Corporate Governance Concepts Report (Assessment)

1. The Global Financial Crisis highlighted the inextricable link between good corporate governance and independence in the board of directors. This means that it is impossible to separate director independence from good corporate governance. The two go hand in hand in today’s business world.
2. The National article highlights three areas in which it is important to have an independent board member. These are finance, future mergers and acquisitions and legal matters. These are all sensitive matters that require the expertise of an experienced practitioner. However, it would be expensive to hire a full-time employee. Thus, having an independent board member check on the decisions made is the best option, especially for small and medium size companies.
3. The UK Corporate Governance Code provides detailed guidance on the composition of an ideal board of governors. This guidance is intended to promote best practise in this area. The code states that at least half of the board should be non- executive directors. These non- executive directors should be independent of the company. This number excludes the chairperson of the board. The exception to this rule is small companies. The minimum recommended number of independent board members for such companies is two.
4. The UK Corporate Governance Code provides detailed guidance on the composition of an ideal board of governors. This guidance is intended to promote best practise in this area. The code states that at least half of the board should be non- executive directors. These non- executive directors should be independent of the company. This number excludes the chairperson of the board. The exception to this rule is small companies. The minimum recommended number of independent board members for such companies is two.
5. The reasons against one person holding both the positions of the CEO and Chairperson of the board include:
   1. Lack of accountability-The Chief Executive Officer is the head of company business. He is required to develop and implement strategies that will ensure company growth and increase in shareholders’ wealth. He is accountable to the board. The board on the other hand represents shareholders’ interests. They act as a check on management’s decisions. The head of the board is the Chairperson. It follows then that the CEO cannot be held accountable by the Chairperson if one person holds both the roles.
   2. Power concentration- Supposing one person, holds the positions of CEO and Chairman, too much power will be concentrated in this person’s hands. This creates temptation to misuse this power.
   3. This option increases the likelihood of corporate mismanagement and eventually company collapse. This problem is compounded if the company has poor internal controls.
   4. This is a formula of preventing corporate misconduct. This is accomplished by reducing the chances of mismanagement of power.
   5. Combining the roles of both CEO and Chairman shows poor succession planning on the part of management.

There are few reasons why it would be beneficial for one person to hold both positions of CEO and Chairman. They are:

1. It is the best option for a company that is undergoing restructuring. It allows one person to focus on the formulation and implementation of company strategies.
2. This method allows for cost effective division of responsibilities. This results in better strategy control and execution.
3. The dual role can be implemented when there is no other individual with suitable personality and character traits. This allows the company to derive maximum benefit from one individual’s expertise.
4. The dual role does away with the issue of power struggles between the CEO and Chairman. This is because one individual will occupy both positions.

In my opinion, the dual role system is not appropriate. Companies should split the roles of CEO and Chairman. This is because doing so increases the accountability of both the CEO and the Chairman. This means that there is a check on either party’s decisions. Thus, the scenario where one individual runs the company as though it was their show is done away with. There is also less temptation to misuse company resources. I believe this system minimizes the chances of corporate scandals. The increase in such cases has necessitated additional corporate governance controls.

There are four key elements of the Kuoni financial methodology. These elements are covered by the value based management approach. They are:

1. Target setting- Kuoni sets annual targets for the business as a whole and for the Strategic Business Units. These targets ensure that the profit earned is more than the WACC. It recognizes the fact that capital is not free it has a cost. This element ensures that shareholders do not receive a return that is lower than the cost of capital.
2. Performance Measurement- The Company measures the change in KEP every quarter. This is then compared with the budgeted KEP and the results reported. This element helps to track the development or decline of the business. The change in KEP is also linked to operational value drivers. This way, the improvement or decline can be explained.
3. Value Communication- Kuoni intends to illustrate its commitment to value creation to the outside world. This will be done by communication of the KEP and ROIC every quarter to financial analysts and investors. Such a move makes the company seem accountable before the investors. This creates a good public image.
4. Management Compensation- The company intends to incorporate the value based management system into its remuneration system. This will be done by making KEP the basis for all bonuses to management and company executives. This method aligns the interests of management to the interests of the company. Managers will focus on increasing the KEP in order to get more bonuses. Increase in KEP will in turn result in increase in shareholder value.

The Weighted Average Cost of Capital represents the minimum rate of return that a company should accept on its investments. This return will enable it to just pay the providers of capital (Weetman,68). To compute the WACC, one needs information about:

1. The cost of debt- This is the cost of all capital that has been provided by all other outside parties apart from shareholders. It includes long-term bank loans and bonds. The cost of bank loans is usually stated in terms of interest while the cost of bonds has to be computed.
2. Proportion of Debt in capital structure-This indicates what percentage of the company’s finance has been provided by creditors. It is expressed as a ratio to the total capital.
3. Cost of Equity-This is the minimum return required by the shareholders for investing their funds in the company. It varies with the risk profile of the company in question. If the company is a high-risk company, either because of the nature of its business or its age, then the cost of equity is likely to be high.
4. Proportion of equity- This is the percentage of equity in a company’s capital structure.

The group WACC set by Kuoni in 2006 was 8.5%. This information is found in the extract from the 2006 Annual Report.

Return on Invested Capital

ROIC=Net Operating Profit after Tax/Investment*100

=5000/40000

=12.5%

Capital Charge=WACC*Investment

=8.5%*40000

=€3400

Kuoni Economic Profit

=NOPAT-Capital Charge

=5000-3400

=€1600

Decision

Kuoni should go ahead and undertake the project. The reason is that this project would result into increase in shareholder value by €1600. This is according to the value driver of Kuoni Economic Profit. It means that over and above the finance cost of €3400, the shareholders will earn an extra €1600.This is consistent with their objectives of increase in wealth. It also ensures that the providers of capital are compensated for the risk they have taken to invest in the business.

The Kuoni Economic Profit is a good indicator of value-based management since it incorporates both the Statement of Financial Position and the Income Statement. NOPAT reflects the increase or decrease in turnover, together with cost efficiency. The Invested capital and WACC reflect the efficiency in managing capital. Given that this is an effective measure of value added, the company can take investment decisions based on this criterion. The company can go ahead and undertake this project since it is consistent with its growth goals (Jones,55).

Works Cited

Jones, Michael. Management Accounting: An Introduction. Chicago: John Wiley and Sons, 2008.

Weetman, Pauline. Financial and Management Accounting: An Introduction. Chicago: Prentice Hall, 2007.