Publications & presentations

GOVERNANCE

In this section we shall deal with:

• What is Corporate Governance?
• Is Good Governance Restricted to Corporations?
• The Board’s Governance Roles
• Establishing an Effective Governance Charter

What is Corporate Governance?

“Corporate governance has succeeded in attracting a good deal of public interest because of its apparent importance for the economic health of corporations and society in general. However, the concept of corporate governance is poorly defined because it potentially covers a large number of distinct economic phenomenon. As a result different people have come up with different definitions that basically reflect their special interest in the field.” ¹

One of the definitions that we like is: “Corporate governance is about promoting corporate fairness, transparency and accountability.” ²

A number of important corporate governance initiatives have been implemented recently or are under implementation in Hong Kong. Firstly, the Stock Exchange of Hong Kong Ltd. (the “SEHK”) amended the Main Board and Growth Enterprise Market (the “GEM”) Listing Rules to introduce comprehensive changes relating to corporate governance. The new Listing Rules came into effect on 31 March 2004 subject to certain transitional arrangements.

The SEHK has now introduced a new Code on Corporate Governance Practices (the “Code”) for listed companies and Listing Rules on the Corporate Governance Report which listed companies are required to include in their summary annual and annual reports. The bulk of the Code’s provisions and the disclosure requirements in the Corporate Governance Report are effective for accounting periods commencing on or after 1 January 2005. The requirements of the Code and the Corporate Governance Report relating to “internal controls” will take effect for accounting periods commencing on or after 1 July 2005.

The Code and Corporate Governance Report are the same for Main Board and GEM issuers, except that while quarterly reporting is a recommended best practice for Main Board issuers under the Code, it remains a mandatory requirement under the GEM Listing Rules.

The Code and the Listing Rules on the Corporate Governance Report are set out in full in Appendices A and B, respectively. Certain other consequential amendments have been made to the Listing Rules in connection with the introduction of the Code and the Rules on the Corporate Governance Report. These amendments are set out in Appendix C.

Please note that copyright ownership in the Listing Rules, of which the Code and the Rules relating to the Corporate Governance Report form part, belongs to the SEHK.

The Code on Corporate Governance Practices

The Code represents a considerable enhancement of the Main Board’s Code of Best Practice in Appendix 14 of the Main Board Rules and the corresponding requirements of GEM Rules 5.35 to 5.45, which it replaces. In the GEM Rules, the Code is set out in a new Appendix 15.

The Code contains 2 tiers of recommended board practices. The first tier contains the “Code provisions” which are the minimum standards of board practices with which listed companies are expected to comply. Compliance is not however mandatory. Instead, the Code has adopted the “comply or explain” approach adopted in the UK Combined Code. Listed companies must state whether they have complied with the Code provisions and, if they have chosen to deviate from them, must give considered reasons for each deviation in their preliminary half-year and annual results announcements and in their half-year and annual reports (and summary half-year and annual reports, if any).

In the case of half-year and summary half-year reports, companies must either give considered reasons for each deviation or may refer to the Corporate Governance Report in the previous annual report and include details of any changes and considered reasons for any deviation not previously reported.

In the case of preliminary half-year and annual results announcements, companies may give the required information by reference to the Corporate Governance Report in the previous annual report, or in the case of preliminary annual results announcements, to the previous half-year report together, in either case, with a summary of changes since the relevant report.

Transitional arrangements will also apply so that:

• companies will not be required to disclose and give considered reasons for every deviation from the Code provisions in their first preliminary annual and half-year results announcements published in respect of an accounting period commencing on or after 1 January 2005. Instead, it will be sufficient to include a summary of the major areas of deviation. Considered reasons will not be required; and
• in the case of half-year reports for periods commencing on or after 1 January 2005 where the company has not previously issued an annual report for a full financial year commencing after that date, companies will not be required to give considered reasons for each deviation from the Code. Instead a company will be required to disclose the deviations and, in respect of each deviation, to either give considered reasons as to why it does not propose to comply with the relevant Code provision in the future or to set out the steps it has taken or proposes to take in order to comply with the relevant Code provision in future.

Companies may also adopt their own codes on corporate governance practices on such terms as they may consider appropriate. They will however be required to give considered reasons for any deviation from the SEHK’s Code provisions in their relevant financial reporting documents.

