Corporate Governance – Principles, Policies and Practices 3e

1. Corporate Governance – Principles, Policies and Practices 3e Chapter 11 The Governance of Private Companies and Other Corporate Entities

2. The Governance of Private Companies and Other Corporate Entities In which we consider: • the governance of: - private corporate entities - individual and family-owned companies - the family council - subsidiary and associated companies - groups - company self-governance - group-wide governance - joint ventures - NGOs and non-profit corporate entities - partnerships and limited liability partnerships - hedge funds, private equity and sovereign funds • the state as shareholder.

3. The governance of private corporate entities The major emphasis of corporate governance principles, policy and practice has been on public, listed companies Yet unlisted private companies and other forms of corporate entity, such as: • not-for--profit organizations • co-operatives • joint ventures • partnerships • non-government organizations (NGOs) are far more numerous and also face basic corporate governance issues.

4. The governance of private and family-owned companies In the early days of the joint-stock limited- liability company, all companies were public companies, incorporated to raise capital from outside investors. Today most companies around the world are private companies, providing tax benefits and limited liability to their Owners.

5. Individual and family-owned private companies • The governance of family-controlled companies • The evolution of family firms • The challenge of introducing non-family experts • The challenge of succession to the next generation • The challenge of management and non-management of family shareholders • The creation of a family council.

6. The governance of family-controlled private companies Life cycle of the family company • The company is incorporated as a business start-up or takes over the existing business of a sole-trader, a family firm, or a partnership. Directors – the founder, family members • Need for additional expertise. Outside non-family directors appointed to the board • Long-serving executives appointed to board • Successful younger family members progress through management and join the board • Succession to second generation CG framework needs to reflect stage of development.

7. The governance of family-controlled private companies The family council – a solution to family conflict As ownership passes through the generations of a family company, often one branch of the family runs the company, whilst other branches becomes just shareholders A potential dilemma: • management members of the family want to conserve cash, limit dividends, and plough surpluses into the business, whilst maximizing remuneration and top management benefits • non-management members of the family want to maximize their dividends.

8. The governance of subsidiary and associated companies Group self-governance in subsidiary companies Directors of subsidiary companies could be from: • the group holding company (who might or might not be on the main board) • the management of the subsidiary company • the management in other group companies • outside the group.

9. The governance of subsidiary and associated companies Group-wide governance Figure 11.1: Control through a group management control system

10. The governance of joint ventures • Joint ventures (strategic alliances) • Enter markets • Transfer technology • Procure supplies • Obtain finance • Share management skills • Manufacture products around the world • Share risk on an international scale.

11. JV agreement JV Partner 1 JV partner 2 Joint Venture Company Complex corporate structures The governance of joint ventures

12. The governance of private companies and other corporate entities • The governance of joint ventures • JV agreement determines purpose, contributions and terms of the joint venture - crucial • Composition of JV board • Should JV CEO be on the board • Settlement of disputes (by JV partners or JV board?) • JV operations across international boundaries (law, tax etc.).

13. Partnership agreement partners Complex corporate structures • Governance of partnerships • Governance of Limited Liability partnerships

14. The governance of NGOs and non-profit entities • All corporate entities need sound governance • Organisations in the voluntary and community sectors • Education authorities, hospital trusts • Sports organisations and other not-for-profit entities • Non-governmental organisations • Public sector corporations, • QUANGOS (Quasi-Autonomous Non-Governmental Organisation) • Co-operative societies.

15. The governance of NGOs and non-profit entities Distinguishing features • Non-profit entities work for the public good (not shareholders) • Their aims reflect community, social or similar objectives • Their legal status may be rooted in the law of trusts, charities, co-operatives or other legal acts (not company law) • Their form can take various legal structures (other than a limited company) • Underpinning constitution determines their form and purpose • Governance is provided by a governing body (council, board of trustees, management committee etc.) • Their performance is measured through multiple goals • Performance often difficult to measure.

16. The governance of NGOs and non-profit entities Distinguishing features (continued) • Multiple objectives can conflict • Governing body often large and drawn from outside, non-executive members • Nomination to governing body may come from members, funding bodies such as the state, representative bodies (staff, beneficiaries, funding bodies, the local community etc.), subject to the constitution • Conflicts of interest can arise between governing body members • The top executive and the top management team are typically invited to attend meetings of the governing body, make reports and answer questions, but are seldom voting members of it • Membership of the governing body is often voluntary.

17. The governance of NGOs and non-profit entities Good Governance in Public Services - UK independent commission - chaired by Sir Alan Langlands - produced a good governance standard for public services in 2005.

18. The governance of NGOs and non-profit entities Langlands Report Good governance means: • Focussing on the organisation's purpose and on outcomes for citizens and service users • Performing effectively in clearly defined functions and roles • Promoting values for the whole organisation and demonstrating values of good governance through behaviour • Taking informed, transparent decisions and managing risk • Developing the capacity and capability of the governing body to be effective • Engaging stakeholders and making accountability real.

19. The governance of NGOs and non-profit entities Typical problems of not-for profit entities • Founders become permanent members of the governing body. • Stagnant membership of the board • Board members elected by representative groups with conflicts of interest • Boards packed with members who are well-meaning but contribute little • Lack of board members with necessary skills, knowledge or experience • Failure to keep board members informed.

20. The governance of NGOs and non-profit entities Typical problems of not-for profit entities • Failure to induct new board members and update other board members • Inadequate control systems, performance measures and monitoring of executive actions • Lack of a strategic focus and failure to rethink strategies • Poor chairmanship of the board, lack of leadership • Inter-personal politics.

21. The governance of partnerships The governance of partnerships and limited liability partnerships • Legal organisational form • Two or more people agree to achieve common goals • Partnership agreement determines the contribution that each partner is required to make the way the partnership will be run the way profits and losses will be shared • Partners personally liable for partnership debts.

