Financial crisis management
According to the article analyzed in this paper, the “inextricable link” that was highlighted by the recent global financial crisis was the strong relationship between the presence of independence on the board of directors of a company and good corporate governance (Asa). The global financial crisis showed clearly the need to have transparency on the board and the adoption of modern practices in the selection of board members. This is because the board of directors is crucial to the performance of a company. The board has the important task of setting the strategic goals of the company, monitoring performance, providing guidance, and evaluating management. Employing directors who have no ties with the company is standard practice in many developed economies and some countries, it is a statutory requirement. Traditionally, many companies in the gulf populate their board of directors with major shareholders and company executives.
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According to the article, it is prudent to have independence in the board of directors of a company in the gulf region because the current business environment after the global financial crisis is much tougher and requires boards that are effective to compete effectively. Secondly, independent directors bring in specialist knowledge and experience as well as much needed fresh perspective into the board room. Organizations often require specialist knowledge in areas such as finance, law, mergers, and acquisition amongst others. The company benefits directly by having such knowledge within the company, and indirectly as well in that it is cheaper to use internal experts than to hire expert consultants for short term contract periods.
The UK Corporate Governance Code was issued by the Financial Reporting Council of the UK in June 2010, in response to the global financial crisis that rocked the world in 2009. It was issued to provide guidelines for good corporate governance that would institute effective entrepreneurial and prudent management in an organization capable of delivering long term success. This would be achieved through greater transparency and accountability on the 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 to enable the board to effectively and responsibly discharge its duties (Class notes). Thus every board should include independent non-executive directors whose role would be to constructively challenge and assist in the development of the organization’s strategy. The independent directors would also evaluate the performance of management in achieving set goals and objectives as well as ensuring the integrity and soundness of financial reporting. Additionally, it is the responsibility of the independent directors to evaluate and advise the board on investment risks (Class notes).
The code does not specify the ideal proportion that should make a board; rather it advocates for a board that comprises independent non-executive directors and states that to be effective the board should have an appropriate balance of independent and executive directors such that no individual or small group of individuals can dominate the board decision making process.
The chairman is the leader of the board of directors while the CEO is the person who oversees the day to day activities of the company; each of them performs a distinct and critical role in the organization. Some companies allow the same person to occupy the same position while others require the positions to be held by different people.
The position of the CEO and the chairman of the board involve two different yet very important duties and responsibilities. The chairman for instance is charged with the responsibility of providing the organization with strategic leadership and directing the organization’s resources towards achieving its goals. Also, the chairman approves the strategies developed by the CEO and ensures they are properly executed, and is responsible for considering and managing risks in an organization. The chairman is the link between the organization and its shareholders and is answerable to them and has the responsibility to ensure that value is delivered to shareholders according to their expectations. Thus, the chairman acts on behalf of the shareholders by ensuring the highest level of corporate governance is achieved within the organization.
The CEO on the other hand is the link between the company and the board. He reports to the board and represents the board in the organization by overseeing the day to day running of the company’s activity. This way he ensures that the goals and objectives of the board are achieved through the development and execution of strategies that are directed towards achieving these goals and objectives set by the board. More importantly, the CEO is the captain who leads and motivates senior executives of the organization.
Therefore, when these two positions are held by one person, it places too much power and responsibilities on one individual and this can hurt the organization’s corporate governance and performance. If the Chairman is also the CEO, it will effectively mean that the CEO will control both the board and the company’s activities. The overall performance of the organization may be affected because too much responsibility is placed on one individual and he may be unable to discharge all of them fully. Separation of these two positions is thus seen to increase transparency and accountability of the board and this represents the shareholder’s wishes.
In any case, separation of the two positions is important during succession and transition, for example, a new CEO may require the guidance and assistance of a superior person who in that case will be the chairman. Also having two senior people at the helm of an organization broadens the perspectives of the leadership and increases the chances of success.
The CEO and the chairman of the board can be the same person because it is not always easy to find a person who is qualified, experienced, and has the credibility and ability to guide an organization. Thus in such instances, the CEO may be the most qualified and experienced person on the board to occupy that position. Refusal to give the CEO that position may be seen as a lack of trust and confidence in him.
Also, combining the two positions may be seen as beneficial to shareholders because they have the person who is directly answerable to them overseeing the day-to-day activities of the organization; this way they are assured that the wishes of the shareholders are carried out.
In the end, accountability and transparency may not be sacrificed if the same person occupies the two positions where there are independent non-executive directors who are charged with the responsibility of evaluating the Chairman CEO. Differences between the CEO and the chairman may affect an organization’s ability to achieve its goals and objectives, by combining these two position organizations are assured of continuity and stable leadership in developing and implementing strategies. The two positions can be combined where there is an able individual, possesses the skills, and has adequate knowledge in the management of a company. This may save the shareholders a lot of money that they would have spent as remuneration for two people. Thus, the argument that separation increases transparency and accountability is not always true because in the past troubled companies such as Enron and WorldCom had both a CEO and chairman who colluded to cover up management crimes.
The best model between the two however is to have the CEO as the chairperson of the board because it shows confidence in the CEO and his work; the company is also assured of decisive development and implementation of strategies and shareholders have someone who directly reports to them in charge of the firm’s day to day activities. The presence of independent non-executive directors should be adequate to control, evaluate, and guide the actions of the chairman CEO.
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Kuoni Group has adopted a value-based management approach to keep the top management aligned as much as possible and create value on behalf of its shareholder. Thus the activities are guided and evaluated by the economic value concept.
The four elements of Kuoni financial methodology that are covered by the value-based management approach include:
- EP- Economic Profit = NOPAT-Cost of capital employed
- WACC- Weighted Average Cost of Capital
- ROIC- Return on Invested Capital = NOPAT/ Average Capital Invested
- EVA- Economic Value Added = ROIC-WACC
The four key pieces of information required to calculate WACC include:
- Cost of Debt
- Size of Debt capital the company has used in its finance
- Cost of Equity
- Size of Equity Capital used to finance the company
The WACC that was set by the Kuoni group for 2006 was 8.5%
- ROIC [Return On Invested Capital]
- the capital charge
- the Kuoni Economic Profit [KEP]
Part C (b)
|Average Capital Invested|
= Invested capital x WACC
= € 40,000 x 8.5%
= € 3,400
KEP = NOPAT- Capital Charge
= € 5,000 – € 3,400
= € 1,600
Therefore, Kuoni Group should go ahead and invest in this project because it has a positive KEP of € 1,600 this shows that the project will contribute positively to the company’s financial position and will deliver added value to shareholders; it should therefore be implemented.
Asa, F. “Mixing it in the boardroom: Quest for independence gathers pace” The National. 2011.
Class notes, Corporate Governance: The Nestle Case Financial Reporting Council (2010). Corporate Governance Code.
Kuoni Group. The future of travel since 1906: Annual report 2006 Kuoni Group. Value Based Management.
Valuad (PTY) Ltd. The Valuad Framework Tutorial.