shareholders having made €11, 520, 000 in profits before tax (Abbey Plc., 2011). The company principal activities are in ‘building and property development, plant hire, and property rental” (Abbey Plc., 2011, p. 9). The company’s board is made up of four executive directors and three non-executive directors, hence meaning that the board is not entirely independent. Ownership concentration is evident in the company as Gallagher Holdings Limited has 44.24% of the share capital, followed by FMR LLC and IG Investment Management Ltd with 14.79% and 4.06% respectively (Abbey Plc, 2011, p. 10). In relation to executive compensation, Abbey plc has a remuneration committee that include all non-executive directors. Additionally, the company does not have long-term incentive schemes or share options, meaning that the remuneration is decided by the board only. When deciding on the pay, it is stated that the board considers the need to “attract, retain and motivate executive directors of the quality required” (Abbey Plc, 2011, p. 12). Alliance Pharma Alliance Pharma Plc is another of the few companies that paid dividends to shareholders in 2011 having made after-tax profits of € 6,636,000. The company is unique in that it has a CEO and a chairman, although the CEO still sits in the board. Overall, there are 5 executive directors, and 3 non-executive directors. Additionally, the company has ownership concentration, which though not specified in the 2011 annual report, is alluded to through reference that the company meets its “institutional shareholders who hold the majority of shares” (Alliance Pharma, 2011, p. 19). Executive compensation is determined by the remuneration committee, which follows provisions of the remuneration policy. The latter allows for basic salaries, benefits in-kind, bonuses, share options schemes, and pensions for the executive directors. --- A review of findings A comparison of UK Coal Plc, Oxford BioMedica, Abbey Plc, and Alliance Pharma reveals that With the exception of UK Coal, the rest are profitable companies in the 2011 financial year. If indeed financial profitability is to be used as a yardstick for performance and non-performance, it would be expected that UK Coal would have a weak corporate governance structure compared to the rest. Incidentally, UK Coal PLC seems to have weak corporate governance measures especially considering that it has two businesses under the same group hence exposing the businesses to unnecessary risks. Abbey Plc is the only company that has its executive compensation set without considering benefits, share options and other benefits. This then means that the management is completely independent of ownership and its performance hence disapproves Berle and Means’ (1932, cited by Ayuso & Argandona, 2007, p. 1) statement that corporate failure should be associated with management-ownership separation. In regard to ownership concentration, it is worth noting that though block shareholders have a substantial amount of share in Oxford BioMedica, Abbey Plc., and Alliance Pharma, and this could then mean that ownership concentration has some influence on corporate governance, and the profitability of the affected companies. This observation is however casual because as Earle, Kucsera, and Telegdy (2004) argue, the question on whether block holder’s influence on corporate value is negative or positive is still widely debated but has yet to attract a comprehensive singular answer. In comparing the companies above, this writer has not considered the differences between them especially in relation to size. The differences notwithstanding, preliminary analysis by this writer suggest that corporate governance affects firms’ performance hence, validating accusations levelled against boards whenever a corporate scandal occurs. In literature, two theories have received prominence in discussions about corporate governance; they are the principal-agent theory which indicates that managers (agents) have a responsibility to maximise wealth on behalf of their principals (shareholders); and the stakeholder theory, which argues that the governance structure should be modelled in a way that ensures that “effective negotiations, coordination, cooperation and conflict resolution” takes place within organisations in order to “maximise and distribute the joint gains among multiple parties of interests” i.e. the stakeholders (Dyck & Zingales, 2002, p. 3). Unfortunately, in the companies featured above, focus seems to be on managers and their shareholders hence negating the possibility of considering the application of the stakeholder theory. It is however clear that the principal-agent theory is applicable in the cases above, if only on paper. In the real sense however, it seems that the focus of at least one of the companies (Oxford BioMedica) is the retention of decision-making by the board and has tried to dissuade shareholders from using their stake at the company to influence decision-making. This is seen in Oxford BioMedica’s statement that “no person holds shares carrying special rights with regard to control of the company” (2011, p. 50). This then means that even the principal-agency theory is not always applicable everywhere and that sometimes the interests of the shareholders may take a back-seat as a company tries to balance all the other interests. In Oxford Biomedica’s case for example, executive compensation (despite having a minimum) was entitled to other benefits based on other factors such as new and active clinical trials, and product-related deals (Oxford BioMedica, 2011, p. 53). Oxford Biomedica’s approach is the complete opposite of what is adopted by Alliance Pharma despite the fact that the two companies operate in the same industry. The latter’s basic salaries, benefits in-kind, bonuses, share options schemes, and pensions for the executive directors is arguably equally controversial as some shareholders may argue that the directors have been allowed too much discretion. Clearly, it appears that short-term interest is not in the cards of both the board and the managers in Oxford Medica, while Alliance Pharma seems to have pegged some of the executive pay on the firm’s performance. Arguably, observation on Oxford Biomedica is subjective considering the nature of the pharmaceutical industry and the capital that may be used in product research and development before the actual sales (and hence profitability) can be realised. Conclusion In conclusion, it is notable that the press is to some extent correct in consistently attributing corporate scandals to governance issues. Mostly, there is a possibility that experiences from the past (e.g. HIH, Enron and others mentioned elsewhere in this paper) have conditioned the press to believe (and rightfully) that corporate governance has an essential role to play in order to build governance structures that can withstand internal and external pressures in organisations’ operating environments. As indicated by Dyck and Zingales (2002, p.1), sometimes the media debate about corporate governance “coincides with shareholders’ value maximisation, others not”. Most times, media attention affects corporate governance by driving politicians to effect corporate law reforms. Keeping the focus on corporate organisations also creates the impression that any ‘dirty’ dealings by the managers will eventually come to light, and that not only affects their reputations in the short-term, but also their careers in the long-term in what Dyck and Zingales (2002, p. 4) call ‘reputational penalties’. Additionally, although the press can be reckless or ill-advised at times, it is rare for journalists to associate corporate scandals with poor governance when they do not have sufficient evidence to do so, especially considering media laws and ethics in some countries; as such, it is clear that the press is to some degree correct in associating the corporate scandals to poor corporate governance. References Alliance Pharma plc 2011, ‘Annual report and accounts for the year ended 31 December 2011’, Avonbridge House, Bath Road, Wiltshire, pp. 1-72. 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