28 Jan 2010

Sample Essay: Corporate Governance

Corporate governance is a continuous process of monitoring corporate activities. The monitoring process is strategic in nature. This is directed towards both the internal and external matrices of operation of the organization with a stronger focus on the later. The principle and practices of corporate governance varies over geographic regions. The fundamental monitoring and controlling aspects of corporate governance in general follow this country specific variation.

Corporate governance is getting phenomenal importance due to changing economic environment of business.  Organizational expansion highly depends on financing. The existing or new sources of finance demands operational transparency from the organizational side. So a monitoring and possible controlling system has been originated to address the problem.

Corporate governance focuses on the relational sides of value creation, increase and maintenance of the shareholders’ interests. The word shareholder is used here in a more generalized sense.  Without bounded only to equity shareholders, it is used in a generic sense to capture the entire group of institutions and group of people with some positive interests in the organization. The risk management domain of corporate governance tries to minimize the negative effects on the organization. (“A Closer Look at Business Education”, 2006)

The corporate governance of an organization in general consists of the high power board of the organization, audit committee, section dedicated to investor relationship, executive committee, section responsible for compliance and internal commitment management.

The board of the organization is the centralized powerhouse of the organization for all important decision making activities. Since organizational decision making capacity will affect all, the true distribution and use of power is extremely important in the composition of the board.  Construction of a board with equitable distribution of authority is the most demanding parameter in this context. Most of the high level corporate conflicts have a common root, -non unanimity regarding the structure of the board.

Audit committee looks after the risk aspects of the organization. Risk exposure to an organization is multidimensional in nature.  An organization is susceptible to risks from both inside and outside. Audit committee is responsible for detection, measurement and control of risk. It is important to note that conventional financial audit is just a part of modern integrated risk management framework. Competence and neutrality is the two main characteristics of a result oriented audit committee.

Investor relationship is one of the primal activities of corporate governance. Investors can be institutional or ordinary. Big institutional investors have considerable influence in the organization. Long-term success of an organization highly depends on the success of managing investor relationship.

The internal liability management (like pension) also comes under the area of corporate governance. The long-term success of an organization is highly correlated to the efficiency and transparency of its corporate governance.

Stakeholders’ Engagement

The structural difference in corporate governance can help in the comparative study between two companies active in similar business areas. The Tesco and The Mark and Spencer’s (henceforth M &P) are two well-known retail giants operating globally. The comparative study on this will focus mainly on their difference in corporate governance and its impact in future investors’ interests.

The corporate governance in Tesco has the following components. The Tesco board is consists of seven executive directors, seven non-executive directors and senior executive deputy director. The chairman is responsible for the smooth running of the board. The chief executive is responsible for the overall performance of the company. The independence of the non-executive directors is important to balance the power equation in the board. Board responsibility includes resolution of the problems through meetings; ensure the quality of the newly appointed directors through training and development. The board process includes the nomination, remuneration, audit committee and executive committee. The nomination committee looks after the appointment, re election and succession of the directors.  Rumination committee sees the rumination related to executive directors. Audit committee is responsible for the overall risk management of the firm. One of the special characteristics of this committee is that, the membership is strictly limited to non-executive directors. This is an attempt to ensure neutrality in operation. There is a system to evaluate the performance of the board. The executive committee is responsible for the strategy formulation, evaluating and monitoring of the company. This committee can work only after informing the board about their activities. Integrated audit and risk management, investor relationship management are the other activities under corporate governance.

