Corporate Governance Final Document

8/2/2019 Corporate Governance Final Document

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CORPORATE GOVERNANCE

Definition of corporate governance

Corporate governance refers to the rules, procedures, and administration of the firms contracts

with its shareholders, creditors, employees, suppliers, customers, and sovereign governments.Governance is legally vested in a board of directors who have a fiduciary duty to serve the interests

of the corporationrather than their own interests or those of the firms management

The main mechanisms for understanding corporate governance are the following:

1. The market for corporate control (i.e. a hostile takeover market and the market for partialcontrol).

2. Large shareholder and creditor monitoring. Corporate governance is a term that refers broadly to

the rules, processes, or laws by which businesses are operated, regulated, and controlled. The term

can refer to internal factors defined by the officers, stockholders or constitution of a corporation, aswell as to external forces such as consumer groups, clients, and government regulations.

A well-defined and enforced corporate

governance provides a structure that, at least in theory, works for the benefit of everyone

concerned by ensuring that the enterprise adheres to accepted ethical standards and best practices

as well as to formal laws. To that end, organizations have been formed at the regional, national,and global levels.

In recent years, corporate governance has received increased attention because of high-profile

scandals involving abuse of corporate power and, in some cases, alleged criminal activity bycorporate officers. An integral part of an effective corporate governance regime includes

provisions for civil or criminal prosecution of individuals who conduct unethical or illegal acts in

the name of the enterprise.

3. Internal control mechanisms, i.e. the board of directors, non-executive committees and the

design ofexecutive compensation contracts.

4. External mechanisms, i.e. product-market competition, external auditors and the regulatory

framework of thecorporate-law regime and stock exchan

1. Board of Directors

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o The board of directors is a corporation's primary rule-making body. Its members are

generally high-level professionals with strong management backgrounds and/or an

understanding of common financial and business practices. Members by and largehave a common stake in the corporation's success.

Policies and Actions

o Using complicated economic modeling of various hypothetical scenarios to predict

return on investment, the board develops a set of policies and actions for corporatemanagers and employees to carry out. Policies and actions are commonly profit-

driven. In other words, the main objective of a policy or action is to produce a

positive return on investment for the corporation as well as its shareholders andcustomers to which it's accountable.

Corporate Governance Structure

o For a board to be effective, it must also have a way to guarantee accountability.This is an important feature of whether or not the corporate governance structure issuccessful. For example, if a policy or action isn't properly carried out and/or the

results that were expected either didn't occur or fell short of the goal, there must be

a system in place to make adjustments. The board also determines these

correctional steps for management to administer to avoid future mistakes.

Shareholder Accountability

o Corporate governance ultimately determines the success or failure of a corporation.

It's therefore important that shareholder and customer input are appropriately

factored into all decisions made by the board. After all, it's the financial investmentof these groups that enables a corporation to operate. To ensure this occurs, the

board holds regular shareholder meetings to report on earnings and to discuss the

direction of the corporation. The shareholders are able to inform and guide thediscussion to ensure a favorable outcome.

Customer Accountability

o Customer feedback is collected in a less direct way than shareholder input, but is

just as important to a corporation's bottom line. Customer feedback is based onconsumer trends and the extent to which goods are bought and sold, which are

reflected by the corporation's quarterly profits. If a corporation does well, it's said tohave exceeded or met its earnings goals for the quarter. If a corporation performs

poorly, it's said to have underperformed its anticipated earnings goals for thequarter.

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2. Efficient, effective and sustainable corporations that contribute to the welfare of society

by creating wealth,

3. employment and solutions to emerging challenges.4. Responsive and accountable corporations

5. Legitimate corporations that are managed with integrity, probity and transparency

6. Recognition and protection of stakeholder rights7. An inclusive approach based on democratic ideals, legitimate representation and

participation

Fair, efficient and transparent administration of corporations to meet well-defined objectives.

Systems and structures of operating and controlling corporations with a view to achieving long-term

strategic goals that satisfy the owners, suppliers, customers and financiers while complying with

legal andregulatory requirements and meeting environmental and society needs;

An efficient process of value-creating and value-adding; and to ensure that:

2 The Board has set strategic objectives and plans and put in place proper management structures

[organization, systems and people] to achieve those objectives and plans.

The structures put in place function to maintain corporate integrity, reputation and responsibility

towardsall stakeholders.

The Board acts as a catalyst, initiating, influencing, evaluating and monitoring strategic decisions

andactions of management and holds management accountable.

Ensuring that the Board is not a mere formality which takes a back seat, leaving management to

make all

strategic decisions. The Board has established and put in place mechanisms to ensure that the corporation operates

within

the objects established by shareholders, the mandate given to it by society, utilizes the resourcesentrusted to it efficiently and effectively in pursuit of the stated mandate, and meets the legitimate

1. expectations of its various stakeholders.

PILLARS OF GOOD GOVERNANCE

In all fields of human endeavour, good governance is founded upon the attitudes, ethics, practices

and values of

the society regarding: Accountability of power based on the fundamental belief that power should be exercised to

promote human

well-being.

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Democratic values in respect of the sharing of power, representation and participation.

The sense of right and wrong, what is fair and just, work ethics, technology and continuing

corporate socialresponsibility.

Efficient and effective use of resources for the production of goods and services.

Protection of human rights and freedoms and the maintenance of essential order and security forthe person

and his/her property.

Recognition of the government as the only entity to which the society gives authority to usecoercive power

to maintain public order and national security, collect taxes, reallocate societys resources to meet

public

needs and to use that coercive power to confiscate assets, deprive a person of liberty or life; butprovided

always that such power and authority are not used to suppress, oppress and deny basic human

rights and

freedoms.

Attitudes towards the generation and accumulation of wealth through hard work and personal

effort.

Factors influencing corporate governance

1. The ownership structure

The structure of ownership of a company determines, to a considerable extent, how a Corporationis managed and controlled. The ownership structure can be dispersed among individual andinstitutional shareholders as in the US and UK or can be concentrated in the hands of a few large

shareholders as in Germany and Japan. But the pattern of shareholding is not as simple as the

above statement seeks to convey. The pattern varies the across the globe.

Our corporate sector is characterized by the co-existence of state owned, private and multinational

Enterprises. The shares of these enterprises (except those belonging to a public sector) are held byinstitutional as well as small investors. Specifically, the shares are held by

(1) The term-lending institutions

(2) Institutional investors, comprising government-owned mutual funds, Unit Trust of India andthe government owned insurance corporations

(3) Corporate bodies

(4) Directors and their relatives and(5) Foreign investors. Apart from these block holdings, there is a sizable equity holding by small

investors.

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2.The structure of company boards

Along with the structure of ownership, the structure of company boards has considerable influenceon the way the companies are managed and controlled. The board of directors is responsible for

establishing corporate objectives, developing broad policies and selecting top-level executives to

carry out those objectives and policies.

