Corporate Governance During the Global Financial Crisis Report (Assessment)

Financial crisis

This article on good corporate states that the inextricable link that was highlighted by the recent global financial crisis was the strong relationship between the independence of the board of directors and good corporate governance (Fitch). The article explains how the global financial crisis highlighted the need for transparency and accountability within a Company’s board of directors. It argues that Companies especially in the gulf region urgently need to abandon traditional practices of using managers and representatives of major shareholders on the board of directors and instead embrace modern practices of corporate governance. This is because the board of directors is crucial to the performance of a company; the board sets the strategic goals of the company and guides and evaluates top management (Fitch). Many companies in a developed country for example are described to be employing directors who have no ties with the company into their board of directors to improve organizations’ ability and overall performance.

Section a

According to the article, it is paramount for companies to ensure that there is the independence of the board of directors because organizations often require expert knowledge in areas such as law, finance, mergers and acquisition amongst others which is more economical when such skills are obtained in the house as opposed to sourcing from elsewhere. Secondly, the post-global financial crisis business environment has become challenging and companies can make use of the extra knowledge and experience that an independent director will bring into the organization

Section b

The UK Corporate Governance Code was issued in June 2010 in response to the global financial crisis which was mainly caused by poor corporate governance among other factors. It was issued to provide guidelines for good corporate governance practices in Companies through greater transparency and accountability on companies’ board of directors. The Code states that to be effective, the board and its committees should have an appropriate balance of skills, experience, and independence necessary to effectively and responsibly discharge its duties. Thus, this code states that every board should include independent non-executive directors whose role would be to constructively challenge proposals on the organization’s strategy and assist in its improvement. The independent directors would also evaluate the performance of management in achieving agreed goals and objectives as well as ensuring the integrity and soundness of financial reporting (Class notes).

Also, it is the responsibility of the independent directors to evaluate the executive director’s decisions and advice on their promotion and other issues such as succession planning. The code does not detail how the board of directors would be made up but it advocates for a board that has the appropriate balance that no one individual or small group of individuals can dominate especially as far as the decision-making process is concerned.

Section c

The chairman of the board of directors is the leader of both the board and the company whereas the CEO is the person who oversees the day-to-day activities of the company. These two positions are distinct with different responsibilities; the chairman for instance main duty involves providing leadership and focus to the company. This means that he/she gets to evaluates and approves strategies formulated by the CEO and ensures that they are effectively executed. The chairman is accountable to the shareholders and acts as a facilitator between the shareholders and the board; it is the chairman who ensures that high standards of corporate governance are maintained.

The CEO on the other hand is charged with the role of developing and executing strategies that are directed towards achieving target results and gets to oversee implementation of the shareholder’s desires. The CEO is also answerable to the board and has the responsibility of delivering against the objectives set by the board of directors. Finally, a CEO provides leadership and motivation to executives in an organization besides representing the board in the organization.

Reason for separation of the two positions

Combining the two positions places too much power and responsibility in one person and there is the possibility that power may be abused and the absence of checks and balances may lead to poor performance. Both the chairman and the CEO play complementary roles in achieving the goals and objectives of the organization. The organization benefits from the diverse experience, skills, and knowledge possessed by the two individuals when these positions are separate and the top management has a broader perspective of issues from two different people. When the CEO is also the chairman, the board can be held hostage as he/she is likely to wield too much power as there will not be an oversight body that is above him/her.

Separation of the two positions, therefore, increases transparency and accountability, and this way the interest of shareholders is represented. Also, separation of the two positions allows for the effective and efficient discharge of responsibilities in the organization as each individual knows clearly what is expected of them. Ultimately, the organization benefits from the synergy of the two-position working towards a common goal that is enhancing shareholders’ value.

Section d

The CEO and the chairman of the board can be the same person because of the lack of a suitable candidate who can undertake both responsibilities of chairman and CEO. Also, the company’s unique position may require one person to occupy both positions; it can also be the wish of shareholders that the position of the chairman and CEO be occupied by one person. Because of possible conflict between the CEO and the chairman, organizations may prefer the two positions to be occupied by one person to ensure strategic continuity and strong leadership.

The best however is to have the CEO as the chairman of the board because it shows confidence in the CEO and his work. This way the organization can save a lot of resources spent on remuneration where two senior executives are hired. It is also argued that the chairman-CEO is more accountable to the shareholders as he ensures that the wishes of the shareholders are implemented. Accountability and transparency can be achieved in a Company by hiring independent non-executive directors whose responsibility will be to provide expert knowledge to the board as well as to monitor, evaluate, and guide the chairman-CEO. Thus, an organization can exist without both the CEO and Chairman but with just one person serving as both because experience which involved financial reporting crimes or poor corporate governance involved both CEO and chairman serving as distinct individuals. According to our study, the greatest threat to effective corporate governance is not a lack of transparency and accountability but a lack of independence of the board of directors.

Market capitalization

Price on the 14^th– 391.75 pence

Price on the 15^th– 386.15 pence

The difference in the share price for the two days

386.15-391.75= -5.6 pence

The lowest price for a Tesco share in week 52 to 15 March 2011 is 368.40 pence

The dividend yield of a Tesco share is shown as 3.5% on 15 March 2011.

Part b

Dividend Yield = Dividend paid/ Share price

= Dividend payable as at 14^th March 2011 = 13.53p

Share price as at 15^th March 2011 = 386.15p

Therefore the Dividend yield as at 15^th March 2011 = 13.53/386.15 = 0.035 = 3.5%

On what date did Tesco’s share last go ex-dividend (xd)? The last day was Monday 14^th, March 2011

What was Tesco’s market capitalization in £m, as of 14 March 2011?

Tesco’s Market capitalization as of 14^th March 2011 was £m 31,522 or £ 31.522 Billion

KEP calculation

1. EP- Economic Profit = NOPAT-Cost of capital employed
2. WACC- Weighted Average Cost of Capital = cost of debt x debt +cost of equity x equity
3. ROIC- Return on Invested Capital = NOPAT/ Average Capital Invested
4. EVA- Economic Value Added = ROIC-WACC

Part b

The four key pieces of information required to calculate WACC include:

1. Cost of Debt
2. Size of Debt capital the company has used in its finance which is equivalent to the market value of debt
3. Cost of Equity
4. Size of Equity Capital used to finance the company which is equivalent to the market value of equity

The WACC that was set by the Kuoni group for 2006 was 8.5%

Part c

• ROIC [Return On Invested Capital]
• the capital charge
• the Kuoni Economic Profit [KEP] and explain – with reasons – whether or not you believe that Kuoni should go ahead with the investment.

Capital Charge

= Invested capital x WACC

= € 40,000 x 8.5%

= € 3,400

KEP = NOPAT- Capital Charge

= € 5,000 – € 3,400

= € 1,600

Kuoni Group should therefore invest in this project because it has a KEP of € 1,600 this shows that the project has a positive economic profit and will enhance the group’s overall financial position and deliver value to shareholders. It is my opinion that the project should be implemented.

Works Cited

Fitch, A. “Mixing it in the boardroom: Quest for independence gathers pace.” The National. 2011. Web.