Due care has been taken to maintain the non-centralization of power. This balance is essential for the proper functioning of the organization. M &P is also retail giant with considerable structural similarities with Tesco. The composition and basic characteristics of corporate governance are defined in company law. Despite this common legal structure, firms can have considerable differences in the structure of the high power board. A number of corporate bylaws can be used to bring change with a motive to imbalance the power equation in the board. This motive can be seen as a shock to accountability and transparency in operation of the organization. The basic reason behind the existence of these bylaws is to handle some exceptional situation.  So any deviation from the expected corporate structure should be analyzed with the possible motive or reason

There is a wave of criticism regarding the selection of Sir Ross at the post of chairman and executive director at M & P.  Sir Ross was appreciated for his strategic leadership to ward off hostile takeover of M &P in time of its adversity. The very recent financial performance of M&P is not encouraging.  The criticizers are saying that the possible fall in profit over 40 % (Craven, 2009) is a poor indication to leadership. So they are against of this motive. Mere financial performance must not be the cause of concern in this regard. Company law, in general prohibits the simultaneous holding of two posts at the board of a company. The executive board is responsible for the performance of the company. Chief executive Director heads this side of the board. The chairman sees the smooth running of the board. The non-executive directors are on independent charge. This clause is important to maintain their neutrality in opinion about the company. This side of the board looks after shareholders’ interest. So the membership to the non-executive side demands seclusion from very personal interests in the firm. Simultaneous membership in both sides of the board affects the expected neutral feature of the board. Many decisions have mutually exclusive interests to shareholders and the executives. (This is known as the agency problem, in light sense) The board is constituted to address the interest of the both groups. The ability of the board to address this dual problem gets crippled in the aforesaid case.

Overall Comments

An investor must be aware of the dynamics of corporate governance of the firm, where s/he invests. Transparent corporate governance is the indication of better protection of shareholders’ interest.

Both the companies Tesco and M&P are well diversified retail giants with well coverage of market. Diversification of services, product pricing and advertising strategies is strategically designed to maximize the possible market penetration.  Tesco is relatively more diversified as M&P is little more concentrated in garment sector. Diversified retail firms can out perform the market due to their highly differentiated portfolio of services. Recent performance of Tesco shows a change in earning per share rose from 22.36 to 26.95.  M&P shows a change from 39.1 to 48.2 i.e. a 20.52 %rise for Tesco and 23.27 % rise for M&P. Although M&P shows a better EPS, yet its performance not as consistent as Tesco (M & S, 2008; Tesco, 2008) The most important warning that goes against M&P is the already discussed present dubious and objectionable practice of corporate governance.  This initiates strong opposition from influential institutional investors. This can seriously affect the company.

Tesco has shown remarkable consistency in performance. M&P is not that much consistent in its performance. Tracking of dividend declaration shows this clearly. Despite the high EPS, there is a recent possible profit warrant in M&P. This shows the fundamental strength of Tesco is more than that of M&P. M&P was initially oriented to quality rather than price. There is a recent change in this strategy. Although it tries to project its price sensitive image yet Tosco is well ahead in this field.   M&P was under the threat of hostile take over. This shows the extreme level of poor risk management capacity of the firm. Risk management is an integral part of corporate governance. This shows another side of weak practice of corporate governance at M&P. The company with a recent history of possible hostile take over cannot be recommended to an investor with moderate risk appetite. The above discussion says that Tesco is a more transparently managed, fundamentally stronger company with consistently good performance than M&P. Poor risk management and resent controversy over the structure of the company board make M&P an opaque investment option as opaque as the practice of its corporate governance.

References

“A Closer Look at Business Education”, (2006), Business Society Program, The Aspen Institute, available at: http://www.beyondgreypinstripes.org/pdf/CGReport.pdf (accessed on March 27, 2009)

Craven, N. (2009), Rose heading for revolt over profits plunge, Mail Online, available at: http://www.dailymail.co.uk/money/article-1163770/Rose-heading-revolt-profits-plunge.html (accessed on March 23, 2009)

M & S, (2008) Annual report and financial statements 2008, available at: http://annualreport.marksandspencer.com/financials/con_income_statement.html (accessed on March 27, 2009)

Tesco, (2008) Summary Review and Summary Financial Statements 2008, available at: http://www.tescoreports.com/areview08/investor.html (accessed on March 27, 2009)

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