3. The financial structure

Along with the notion that the structure of ownership matters in corporate governance is the notion

that the financial structure of the company, that is proportion between debt and equity, hasimplications for the quality of governance.

4. The institutional environment

The legal, regulatory, and political environment within which a company operates determines in

large measure the quality of corporate governance. In fact, corporate governance mechanisms areeconomic and legal institutions and often the outcome of political decisions. For example, the

extent to which shareholders can control the management depends on their voting right as definedin the Company Law, the extent to which creditors will be able to exercise financial claims on a

bankrupt unit will depend on bankruptcy laws and procedures

Combined Code compliance

The Board is committed to the highest standards of corporate governance set out in the CombinedCode on Corporate Governance published by the Financial Reporting Council in June 2008 (the

Code). The Board is accountable to the Companys shareholders for good governance and this

Report, together with the Directors Remuneration report, describes how the Board has applied themain principles of good governance set out in the Code during the year under review. It is the

Boards view that the Company has been fully compliant.

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Corporate governance is the set ofprocesses, customs,policies, laws, and institutions affecting the

way a corporation (orcompany) is directed, administered or controlled. Corporate governance alsoincludes the relationships among the many stakeholders involved and the goals for which the

corporation is governed. The principal stakeholders are the shareholders, the board of directors,

employees, customers, creditors, suppliers, and the community at large.Corporate governance also refers to the manner in which the power of a corporation is exercised in

the stewardship of the corporations total portfolio of assets and resources with the objective of

maintaining and increasing shareholder value and satisfaction of other stakeholders in the context

of its corporate mission. It is concerned with creating a balance between economic and social goals

and between individual and communal goals while encouraging efficient use of resources,

accountability in the use of power and stewardship and as far as possible to align the interests of

individuals, corporations and society. It is about promoting:

Fair, efficient and transparent administration of corporations to meet well-defined

objectives.

Systems and structures of operating and controlling corporations with a view to achieving

long-term strategic goals that satisfy the owners, suppliers, customers and financiers while

complying with legal and regulatory requirements and meeting environmental and society

needs (Private Sector Corporate Governance Trust, 1998)

Efficient corporate governance practices 1) attract investors (both local and foreign) and assure

them that their investments will be secure and efficiently managed, and in a transparent and

accountable process, 2) create competitive and efficient companies and business enterprises, 3)

enhance the accountability and performance of those entrusted to manage corporations and 4)

promote efficient and effective use of limited resources.

The objectives of the study are:

To examine the corporate governance practices and establish their role in business failure.

To study the agency problem and highlight its contributions in business failure.

Significance of the Study

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This study is has a lot of importance to the business community but will be of particular interest to

the following parties:

Corporate managers and directors who have been entrusted with the responsibility of

managing business profitably. The study will expose them to the code of good corporate

governance that should improve their understanding and performance, thereby reducing

chances of business failure.

Investors who entrust their capital with the corporate managers with expectation of

efficient management of the capital to yield good returns. The study will enable them

understand their role in instilling good corporate practices in the organizations where they

have invested their capital and also reduce cases of agency problem.

Business students who will constitutes future corporate teams. Study will expose them to

the concept of corporate governance and improve their capacity in understanding the

technicalities of corporate governance and business failure.

An important theme of corporate governance is to ensure the accountability of management of an

organization through mechanisms that try to reduce or eliminate the principal-agent problem. A

related thread of discussions focuses on the impact of a corporate governance system in efficiency,

with a strong emphasis on shareholders' welfare. There are yet other aspects to the corporate

governance subject, such as the stakeholder view.

Corporate governance is a system of structuring, operating and controlling a company with a view

to achieve long term strategic goals to satisfy shareholders, creditors, employees, customers and

suppliers, and complying with the legal and regulatory requirements, apart from meeting

environmental and local community needs.

In Gandhian principle of trusteeship, corporate governance is defined as the acceptance by

management of the indisputable rights of shareholders as the true owners of the corporation and of

their own role as trustees on behalf of the shareholders. It is about commitment to values, about

ethical business conduct and about making a distinction between personal & corporate funds in the

management of a company.

Principles of good corporate governance

Commonly accepted principles of corporate governance include:

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Principle 1: Performance Orientation

The principal objective of business enterprises is to enhance wealth for all shareholders by making

the most efficient use of resources. A company that meets this shareholder value creation objective

will have greater internally generated resources, improving its prospects for meeting its

environmental, community, and social obligations; pay taxes; reward, train, and retain key staff;

and enhance employee satisfaction. A key focus area is a companys human capital strategy, which

is a lead indicator of corporate success.

Principle 2: Nomination and Compensation Committees

A key success factor is the quality of leadership of an enterprise. A nomination committee with a

written mandate and terms of reference consistent with good practice may ensure the selection of

directors and a chief executive officer (CEO) of the highest caliber. A compensation committee

should set the compensation policy for directors and senior management, commensurate with

performance measured against comparable industry benchmarks and key performance indicators

such as economic value added.

Principle 3: Disclosure

To ensure transparency, companies annual reports should disclose true and fair accounting

information prepared in accordance with applicable standards; disclose and discuss all material

risks; disclose and explain the rationale for all material estimates; show manner of compliance, or

explain deviations, if any, with applicable corporate governance codes; discuss goals, plans, and

progress; and provide access to the register of shareholders showing beneficial ownership.

Disclosures should be timely and adequate to enable investors, third party analysts, or rating

agencies to assess the quality of corporate governance and the true financial condition of the

enterprise.

Principle 4: Audit Committee

Audit committees with the following attributes are more effective: composed solely of independent

directors, at least two of whom should have the requisite knowledge of accountancy, financial

analysis, and financial reporting; at least one member should have a good understanding of the

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business of the enterprise; have a written mandate and terms of reference; engage only independent

external auditors who should be answerable to the committee; and require that a suitable system of

internal control and risk management is entrenched into the fabric of the company.

Principle 5: Code of Conduct

All enterprises must have a written code of business conduct and establish systems to ensure that it

and all applicable laws are followed in letter and spirit.

Principle 6: Conflicts of Interest

Directors owe an obligatory duty to the company that requires them to act in the best interest of the

company. Actual and potential conflicts of interest should be identified, disclosed, and explained in

sufficient detail to enable valid judgments to be made on their adverse impact. The persons who

are conflicted should not participate in discussion and decision of the issue in question, nor be

entitled to vote on any resolution where they are conflicted. Related party contracts should be

disclosed in the annual report.

Principle 7: Environmental and Social Commitment

There is an inextricable relationship among the objectives of corporate performance, social

development, and environmental protection. Enterprises, to be sustainable, will need to recognize

and effectively deal with this triad of concerns, which, at times, may conflict with each other.

Principle 8: Conduct of the Board of Directors

Directors are expected to preserve and enhance shareholder value. Their effectiveness can be

enhanced if they are legally empowered, have the requisite qualifications for the board committees

on which they sit, make the needed time commitment, given the appropriate directorship training,

are suitably compensated, receive proper notice of meetings, have the right to propose agenda

items, consult each other privately in the absence of management and executive directors, and

provided with appropriate information to enable them to perform their monitoring role and

evaluate the performance of directors. They should be proactive and diligent.

