Framing The Future of Corporate Governance

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The Future of Corporate Governance

  • The Future of Corporate Governance Explore the developments and trends shaping the future of corporate governance globally in 2018.
  • Date: Jan 10, 2018
  • Category: Corporate Governance

With the update of the new Malaysian Code on Corporate Governance in April 2017 (MCCG), there is a renewed focus on continuous improvement and transparency in corporate governance for Malaysian companies. While the core pillars and principles of good corporate governance are somewhat constant, the broader landscape is changing and stakeholder expectations of what constitutes good governance are intensifying. Companies cannot risk falling behind.

Drawing on existing research, this article explores four trends shaping the future of corporate governance. It aims to give insights into the issues on which companies should prepare for increased scrutiny from stakeholders. Please also download and share our Infographic on Corporate Governance Trends 2018.

1. Emphasis on Director Independence

Having independent directors has been considered best practice in corporate governance for a long time. The reason being, independent directors have an obligation to bring oversight and objectivity to the board. This allows them to challenge the senior management team and the other executive members of the board to protect the interests of a company and its shareholders, including minority shareholders.

The MCCG has enhanced its position and guidance on director independence. Practice 4.1 on page 22 of the MCCG prescribes that at least half of the board comprises independent directors. For Large Companies1 , the MCCG asks that the board comprises a majority independent directors. Prescribing the number of independent directors this way, encourages companies to have a “critical mass” of independent voices that can stand up to the executive members of the board and support each other in safeguarding value creation and sustainability of the business.

Shareholders and investors are also increasingly engaging companies on the independence of directors. On page 16 of its Investment Stewardship 2017 Annual Report, the global investor Vanguard stated that about half of their engagements this past year talked about board composition, including board independence, tenure, and diversity. On the issue of tenure, the MCCG has also rebuffed its position on this issue in relation to independence. Practice 4.2 on page 22 of the MCCG addresses the impact that long tenure can have on director independence. It states that the tenure of independent directors should not exceed 9 years. If a director has been in place for more than 9 years, annual shareholders’ approval is required, and if the tenure exceeds 12 years, an annual two tier voting process should be adopted. Given these developments and growing emphasis on independence from shareholders and investors, having independent directors on the board of a listed company sends a positive signal to the market and engenders more trust from shareholders.

2. Diversity in the Boardroom

It is well understood that boards need the right composition of independent directors and mix of skills to meet the needs of the company and its shareholders. While this continues to be fundamental, gender diversity has increasingly become an important part of the board composition conversation. Initiatives such as Bursa Malaysia Rings the Bell for Gender Equality and The 30% Club Malaysia are encouraging companies to step up their efforts on gender diversity in the boardroom. Furthermore, the MCCG has enhanced expectations on the matter. The MCCG asks companies to disclose policies, targets and measures to meet the targets relating to gender diversity. It also now expects Large Companies to have at least 30% women directors, which is an enhancement from the previous version of the MCCG.

As Malaysian companies prepare their annual reports in 2018 and beyond, regulators are not the only parties pushing for more diverse boards. Banks and investors increasingly see boardroom diversity as directly linked to long-term performance in their assessments and valuations. Research from Credit Suisse shows that companies with greater gender diversity on the board exhibit higher returns on equity, higher valuations and a higher pay-out ratio. This improved performance is often referred to as the “diversity dividend”.

Furthermore, this article would be remiss if it didn’t also mention that gender is not the only important aspect of diversity on boards. Practices 4.4 and 4.5 of Bursa Malaysia’s Corporate Governance Guide (3rd edition) provides guidance here, stating that companies should also give due regard to a diversity of skills, experience, age, and cultural background (ethnicity) when appointing the board and senior management. Therefore, companies must ensure that they are reporting on boardroom diversity, and that the nominating committee is thinking about diversity – in all its forms – in selection and succession planning.

3. Increased Scrutiny of Executive Pay

In many global markets, executive pay has been increasingly under the spotlight, as investors look for disclosure on pay and its link to long-term business performance. A significant aspect is whether a firm’s shareholders have a right to vote on the remuneration of executives, or have a “say-on-pay2” . In Malaysia, under the Companies Act 2016 (section 230), fees of directors and benefits payable to directors are subject to shareholders’ approval at a general meeting. While other countries in Southeast Asia have not adopted a say-on-pay requirement for shareholders, the debate has already begun in the region. Some analysts believe giving shareholders a say-on-pay will be inevitable, although it is currently unclear how long this will take
(Asia One).