22. The governance of partnerships • A partnership has fewer constraints than a company • Lower reporting requirements • Partners are free to decide how they want to govern their partnership • Governed by partnership law not company law.

23. The governance of partnerships • In small partnership the normal form of governance is through a meeting of all the partners • In larger practices the partnership may decide to appoint a managing partner and a governing body • This committee meets regularly to manage partnership affairs • A periodic meeting of the entire partnership accepts the accounts, transacts business reserved to the meeting, and appoints members to the governing body.

24. The governance of partnerships Limited liability partnership (LLP) • Some countries now allow a form of partnership giving limited liability to the partners but with the flexibility of a traditional partnership • The governance of an LLP is similar to that of a partnership: • members provide the capital • contribute personally • and share profits and losses • But to protect those dealing with a limited partnership disclosure requirements are more stringent, closer to those of a company.

25. The governance of hedge funds • The nature of hedge funds • Complex trades, hedging strategies • Closed and open funds • Equity shares, trade in debt, futures - such as energy futures, sugar prices, carbon emission prices, even the weather and other exotic contracts • Heavily geared • High risk profile.

26. The governance of hedge funds • Hedge funds – some criticisms • Political concerns • – hostile takeovers, de-stabilizing markets • Excessive privacy • High fees and managerial rewards • Low regulation and disclosure • International Corporate Governance Network • – Code of Best practice for hedge funds.

27. The governance of private equity firms • Raise capital from institutional investors, banks, and other financial institutions, and from rich individuals • Investors subscribe to a fund managed by a firm, becoming a limited partner • Funds can be locked in for long periods • Risk is high. With potential to lose entire investment • Investors expect high returns • Some private equity funds spread risk by investing in other private equity funds (fund of funds) • Managers also invest their own money in their funds • Private equity institutions acquire listed companies • Some listed companies privatised by private equity.

28. The governance of private equity firms • Private equity firms - some criticisms • Notoriously secretive • Do not publish information history, ownership, management or investment strategy • Only disclose companies in the fund to their investors • Dilute stock markets by 'privatisation' • Private equity firms are relatively unregulated • Privatisation avoids public company disclosure requirements • Calls for more transparency and greater disclosure.

29. The governance of private equity firms • The governance of private equity firms – strengths and weaknesses • High gearing increases volatility and risk • Strategic orientation towards financial rather than business strategies • Cost reduction policies strip out costs ignoring other stakeholders • Disposal of unnecessary assets, asset-stripping, the use of tax advantages on the sale of entities in some tax jurisdictions • High fees and top management remuneration.

30. The governance of private equity firms • The governance of private equity firms – • Sir David Walker's voluntary code for UK private equity firms • Show how an entity authorised by the Financial Services Authority fits into the firm, indicating the firm's history and investment approach • A commitment to conform to the guidelines on a 'comply or explain' basis • An indication of leadership of the UK element of the firm, identifying the senior members of management and advisory team • Arrangements to deal appropriately with conflicts of interest • Description of the UK companies in the firm's portfolio • Categorisation of the limited partners in the fund.

31. The governance of sovereign wealth funds Sovereign-wealth investing country Funds invested US$bn Kuwait-Reserve Fund for Future Generations 250 Norway Government- National pension fund 380 Peoples' Republic of China - China Investment Corporation 200 - China Development Bank 150 - Citic 60 Saudi Arabia 300 Singapore -Temasek Holdings 100 - GIC 100 United Arab Emirates - Abu Dhabi Investment Authority 875

32. The governance of sovereign wealth funds Sovereign wealth funds - some governance issues • Lack of transparency and secretive • Do not state their objectives • Do not disclose their portfolios • Lack accountability other than to their government • Inadequately regulated • Not accountable to members, shareholders, or regulators • Only accountable to rulers of the sovereign nation.

33. The governance of sovereign wealth funds Sovereign wealth funds - other governance issues • Concerns about the strategic intent of sovereign nation • Worry that it may not be driven by financial motives • Financial markets could be manipulated • Political threat to withhold funds unless the country acceded to its demands • Close down acquired company to protect own industries • Run the company for political rather than economic reasons.

34. The state as shareholder Mid-20th century • Political nationalization of companies –UK, other Commonwealth countries • State operated enterprises – Communist countries Government established the governing body, nominating and appointing members. Government determined corporate objectives, provided funding, and decided performance criteria. Government intervened in management, influencing operations, appointing managers, and fixing market prices. Incentives for managers to meet corporate objectives became determined political Late 20th century.

35. The state as shareholder Late 20th century • Era of privatisation • UK water, power utilities, transport, etc. • New Zealand energy, water, rail etc. • Russia state enterprises, Gasprom, Yukos • China State-owned enterprises.

36. The state as shareholder Financial crisis 2007 – Government bail-out investment US – Freddie Mac, Fannie Mae, AIG, General Motors, Bear Stearns UK – Northern Rock Bank, Lloyds Bank, RBS, HBOS.

37. The state as shareholder Governance issues in state-owned enterprises (whether wholly or partly-owned) • Relationship between company and government • Form of company’s governance • Corporate constitution • Type of governing body • Appointment of directors • Objectives and strategy formulation • Transparency and accountability • Financial incentives for management • Role of overseeing government departments – corporate, industry and finance • Need for balance between freedom of corporate decision and state bureaucratic control.

38. The Governance of Private Companies and Other Corporate Entities We have considered • the governance of: - private corporate entities - individual and family-owned companies - the family council - subsidiary and associated companies - groups - company self-governance - group-wide governance - joint ventures - NGOs and non-profit corporate entities - partnerships and limited liability partnerships - hedge funds, private equity and sovereign funds • the state as shareholder.