Principle 9: Responsibilities of Investors

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The pursuit of good corporate governance in investee enterprises is a risk management tool.

Institutional investors, general partners, and fund managers have a binding duty to actively monitor

and vote on issues vital to the success of enterprises in which they invest as guardians of the

savings entrusted to them. Enterprises will find it helpful to communicate with them, deliver in a

timely manner true and fair disclosure reports, and remove impediments from voting by all

shareholders by taking advantage of modern communications and follow a one-vote for one-share

policy. The fair treatment of minority shareholders must be ensured and large institutional

investors should lead the pursuit of shareholder rights.

Principle 10: The Role of Directors in Turnaround Situations

Directors of troubled companies must play a proactive role in turnaround situations, but avoid

preferential treatment of creditors, or trade when the company is insolvent.

Issues involving corporate governance principles include:

internal controls and internal auditors

the independence of the entity's external auditors and the quality of their audits

oversight and management of risk

oversight of the preparation of the entity's financial statements

review of the compensation arrangements for the chief executive officer and other senior

executives

the resources made available to directors in carrying out their duties

the way in which individuals are nominated for positions on the board

A good corporate governance practice must includes a fair, efficient and transparent administration

and strive to meet certain well defined, written objectives. Corporate governance must go well

beyond law. The quantity, quality and frequency of financial and managerial disclosure, the degree

and extent to which the board of Director exercise their trustee responsibilities, and the

commitment to run a transparent organization.

2.1.5 Corporate Governance Guidelines and Codes of Practice

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Corporate governance principles and codes have been developed in different countries and issued

from stock exchanges, corporations, institutional investors, or associations of directors and

managers with the support of governments and international organizations. One of the most

influential guidelines has been the Organization for Economic Cooperation and Developments

(OECD) Principles of Corporate Governance developed in 1999 and revised in 2004. The OECD

remains a proponent of corporate governance principles throughout the world. Building on the

work of the OECD, the United Nations Intergovernmental Working Group of Experts on

International Standards of Accounting and Reporting (ISAR) has produced voluntary Guidance on

Good Practices in Corporate Governance Disclosure. This internationally agreed benchmark

consists of more than fifty distinct disclosure items across five broad categories:

Auditing

Board and management structure and process

Corporate responsibility and compliance

Financial transparency and information disclosure

Ownership structure and exercise of control rights

In Kenya, corporate governance guidelines and codes of practice have been developed across

various business sectors by regulatory institutions such as ICPAK, CMA among others. For

example, CMA have developed codes of practice that the management of all companies listed in

Nairobi Stock Exchange need to adhere to.

Alongside this, in response to the global development, Kenyan business sector through

Consultative Corporate Sector established Private Sector Initiative for Corporate Governance in

1999 with the key objective of:

Formulating and developing a code of best practice for corporate governance in Kenya;

Explore ways and means of facilitating the establishment of a national apex body to

promote corporate governance in Kenya;

Co-ordinate developments in corporate governance in Kenya with other initiatives in East

Africa, Africa, the Commonwealth and globally.

The body has formulated the following code of practices which have become the hallmark of

corporate governance practice in Kenya.

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1. Authority and Duties of Shareholders

Shareholders of the company shall jointly and severally protect, preserve and actively exercise the

supreme authority of the company in general meetings. They have a duty, jointly and severally, to

exercise that supreme authority to:

Ensure that only competent and reliable persons who can add value to the company are

elected or appointed to the Board of Directors;

Ensure that the Board of Directors is constantly held accountable and responsible for

the efficient and effective governance of the company.

Change the composition of a Board of Directors that does not perform to expectation

or in accordance with the mandate of the corporation.

2. Leadership of the Company

The Board of Directors shall exercise leadership, enterprise, integrity and sagacious judgment in

directing the company so as to achieve continuing prosperity for the company and shall always act

in the best interests of the company.

3. Role and Functions of the Board

The Board of Directors shall exercise all the powers of the company subject only to the limitations

contained in the law and the memorandum and articles of incorporation. In this regard, it is

expected that the Board of Directors shall fulfill the following functions:

Exercise leadership, enterprise, integrity and sound judgments in directing the corporation so

as to achieve continuing prosperity and to act in the best interest of the enterprise while

respecting the principles of transparency and accountability;

Ensure that through a managed and effective process, board appointments are made that provide

a mix of proficient directors, each of whom is able to add value and bring independent

judgment to bear on the decision-making process;

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Determine the corporations purpose and values, determine the strategy to achieve its purpose and

to implement its values in order to ensure it survives and thrives, and ensure that procedures and

practices are in place that protect the corporations assets and reputation;

Monitor and evaluate the implementation of strategies, policies, management performance

criteria and business plans;

Ensure that the corporation complies with all relevant laws, regulations and codes of best

business practice;

Ensure that the corporation communicates with shareholders and other stakeholders effectively;

Serve the legitimate interest of the shareholders and the corporation and account to them fully;

Identify the corporations internal and external stakeholders and agree on a policy, or policies

determining how the corporation should relate to them;

Ensure that no one person or a block of persons has unfettered power and that there is an

appropriate balance of power and authority on the board which is, inter alia, usually reflected by

separating the roles of the Chief Executive Officer and Chairman, and by having a balance

between executive and non-executive directors;

Composition of the Board

The Board shall include a balance of executive and non-executive directors (including independent

non-executive directors) such that no individual or group of individuals or interests can dominate

its decision taking.

The Board shall be chaired by an independent director who is not managing the

company.

There are two key tasks at the top of the company, that of running the Board and that of the Chief

Executive responsible for running the company. Therefore as a general rule, there is a clear

division of these roles to ensure that a balance of power and authority is maintained, and that no

one individual has unfettered powers of decision. Where these roles are combined, the reasons

thereof shall be publicly explained.

The roles of the Chairman are:

To lead the Board;

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To chair meetings of the Board and members, ensuring order, proper conduct of meetings,

affording participants a reasonable opportunity to speak, ensuring decisions are fairly made,

deciding on technicalities and to cast the deciding vote in case of ties;

To organize and facilitate a balance of internal and external relationships, and

To facilitate effective Board management.

Appointments to the Board

There will be formal and transparent procedures for nomination and appointment of new directors

to the Board. In this regard:

There shall be set up a search and nominations committee of the Board.

The Board of Directors will formally review its composition and performance at least

once every year to ensure that:

- The mix of membership is appropriate and compatible with the needs of the Board and company.

- Every non-executive director commits adequate time to his responsibilities and

contributes effectively.

Based on the priority needs of the Board and the Company, the nominations committee

will recommend to the Board qualified, competent fit and proper persons to be nominated for

election to the Board.

All directors shall be required to submit themselves for re-election at regular intervals and at

least once every three years.