Whether say-on-pay becomes widely adopted or not, the trend in executive remuneration across Southeast Asia is for compensation to include short- and long-term incentives. In Malaysia, the MCCG encourages companies to link remuneration with their business strategies and long term objectives and to be transparent on remuneration matters. This is aligned with shareholder interests. Based on interviews with several Asian-based institutional investors, Willis Towers Watson found that investors are not necessarily against higher pay. However, they do want better disclosure and engagement on how pay is structured, and to see the rationale behind executive pay decisions. Therefore, boards and remuneration committees should expect more inquiries related to executive pay and how compensation is linked to performance.

4. Cybersecurity

As Malaysia – along with the rest of the world – embraces Information and Communications Technology (ICT) and becomes cyber-dependent, the risk of cyberattacks, data fraud and theft increases. The Malaysian government recognises this growing threat and is taking steps to strengthen national cybersecurity through the government agency Cybersecurity Malaysia. While government action is necessary, it is insufficient alone. Companies need to take accountability for strengthening risk management and securing data and computer systems. A 2017 report on Cyber Risk in Asia-Pacific found that Cyber Risk ranked 5th amongst top risks in Asia, however, “70% of firms in Asia do not have a strong understanding of their cyber posture”. The report goes on to recommend that cyber security needs to be a priority on the Board’s agenda. Cyber risk should be seen as an enterprise-wide risk, not left to ICT departments to manage alone, but led from the top.

5. Sustainability Reporting is Now a Business Norm

Organisations worldwide are increasingly integrating sustainability considerations into their business and reporting on their non-financial performance. Having just celebrated its 20 year anniversary in 2017, the Global Reporting Initiative (GRI) has been instrumental in supporting the growth in sustainability reporting. In 1999, the organisation had just 12 reports registered on its reporting database. In 2016, this has grown to 6,824 reports and the organisation has been named the most popular framework for sustainability reporting in a recent survey of sustainability reporting by KPMG. The GRI’s Chief Executive Tim Mohin was recently interviewed on the state of sustainability reporting and is quoted as saying, “Of the 250 largest companies in the world, 90 per cent of them are reporting sustainability performance.” He goes on, “The fastest growth rate is in Asia, where we have seen a doubling of GRI reporting in the last five years.”

While the growth in sustainability reporting has been voluntary by many companies, it is also increasingly being mandated by regulators. Bursa Malaysia introduced its requirements on sustainability, supported by guidance and tools, through a staggered approach that will come into effect over three years from 31 December 2016. This means that sustainability reporting is now commonplace in Malaysia. However, Junice Yeo, Corporate Citizenship’s Director of Southeast Asia, is quick to remind companies that, “while sustainability reporting has been mandated, it shouldn’t be seen as a compliance issue. A good sustainability report communicates how a company creates and sustains economic, environmental and social value in order to build the trust and confidence stakeholders have in a company’s management and prospects.”

6. Emergence of Responsible Investment

Closely linked to the rise in sustainability reporting mentioned above, is the emerging importance of environmental and social risks – under the umbrella term of sustainability – for investors. Today, investors consider sustainability topics to be mainstream priorities that are intrinsically linked with good corporate governance to drive long term value creation. One of the best examples of this has been a letter from Larry Fink, the Chief Executive of asset manager Blackrock, to the CEOs of investee companies. The letter states that, “Generating sustainable returns over time requires a sharper focus not only on governance, but also on environmental and social factors facing companies today.”

According to Fink, the management of Environmental, Social and Governance (ESG) factors has become a sign of “operational excellence”. Other large institutional investors have taken similar stances. Combined with the rise in investor stewardship, this means that companies are now being scrutinised and evaluated on ESG considerations in order to determine how well they are positioned to weather risks (e.g. climate change) or take advantage of opportunities (e.g. employee engagement) over the long term. Boards, led by the CEO, need to understand what the material economic and ESG issues are for their business and demonstrate how these material issues are being managed as part of a long-term value creation strategy (For more information, see How to Demonstrate the Value of Sustainable Business to Investors).

1Companies on the FTSE Bursa Malaysia Top 100 Index or with market capitalisation of RM2 billion and above at the start of the financial year.

2Say-on-pay is a term used to describe when a firm’s shareholders have the right to vote on the remuneration of executives.

Author

Thomas Milburn, Corporate Citizenship

Thomas Milburn is a Senior Consultant at Corporate Citizenship based in our Singapore office. He specialises in working with companies on corporate governance, integrating sustainability into management approaches, and sustainability reporting. He has over eight years helping businesses to navigate the complex and changing sustainability agenda and holds an MSc in Corporate Governance and Business Ethics from Birkbeck College, University of London.

  • Tags : Corporate Governance, Director Independence, Diversity, Executive Pay, Cybersecurity, Sustainability Reporting, Responsible Investment.

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