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The Code of Best Practices and the Board of Directors

Professor Florencio Lopez-de-Silanes

Yale University

School of Management

International Institute for Corporate Governance

April 9th, 2002.

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Corporate Governance and the Code of Best Practices

Corporate governance is the system through which companies are directed and controlled.

Good corporate governance implies: Efficient Board of Directors. Adequate investors’ protection.

International experience has shown that improved transparency and disclosure of corporate practices increase investors’ trust in the companies.

Different countries have found that a way to improve the corporate governance of their companies is through the development of Codes of Best Practices (CBP).

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Although the Codes have common factors, each one emphasizes the problems or characteristics of each country.

In general terms, the Codes establish basic principles, of voluntary adherence, to improve corporate governance.

The CBPs make recommendations in five areas:

1. Board of Directors

2. Auditing and Accounting

3. Board’s Compensation

4. Selection of the Members of the Board

5. Shareholder rights

The Code of Best Practices

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Code of Best Practices

Total number of companies that answered the questionnaire: 239

The companies that requested a deferment have already submitted the requested information

5%

14%

75%

6%

SUSPENDED33Companies DEFERMENT

15 Compani

es

SUBMITTED178 Companies

MISSING13

Companies

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Composition of the Board of Directors

1) The number of directors is between 5 and 15 89%

2) There are not substitute Directors33%

3) At least 40 % of the directors are independent 83%

4) At least 20 % of the directors are independent 75%

Total of companies that commented on best practices: 178

51%

49%Adopted

Not adopted

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Structure of the Board of Directors

1) The Board performs functions of compensation and evaluation, audit, planning and financial management

72%2) The audit committee is chaired by an independent director

26%

55%

45%

Adopted

Not adopted

Total of companies that commented on best practices: 178

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Committees and the Board’s Functions

It is considered important that the Board is properly informed and that the Directors participate in the discussion of the topics of relevance. Recommendations:

o The creation of intermediate entities, committees, to support the Board in the execution of its functions

• These committees are extensions of the Board

There are at least three functions in which the Board should be involved. These are: Evaluation and Compensation Audit Financial and Planning

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Compensation and Evaluation Function

1) The evaluation and compensation committee revises the selection

of the company’s executives58%

2) Information (structure and form) about compensation packages for directors and executives is disclosed

33%

Total of companies that commented on best practices: 178

54%

46%AdoptedNot adopted

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Audit Function

32%

68%

AdoptedNot adopted

Total of companies that commented on best practices: 178

1) The external auditor’s fee is less than 20% of the audit firm’s revenue 83%

2) External auditor is different than the “comisario”67%

3) The committee submits accounting policies to the approval of the board 41%

4) The board approves guidelines of the internal control system 57%

5) The committte verifies the compliance with applicable dispositions 54%

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Financial and Planning Function

Total of companies that commented on best practices: 178

36%

64%

AdoptNot adopted

The Financial and Planning Committee evaluates the viability of the

investment and financing63%

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Disclosure of Information to Shareholders

Total of companies that commented on best practices: 178

40%

60%AdoptedNot adopted

1) Miscellaneus topics are omitted during the annual meeting76%

2) Information needed for the annual meeting is available 15 days in advance

90%3) Shareholders with enough information and voting alternatives

can instruct their agents

31%4) Relevant aspects of the committees’ performance are

included 22%

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Benefits and Limits

Benefits of CBP Provides a guideline for shareholders for some reforms Gives investors more information to sort good from bad Market push to institutionalize and professionalize companies To improve the image of companies that uphold the principles

recommended by the CBP

Limits Only guideline, not forcing anybody Some principles need more bite Big missing point: director’s responsibilities Need other forces (the press) to excersice some monitoring

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Appendix

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Board of Directors

The Board of Directors must be committed to its function, be functional and make informed decisions. The CBP suggests:

o The separation of the CEO and the President’s roles o To define more concretely the functions of the Board o To limit the Board’s size o That substitutes are not included in the Board o Principles about the Directors’ duties

It is considered as an essential element for the good operation of the Board that it has plurality of ideas and that it acts with objectivity. The Code suggests:

o The appointment of independent Directors o Minimum percentages of representation of the different categories of

directors

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Evaluation and Compensation Function

It is necessary that the Board supervises the administration of the company, the execution of the goals, as well as to make sure that the Directors’ compensation is not disproportioned.

The CBP recommends:

o That the board is informed about the policies on evaluation and to compensation of Directors

o That information is disclosed

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Audit Function

The Board should guarantee that the financial information is revised and that external auditors participate in this process so that the information that is disclosed is accurate and has a high degree of transparency.

Recommendations:

o To assure the objectivity in the selection of the auditors

o That the Chairman of the audit committee is independent

o Consistency in the company’s accounting policies

o To have an internal control system

o To make sure that the company fulfills all the legal dispositions that are applicable

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Financial and Planning Function

The Board should establish the company’s investment and financing policies, guaranteeing that these are consistent with the strategic planning of the company.

It is recommended:

o That the Board approves the company’s investment and financing policies, as well as the annual budget

o That the strategic position of the company is periodically revised

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Disclosure of Information to Shareholders

Shareholders, especially the minority shareholders, should have access to all the necessary information to be able to participate in the annual Shareholders meeting.

The CBP recommends that:

o The topics that will be discussed during the annual meeting are well defined.

o The disclosure of all necessary information

o The existence of policies and mechanisms that facilitate the communication between the shareholders and the company