Service contracts of Executive Directors shall not exceed three years but these are renewable

with the approval of shareholders on the recommendation of the Board.

Directors Remuneration

In order to avoid potential conflict of interest, the Board of directors shall set up independent

remuneration committee to determine the remuneration of respective individual executive

directors. The committee shall make a report to the shareholders every year.

The Committee shall:

Establish a formal and transparent procedure for developing policy on executive remuneration

and for fixing the remuneration packages of individual executive directors.

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Ensure that the level of remuneration shall be sufficient to attract and retain the quality and

calibre of directors needed to run the company successfully while the make up should be so

structured as to link corporate and individual performance.

Ensure that the companys annual report contains a statement of the remuneration policy and

details of the remuneration and benefits of each director, including family- related benefits.

Disclosures of Information by Directors

On first appointment and at regular intervals (at least once every year), or at any time when

circumstances change, all directors shall, in good faith, disclose to the Board for recording and

disclosure to the external auditors, any business or other interests that are likely to create a

potential conflict of interest, including:

- All business interests (direct or indirect) in any other company, partnership or other business

venture.

- Membership in trade, business or other economic organizations.

- Their shareholding, share options and/or other interest in the company.

- Any interest (direct or indirect) in any transaction with the company.

- Any gifts, monies, commissions, benefits or other favours extended or received from whatsoever

party in respect of or in relation to any business dealings with the company. At any time when a

director resigns or is removed from office before the expiry of his term, he shall disclose to the

companys external auditors and if necessary to the shareholders (if the reason for removal or

resignation is refusal to compound fraud, corruption or other activities or behaviour incompatible

with the shareholders interests) the reasons for his resignation or removal.

Supply of Information to Directors

For Board members to exercise informed, intelligent, objective and independent judgments on

corporate affairs, they shall have access to accurate, relevant and timely information. In this regard:

There shall be established a formal procedure to enable independent directors to take

professional advice on any matter pertinent to their functions if and where they deem it necessary

and at the companys expense but subject always to the limitations, restrictions and conditions

stipulated by the Board.

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All directors shall have unlimited access to the advice and services of the Company Secretary

who has a statutory duty to advice the Board on maters of procedures, rules and regulations, and to

any other professional officer of the company.

It is the duty of every director to demand and obtain any information he deems critical to the

performance of his duties as a director.

Accounts: Audit and Disclosure

It is the statutory duty of directors, jointly and severally, to cause to be kept proper and

accurate books of accounts in respect to all sums of money received and expended by the

company, and the matters in respect of which receipt or expenditure takes place; all sales

and purchases by the company; and of all the assets and liabilities of the company, as

necessary to give with reasonable accuracy at anytime, the financial position of the

company at that time; and to lay before the companys annual general meeting, a profit

and loss account and a balance sheet reflecting a true and fair view of the profit or loss of

the company and of the state of affairs of the company.

Consequently the Board of Directors is responsible for:

- Maintaining adequate systems of financial management and internal control over

the company, including procedures designed to minimize the risk of fraud.

- Ensuring the integrity and adequacy of the accounting and financial systems.

- Ensuring that qualified, competent, fit and proper persons are employed to

undertake accounting and financial responsibilities.

- Ensuring that the company complies with the accounting standards applicable.

The Board shall present to the shareholders balanced and understandable assessment of the

companys position and prospects at least once a every year and preferably every six

months.

It shall also establish formal and transparent arrangements for maintaining an arms

length relationship with the external auditors, and ensure that there is timely and accurate

disclosure to the shareholders of any information that would materially affect either the

value or worth of their investment or earnings there-from including:

Material changes in ownership structures, take over bids, shareholders arrangements,

acquisitions, mergers, script splits and consolidations, or other arrangements.

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Extension of Scope and Duties of Auditors

The Board of Directors shall ensure that persons who are qualified, reliable and

independent of the Board and management are appointed as auditors. In light of

developments elsewhere, the Board shall endeavour to:

Extend the definition and scope of audit to cover:-

to provide an independent opinion to those with interest in the company that they

have received from those responsible for the direction and management of the

company an adequate account of:

- The proper conduct of the companys affairs;

- The companys financial performance and position;

- Future risks.

Facilitate an extension of Auditors duties in regard to:

- Reporting on whether the company has financial and other risk management

Controls.

- Evaluating and reporting on aspects of propriety and efficiency

- Reporting directly to the Board, regulatory authorities and shareholders as

appropriate, when illegal acts are discovered and to monitor basic ethical

behaviour particularly in regard to the public interest

Enhance the independence of the auditor from the Board and management;

Extend the liability of Auditors to third parties.

The Role of Audit Committees

A separate audit committee enables a Board to delegate to a sub-committee the

responsibility for a thorough and detailed review of Audit matters, enables the nonexecutive

directors to contribute an independent judgment and play a positive role in an

area for which they are particularly fitted, and offers the auditors a direct link with the

non-executive directors. The appointment of a properly constituted Audit Committee shall

therefore be an important step in raising standards of corporate governance.

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The Board shall establish an Audit Committee composed of independent nonexecutive directors

to keep under review the scope and results of audit, its effectiveness and the independence and

objectivity of the auditors.

The Audit Committee shall be given written terms of reference which deal adequately

with their membership, authority and duties and shall meet at least twice a year.

The Audit Committee will:

Review the half year and annual financial statements before submission to the

Board focusing particularly on:-

- Changes in accounting policies

- Significant adjustments arising from the audit

- Major judgmental areas

- Compliance with accounting standards, disclosure and legal requirements, and

- Subject the financial statements to independent critical appraisal

Consider appointment, remuneration and the resignation or dismissal of external

auditors.

Discuss and agree on the scope, nature and priorities of audit.

Rights of Shareholders

All shareholder rights shall be recognized, respected and protected.

Basic shareholder rights include:

To secure methods of ownership registration;

To convey or transfer shares;

To obtain relevant information on the corporation on a timely and regular basis;

To participate and vote in general shareholder meetings;

To elect members of the Board; and

To share in the residual profits of the company.

Shareholders have the right to participate in, and to be sufficiently informed on,

decisions concerning fundamental corporate changes such as:

Amendments to the statutes, or articles of incorporation or similar governing

documents of the company;

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The authorization of additional shares; and

Extra-ordinary transactions that in effect result in the sale of the company.

The Board of Directors shall ensure that there is equitable treatment of all

shareholders. In particular the Board shall ensure that:

All shareholders of the same class are treated equally.

Equitable treatment of all shareholders, including minority and foreign shareholders.

All shareholders shall have the opportunity to obtain effective redress for violation to

their rights.

Within any class, all shareholders should have the same voting rights. All investors

should be able to obtain information about voting rights affiliated with all classes of

shares before they purchase them. Any changes in voting rights within or between

classes of shares should be subject to shareholder vote.

Votes shall be cast by custodians or nominees in a manner agreed upon with the

beneficial owner of the shares.

The Shareholders in turn have a duty and are well advised to exercise the supreme authority

of the company in general meetings to hold the Board accountable for stewardship of the

company.

Responsibilities to Other Stakeholders

The Board of Directors and the company recognize the rights of stakeholders as

established by law and shall encourage active co-operation between the company and its

stakeholders in creating wealth, jobs and the sustainability of financially sound enterprises.

In this regard, the Board of Directors shall:

Ensure that the rights of stakeholders that are protected by law are respected.

Where stakeholder interests are protected by law, ensure that stakeholders have the

opportunity to seek effective redress for any violation of their rights.

Permit and facilitate performance-enhancing mechanisms for stakeholder participation.

Ensure that where stakeholders participate in performance-enhancing mechanisms,

they have access to all relevant information.

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Mechanisms and controls in corporate governance

Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise

from moral hazard and adverse selection. For example, to monitor managers' behaviour, an

independent third party (the external auditor) attests the accuracy of information provided by

management to investors. An ideal control system should regulate both motivation and ability.

Internal corporate governance controls

Internal corporate governance controls monitor activities and then take corrective action to

accomplish organizational goals. Examples include:

Monitoring by the board of directors: The board of directors, with its legal authority to

hire, fire and compensate top management, safeguards invested capital. Regular board

meetings allow potential problems to be identified, discussed and avoided. The ability of

the board to monitor the firm's executives is a function of its access to information.

Executive directors possess superior knowledge of the decision-making process and

therefore evaluate top management on the basis of the quality of its decisions that lead to

financial performance outcomes.

Internal control procedures and internal auditors: Internal control procedures are

policies implemented by an entity's board of directors, audit committee, management, and

other personnel to provide reasonable assurance of the entity achieving its objectives

related to reliable financial reporting, operating efficiency, and compliance with laws and

regulations. Internal auditors are personnel within an organization who test the design and

implementation of the entity's internal control procedures and the reliability of its financial

reporting.

Balance of power: The simplest balance of power is very common; require that the Chief

Executive Officer be a different person from the Chief Finance Officer. This application of

separation of power is further developed in companies where separate divisions check and

balance each other's actions. One group may propose company-wide administrative

changes, another group review and can veto the changes, and a third group check that the

interests of people (customers, shareholders, employees) outside the three groups are being

met.

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Remuneration: Performance-based remuneration is designed to relate some proportion of

salary to individual performance. It may be in the form of cash or non-cash payments such

as shares and share options or other benefits.

ii. External corporate governance controls

External corporate governance controls encompass the controls external stakeholders exercise over

the organisation. Examples include:

competition

debt covenants

demand for and assessment of performance information (especially financial statements)

government regulations

managerial labour market

media pressure

takeovers

Challenges to Corporate Governance

Supply of accounting information: Financial accounts form a crucial link in enabling

providers of finance to monitor directors. Imperfections in the financial reporting process

will cause imperfections in the effectiveness of corporate governance. This should, ideally,

be corrected by the working of the external auditing process.

Financial reporting is a crucial element necessary for the corporate governance system to

function effectively. Accountants and auditors are the primary providers of information to

capital market participants. The directors of the company should be entitled to expect that

management prepare the financial information in compliance with statutory and ethical

obligations, and rely on auditors' competence.

Current accounting practice allows a degree of choice of method in determining the method

of measurement, criteria for recognition, and even the definition of the accounting entity. The

exercise of this choice to improve apparent performance imposes extra information costs

on users. In the extreme, it can involve non-disclosure of information.

One area of concern is whether the auditing firm acts as both the independent auditor and

management consultant to the firm they are auditing. This may result in a conflict of

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interest which places the integrity of financial reports in doubt due to client pressure to

appease management. The power of the corporate client to initiate and terminate

management consulting services and, more fundamentally, to select and dismiss accounting

firms contradicts the concept of an independent auditor.

Changes enacted in the United States in the form of the Sarbanes-Oxley Act in response to

the Enron situation prohibit accounting firms from providing both auditing and

management consulting services. The Enron collapse is an example of misleading financial

reporting. Enron concealed huge losses by creating illusions that a third party was

contractually obliged to pay the amount of any losses. However, the third party was an

entity in which Enron had a substantial economic stake.

However, good financial reporting is not a sufficient condition for the effectiveness of

corporate governance if users don't process it, or if the informed user is unable to exercise a

monitoring role due to high costs.

2.1 AGENCY PROBLEM

Agency problem arises whenever one party (principal) contracts another party (agent) to act on his

behalf. The principal will cede authority to the agent in order for the agent to execute his tasks. The

agent is normally compensated for providing the service. Agency problem occurs since agents tend

to act in their own interest rather than wholly in the interest of the principal.

Agency Theory

Agency theory has its roots in economic theory by Alchian and Demsetz (1972) and further

developed by Jensen and Meckling (1976).

Agency theory is defined as the relationship between the principals, such as shareholders and

agents such as the company executives and managers. In this theory, shareholders who are the

owners or principals of the company, hires the gents to perform work. Principals delegate the

running of business to the directors or managers, who are the shareholders agents (Clarke, 2004).

Below diagram explain this theory.

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The theory reduces the corporation to two participants of managers and shareholders and suggests

that employees or managers in organizations can be self-interested. Shareholders expect the agents

to act and make decisions in the principals interest. On the contrary, the agent may not necessarily

make decisions in the best interests of the principals (Padilla, 2000). In this theory, the agent may

be succumbed to self-interest, opportunistic behavior and falling short of congruence between the

aspirations of the principal and the agents pursuits.

Agency theory was introduced basically as a separation of ownership and control. Holmstrom and

Milgrom (1994) the agents will only focus on projects that have a high return.

This theory can be employed to explore the relationship between the ownership and management

structure. However, where there is a separation, the agency model can be applied to align the goals

of the management with that of the owners. Due to the fact that in a family firm, the managementcomprises of family members, hence the agency cost would be minimal as any firms performance

does not really affect the firm performance (Eisenhardt, 1989). The model of an employee

portrayed in the agency theory is more of a self-interested, individualistic and are bounded

rationality where rewards and punishments seem to take priority (Jensen & Meckling, 1976). This

theory prescribes that people or employees are held accountable in their tasks and responsibilities.

Employees must constitute a good governance structure rather than just providing the need of

shareholders.

2.2.2 Agency Problem in Kenya

Agency problem in Kenya is evidence mostly in large corporations with government connections.

The problems range from either deliberate or incompetent investment decisions to unethical

practices by the directors.

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Pan African Paper Mills (EA) Ltd is one recent case of agency problem. The major shareholders of

the company were Birla Group of India (54.3%) and the government of Kenya (34%). Since 1970,

the company has been under the management of Oriental Paper Industries having been appointed

by the majority shareholders, Birla Group at a fixed annual payment of Kshs.96 million.

Investigations by various media houses including Nation Media Group established that Oriental

Paper Industry was fully owned by the leading directors of Birla Group, and according to a report

dated 14th April 2009, prepared by a committee appointed by the government to evaluate the status

of the company, the Indian management company was paid even when there was nothing to show

for it by Pan African Paper Mills (EA) Ltd managers. The report also pointed out that there no

evidence of set benchmarks againstwhich to measure performance as the company has never had a

strategic plan. (Daily Nation, Feb. 8, 2010).

The Indian managers were on the Pan Paper Mills payroll as well which was a clear case of double

payment according to the report. The Orient also enjoyed additional fees pegged on sales and net

profit.

The Indians, The Vice President of Oriental, Mr. Saha and his team left a month after realising that

they had run down the company to the point where they could not even pay Kenya Power and

Lighting Company for power consumed. In January 2009 KPLC switched off electricity supply

over an unpaid bill of Sh201 million.

That triggered a chain reaction, which saw short-term lenders including Kenya Commercial

Bank, Barclays Bank Kenya, Ecobank Kenya and Bank of Baroda Kenya place the company

under receivership in March last year.

They are jointly owed Sh1.4 billion with the balance of Sh9 billion owed to long-term lenders and

suppliers including KenolKobil that moved to court in November 2009 seeking orders to have the

companys assets sold over failure to pay Sh530 million for supply of petroleum products.

The report cast doubt over Paper Mills ability to carry the existing total debt. Since 2001 Pan

Paper has not repaid any of its debts, while it stopped paying interest on loans in 2005.

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This is a perfect example of agency problem. The board acting in total disregard of the

sharehholders interest, the biggest casualty being the Kenyan taxpayers through the government

34%. The aim of the government was to get a fair return for its investment whereas Pan Paper

director had their own personal interests, to enrich themselves.

Another case of agency problem in Kenya was in NSSF. This institution is the custodian of the

social funds contributed by the Kenya workers for their old age/retirement benefits. The

contributions of the workers places them (workers) in the position of shareholder. The workers,

like the shareholders in other companies would expect a better yield from their contributions in

NSSF.

In endeavour to achieving this objective, NSSF invests these funds in various securities. However

in the 2008, NSSF was found to have engaged in underground deal with a security company,

Discount Securities, where it lost over 2 billion shillings of the contributors money.

The minister for Labour and Human Resource Development in their audit established that the

management of NSSF could not account for over Sh2 billion of the funds paid to Discount

Securities for investment purposes. This forced the minister to suspend the entire NSSF Board of

Trustees.

Capital Markets authority established that the transactions were done off the stockbrokers books

and were neither disclosed in the Discount Securities Ltd returns to the Authority nor did NSSF

ever raised any concern to the Authority on the matter.

The managing trustee was later, in April 2009, charged in court with two cases of fraud involving

over Kshs.149 million.

This is another case of agency problem where the directors have gone against the interest of the

contributors (shareholder) to involve in both risky and fraudulent investment.

This report is contained in the Daily Nation Newspapers of 17 th November 2008 and 21st April

2009.

BUSINESS FAILURE

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Overview of Business Failure

Business failure is directly linked to inadequate organizational leadership and unlawful practices of

fraud, conspiracy, falsifying documents, and embezzlement, examples being WorldCom

which has been classification as being one of the biggest corporate scandals in Unites

States history (Braun, Warder, & Zekany, 2004).

In 2001, the financial condition of the company began to decline because of the slowing

telecommunications industry, which eventually put pressure on the companys executive

officers to increase profits (Jonesington, 2007). Unfortunately, the executive officers made

decisions to commit accounting fraud by falsifying documents to reflect a positive cash

flow rather than a negative cash flow. All the individuals involved plead guilty to fraud and

conspiracy charges (Jonesington, 2007).

The reason for WorldComs company failure is not due to poor financial conditions in the

telecommunications industry, but due to the lack of leadership, management, and

organization in the company structure to solve the financial problems. The market

conditions of the telecommunications industry dropped significantly to affect not only

WorldCom, but also other companies. However, a prediction for the telecommunications

industry was improvement within the next 5 to 10 years, which it did for some companies

(Braun, Warder, & Zekany, 2004). If WorldCom made decisions with the benefit of the

organization in mind it would have seen improvements in the market and the companys

financial statements.

The study of Professor Kaira D. Carter of the University of Phoenix has established that the key

underlying factor in business failure is poor corporate governance practices which are evidenced in

inept business performance in such critical areas as marketing, finance, human resource, planning

among others.

2.3.2 Causes of Business Failure

The study outlined the following as the immediate causes of business failure

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Lack of clear objectives

Successful organisations have clearly focused and communicated objectives that enable

everyone in the organisation to pull in the same direction.

Poor management

Weak and inexperienced management is one of the major causes of business failure. Managers

have to work extremely hard, and to understand their customers needs, and the business that they

are in if they are to be successful.

Poor human resource relations

Often a cause of failure. Successful businesses motivate their employees to work hard to help the

business to succeed.

Poor marketing

Successful modern businesses are ones that understand and meet the requirements of their

customers. Detailed market planning and market research is therefore an essential for new

businesses, to find out details such as the potential size of the market, the extent of competition, as

well as consumer preferences and tastes.

Cash flow problems

Many businesses struggle through poor cash flow management. It is all very well having a good

idea and a good product but it is also necessary to be able to meet short term cash outflows. Many

businesses try to grow too quickly, and end up borrowing too much money externally, resulting in

crippling interest repayment charges.

Poor business planning

Business planning should cover aspects such as marketing, finance, sales and promotional plans, as

well as detailed breakdowns of costings and profit predictions. It is often said that failing to plan, is

planning to fail.

Lack of finance

Insufficient finance often means that businesses are unable to take opportunities that are available

to them, or have to compromise - going for high cost solutions to problems, rather than lower cost

ones that would yield greater competitive advantage.

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Failure to embrace new technologies and new developments

In a fast changing world leading businesses are ones that make best use of advanced modern

technologies in an appropriate way. Firms that operate with outdated technologies and methods

frequently find themselves at a cost disadvantage over more dynamic rivals.

Poor choice of location

Location is a very important business decision. A good location is one that appeals to large

numbers of customers, while at the same time minimizing costs. For example in retailing it is often

a mistake to choose a low cost location, that is not visible to customers. However, conversely there

are considerable cost advantages to out-of-town retailers that customers are prepared to travel to

visit.

Business failure in Kenya and the Roles of Corporate Governance and Agency ProblemAs stated in the introductory part of this literature, the 1990s and early 2000s saw a lot of major

business enterprises closing down. These included Rivertex, Kenya Co-operative Creameries,

Farm Machinery Distributors, East African Tanning Extract, Kenya Meat Commission, Kisumu

Cotton Mills, Euro Bank, Daima Bank, Trust Bank and recently Pan Paper Mills, just to mention a

few. Most of these organizations were closely associated with the government and thus their

boards were made mostly of government appointees based in their close association with the senior

government officials. Such boards had the following weaknesses;

First, they were composed of individuals with no professional management skills, secondly, they

were bound by their political patronage to act in the interest of the political forces and not the

organizations and thirdly, a number of individuals on such boards were people with very poor

integrity rating.

With weak regulatory system, the organization experienced very poor corporate governance

practices; lack of integrity, poor corporate culture, weak policies among others.

The major reasons for the collapse of these institutions as highlighted earlier are;

Weak corporate governance practices.

Poor risk management strategies.

Lack of internal control.

Weakness in regulatory and supervisory systems.

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Technical incompetence of the boards.

Conflict of interests between the organization strategies and the top managements self

interests.

However, the recent years have seen most of Kenya large corporations adopting international

codes of corporate governance practices. Such awards as Company of the Year (COYA) encourage

most organizations to improve their corporate culture so as to remain competitive. The awards also

recognizes the chief executive officers who have performed well entrenching the best corporate

practices in their organizations. Such awards have great impacts on CEOs public ratings and their

future career development and thus most of them have now fully embarked on corporate image

building.

Private Sector Corporate Governance Trust (Kenya) in conjunction with The Global Corporate

Governance Forum and The Commonwealth Association for Corporate Governance and the Kenya

regulatory institutions such as Capital Markets Authority, Institute of Certified Public Accountants

of Kenya have also played key roles in promoting prudent corporate governance which has greatly

reduced the cases of business failure in Kenya.

With this development, the strong corporate governance practices has greatly reduced agency

problem in most organizations and thus its contribution to business failure in Kenya is equally

reduced.

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3.0 STUDY METHODOLOGY

3.1 Research Design

The study seeks to investigate the relationship between corporate governance practices, agency

problem and business failure in Kenya. This study has been conducted mainly through

survey and empirical approaches.

3.2 Population

The study targeted ten firms in Kenya that have closed due to problem related to corporate

governance. The sample respondents are expected to be the CEOs, departmental heads and

employees of these organizations.

3.3 Data Collection

The study made use of both primary and secondary data in particular same corporate governance

measures that were not publicly available are to be obtained by the use of questionnaires

and interviews techniques. The questionnaires are to be in three sets; for CEOs,

departmental heads and employees. The interview schedules are to be used to supplement

the results from the questionnaires. It will also give opportunity for probing slightly for

more details that the questionnaires. The interview schedules to consist of unstructured

items for interviewing before distribution of the questionnaires.

3.4 Data Analysis Techniques

The data to be generated from closed ended questionnaire are to be recorded, coded, numbered and

classified under different variables for easy identification and then summarized in answer

summary sheets.

4.0 CONCLUSION AND LIMITATIONS

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From Global Investor Opinion Survey of over 2000, McKinsey found that 80% of the respondents

would pay a premium for well-governed companies. They defined a well-governed company as

one that was responsive to investors' requests for information on governance issues.

Other studies have linked broad perceptions of the quality of companies to superior share price

performance. Business Weekenlisted institutional investors and experts to assist in differentiating

between boards with good and bad governance and found that companies with the best corporate

governance practices had the highest financial returns.

Agency problem arise out of the managements quest to satisfy their personal interest relative those

of the shareholders. However with the good corporate governance whereby the directors

understand their roles as agents of the principals with the key responsibility of safeguarding the

interest of the principal through maximization of the firms value, upholding integrity and honesty

and respecting the shareholders right to information regarding the firms business activities, the

agency problem would be greatly reduced.

This points to the fact that good corporate practice is directly correlated and is the key determinant

of business success.

Limitations

Despite its immense role in business in Kenya, corporate governance has not captured the interest

of Kenya business researchers and writers and thus there is great scarcity of materials for study on

Kenya.

CODE ON CORPORATE GOVERNANCE

. PREAMBLE1. This Code supersedes and replaces the Combined Code issued by the

Hampel Committee on Corporate Governance in June 1998. It derivesfrom a review of the role and effectiveness of non-executive directors by

Derek Higgs1 and a review of audit committees2 by a group led by Sir

Robert Smith.

2. The Financial Services Authority has said that it will replace the 1998

Code that is annexed to the Listing Rules with the revised Code and willseek to make consequential Rule changes. There will be consultation on

the necessary Rule changes but not further consultation on the Code

provisions themselves.

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3. It is intended that the new Code will apply for reporting years beginning on

or after 1 November 2003.

4. The Code contains main and supporting principles and provisions. The

existing Listing Rules require listed companies to make a disclosure

statement in two parts in relation to the Code. In the first part of thestatement, the company has to report on how it applies the principles in

the Code. In future this will need to cover both main and supporting

principles. The form and content of this part of the statement are notprescribed, the intention being that companies should have a free hand to

explain their governance policies in the light of the principles, including

any special circumstances applying to them which have led to a particular

approach. In the second part of the statement the company has either toconfirm that it complies with the Codes provisions or where it does not

to provide an explanation. This comply or explain approach has been

in operation for over ten years and the flexibility it offers has been widely

welcomed both by company boards and by investors. It is forshareholders and others to evaluate the companys statement

5. While it is expected that listed companies will comply with the Codes

provisions most of the time, it is recognised that departure from the

provisions of the Code may be justified in particular circumstances. Everycompany must review each provision carefully and give a considered

explanation if it departs from the Code provisions.

6. Smaller listed companies, in particular those new to listing, may judge thatsome of the provisions are disproportionate or less relevant in their case.

Some of the provisions do not apply to companies below FTSE 350. Such

companies may nonetheless consider that it would be appropriate toadopt the approach in the Code and they are encouraged to consider this.

Investment companies typically have a different board structure, which

may affect the relevance of particular provisions.

7. Whilst recognising that directors are appointed by shareholders who are

the owners of companies, it is important that those concerned with the

evaluation of governance should do so with common sense in order topromote partnership and trust, based on mutual understanding. They

should pay due regard to companies individual circumstances and bear

in mind in particular the size and complexity of the company and thenature 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 fromthe Code should not be automatically treated as breaches. Institutional

shareholders and their agents should be careful to respond to the

statements from companies in a manner that supports the comply or

explain principle. As the principles in Section 2 make clear, institutional

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shareholders should carefully consider explanations given for departure

from the Code and make reasoned judgements in each case. They should

put their views to the company and be prepared to enter a dialogue if theydo not accept the companys position. Institutional shareholders should be

prepared to put such views in writing where appropriate.

8. Nothing in this Code should be taken to override the general requirements

of law to treat shareholders equally in access to information.

9. This publication includes guidance on how to comply with particular parts

of the Code: first, Internal Control: Guidance for Directors on the

Combined Code3, produced by the Turnbull Committee, which relates to

Code provisions on internal control (C.2 and part of C.3 in the Code); and,second, Audit Committees: Combined Code Guidance, produced by the

Smith Group, which relates to the provisions on audit committees and

auditors (C.3 of the Code). In both cases, the guidance suggests ways

of applying the relevant Code principles and of complying with therelevant Code provisions.

10. In addition, this volume also includes suggestions for good practice from

the Higgs report.

11. The revised Code does not include material in the previous Code on the

disclosure of directors remuneration. This is because The Directors'

Remuneration Report Regulations 20024 are now in force and supersedethe earlier Code provisions. These require the directors of a company to

prepare a remuneration report. It is important that this report is clear,

transparent and understandable to shareholders.

CODE OF BEST PRACTICE

SECTION 1 COMPANIES

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 boards 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 companys strategic

aims, ensure that the necessary financial and human resources are in

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place for the company to meet its objectives and review management

performance. The board should set the companys values and standards

and ensure that its obligations to its shareholders and others areunderstood and met.

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

As part of their role as members of a unitary board, non-executivedirectors 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 integrityof 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.

Code Provisions

A.1.1 The board should meet sufficiently regularly to discharge its duties

effectively. There should be a formal schedule of matters specificallyreserved for its decision. The annual report should include a statement of

how the board operates, including a high level statement of which types

of decisions are to be taken by the board and which are to be delegated

to management.

A.1.2 The annual report should identify the chairman, the deputy chairman

(where there is one), the chief executive, the senior independent directorand the chairmen and members of the nomination, audit and

remuneration committees. It should also set out the number of meetings

of the board and those committees and individual attendance by directors.

A.1.3 The chairman should hold meetings with the non-executive directors

without the executives present. Led by the senior independent director,

the non-executive directors should meet without the chairman present atleast annually to appraise the chairmans performance (as described in

A.6.1) and on such other occasions as are deemed appropriate.

A.1.4 Where directors have concerns which cannot be resolved about the

running of the company or a proposed action, they should ensure that

their concerns are recorded in the board minutes. On resignation, a nonexecutivedirector should provide a written statement to the chairman, for

circulation to the board, if they have any such concerns.

A.1.5 The company should arrange appropriate insurance cover in respect of

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of sufficient size that the balance of skills and experience is appropriate

for the requirements of the business and that changes to the boards

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 bothexecutive and non-executive directors.

The value of ensuring that committee membership is refreshed and thatundue 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.

July 2003 The Combined Code

6

5 Compliance or otherwise with this provision need only be reported for the year in which theappointment is made.

Code provisions

A.3.1 The board should identify in the annual report each non-executive director

it considers to be independent6. The board should determine whether thedirector is independent in character and judgement and whether there are

relationships or circumstances which are likely to affect, or could appear

to affect, the directors judgement. The board should state its reasons if it

determines that a director is independent notwithstanding the existence ofrelationships or circumstances which may appear relevant to its

determination, including if the director:

_ has been an employee of the company or group within the last fiveyears;

_ has, or has had within the last three years, a material business

relationship with the company either directly, or as a partner,shareholder, director or senior employee of a body that has such a

relationship with the company;

_ has received or receives additional remuneration from the company

apart from a directors fee, participates in the companys shareoption or a performance-related pay scheme, or is a member of the

companys pension scheme;

_ has close family ties with any of the companys advisers, directors orsenior employees;

_ holds cross-directorships or has significant links with other directors

through involvement in other companies or bodies;_ represents a significant shareholder; or

_ has served on the board for more than nine years from the date of

their first election.

A.3.2 Except for smaller companies7, at least half the board, excluding the

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chairman, should comprise non-executive directors determined by the

board to be independent. A smaller company should have at least two

independent non-executive directors.A.3.3 The board should appoint one of the independent non-executive directors

to be the senior independent director. The senior independent director

should be available to shareholders if they have concerns which contactthrough the normal channels of chairman, chief executive or finance

director has failed to resolve or for which such contact is inappropriate.

July 2003 The Combined Code7

6 A.2.2 states that the chairman should, on appointment, meet the independence criteria set out in

this

provision, but thereafter the test of independence is not appropriate in relation to the chairman.7 A smaller company is one that is below the FTSE 350 throughout the year immediately prior to

the

reporting year.

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.


Appointments to the board should be made on merit and against objective

criteria. Care should be taken to ensure that appointees have enoughtime 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 orderlysuccession 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.

Code Provisions

A.4.1 There should be a nomination committee which should lead the process

for board appointments and make recommendations to the board. Amajority of members of the nomination committee should be independent

non-executive directors. The chairman or an independent non-executive

director should chair the committee, but the chairman should not chair thenomination committee when it is dealing with the appointment of a

successor to the chairmanship. The nomination committee should make

available8 its terms of reference, explaining its role and the authoritydelegated to it by the board.

A.4.2 The nomination committee should evaluate the balance of skills,

knowledge and experience on the board and, in the light of this evaluation,

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prepare a description of the role and capabilities required for a particular

appointment.

A.4.3 For the appointment of a chairman, the nomination committee should

prepare a job specification, including an assessment of the time

commitment expected, recognising the need for availability in the event ofcrises. A chairmans other significant commitments should be disclosed to

the board before appointment and included in the annual report. Changes

to such commitments should be reported to the board as they arise, andincluded in the next annual report. No individual should be appointed to a

second chairmanship of a FTSE 100 company9.

July 2003 The Combined Code

8

A.4.4 The terms and conditions of appointment of non-executive directors

should be made available for inspection10. The letter of appointment

should set out the expected time commitment. Non-executive directorsshould undertake that they will have sufficient time to meet what is

expected of them. Their other significant commitments should bedisclosed to the board before appointment, with a broad indication of the

time involved and the board should be informed of subsequent changes.

A.4.5 The board should not agree to a full time executive director taking on more

than one non-executive directorship in a FTSE 100 company nor the

chairmanship of such a company.

A.4.6 A separate section of the annual report should describe the work of the

nomination committee, including the process it has used in relation to

board appointments. An explanation should be given if neither an externalsearch consultancy nor open advertising has been used in the

appointment of a chairman or a non-executive director.

A.5 Information and professional development

Main Principle

The board should be supplied in a timely manner with information in

a form and of a quality appropriate to enable it to discharge its

duties. All directors should receive induction on joining the board

and should regularly update and refresh their skills and knowledge.


The chairman is responsible for ensuring that the directors receive

accurate, timely and clear information. Management has an obligation to

provide such information but directors should seek clarification or

amplification where necessary.

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The chairman should ensure that the directors continually update their

skills and the knowledge and familiarity with the company required to fulfil

their role both on the board and on board committees. The companyshould provide the necessary resources for developing and updating its

directors knowledge and capabilities.

Under the direction of the chairman, the company secretarysresponsibilities include ensuring good information flows within the board

THE COMBINED CODE ON CORPORATE GOVERNANCE

July 2003

CONTENTS

Pages

The Combined Code on Corporate Governance

Preamble 1-3

Section 1 COMPANIES 4-19A Directors 4-11

B Remuneration 12-14C Accountability and Audit 15-17

D Relations with Shareholders 18-19

Section 2 INSTITUTIONAL SHAREH

Corporate Governance Final Document

Documents

Transcript of Corporate Governance Final Document