The second tier of recommended board practices comprises recommended best practices which listed companies are encouraged to adopt. They are based largely on certain UK Combined Code provisions and other UK guidelines. Listed companies are encouraged, but not required, to include a statement as to compliance with the recommended best practices and considered reasons for any deviation from them in their half-year and annual reports (and summary half-year and annual reports, if any).

The Code covers 5 principal areas: Directors; Remuneration of Directors and Senior Management; Accountability and Audit; Delegation by the Board; and Communication with Shareholders. Under each heading, the Code sets out a general principle, the Code provisions and Recommended Best Practices.

A number of the provisions of the UK Combined Code have been omitted from the Code, at least for the time being. These include a requirement for boards to formally evaluate their own performance and provisions relating to institutional shareholders’ responsibilities, the appointment of a senior independent director and enhanced responsibilities for company secretaries.

The Corporate Governance Report

Listed companies are required to include a separate report on their corporate governance practices in their annual and summary annual reports for accounting periods commencing on or after 1 January 2005. The Corporate Governance Report included in a company’s summary annual report may be a summary of that contained in its annual report and may incorporate information by reference to its annual report. The summary must contain, as a minimum, a narrative statement indicating overall compliance with, and highlighting any deviation from, the Code provisions.

The Corporate Governance Report consists of 2 levels of disclosure requirements. The first level comprises mandatory disclosure requirements. Failure to meet any of the mandatory disclosure requirements constitutes a breach of the Listing Rules. The mandatory disclosure requirements include, among others:

• a narrative statement of how the listed company has applied the principles of the Code, providing an explanation enabling its shareholders to evaluate how the principles have been applied; a statement as to whether the company meets the provisions of the Code; and details of, including considered reasons for, any deviation from the Code provisions;
• whether the company has adopted a code of conduct for securities transactions by directors on terms no less exacting than the minimum standard required by the Model Code for Directors’ Dealings (Appendix 10 of the Main Board Rules) and by GEM Rules 5.48 to 5.67; confirmation of compliance with the required standard and, in the event of any non-compliance, details of the non-compliance and an explanation of the remedial steps taken;
• information about the company’s directors (including composition of the board, number of meetings held and details of non-compliance with certain of the Listing Rules’ requirements relating to independent non-executive directors (“INEDs”)); and
• an analysis of auditors’ remuneration and information about the audit committee (including its role and composition, a report on work performed by the committee and details of any non-compliance with the Listing Rules’ requirements as to the establishment and constitution of an audit committee).

Certain Code provisions also expect listed companies to make specified disclosures in their Corporate Governance Reports. Where companies choose not to make any expected disclosure, they must give considered reasons for the deviation. The expected disclosures under the Code provisions include a statement that the directors have conducted a review of internal controls and an explanation by the audit committee of its recommendation and the reasons for any different view taken by the board in relation to the selection, appointment, resignation or dismissal of the external auditors.

The second level consists of recommended disclosures which are set out at paragraph 3 of the Corporate Governance Report. Companies are encouraged to make these disclosures. As an alternative to disclosure of detailed and lengthy information relating to the recommended disclosures in their Corporate Governance Reports, companies may choose to include all or part of such information on their websites, if they highlight to investors where they can access the soft copy of the information by giving a hyper-link directly to the relevant webpage and/or collect a hard copy of the information free of charge. Alternatively, if the relevant information is publicly available, companies may state where the information can be found. Any hyperlink must be directly to the relevant webpage.

With the demise of a number of high profile corporations worldwide this is a further attempt to restore public and investor confidence in Hong Kong corporate leadership.

Non-statutory Guidelines on Directors’ Duties

The Hong Kong Companies Registry also published Non-statutory Guidelines on Directors’ Duties (the “Guidelines”) in January 2004 which are reproduced with the permission of the Companies Registry at Appendix D. All rights reserved. The latest version of the Guidelines is available for downloading from the “List of Circular” section of the Companies Registry’s homepage on the internet (website: http://www.info.gov.hk/cr/) or at the enquiry counters of the Companies Registry on the 13th and 14th floors of the Queensway Government Offices.

The Guidelines outline the general principles for directors in the performance of their duties which are largely derived from case law. They are intended for directors of all companies irrespective of whether they are public or private, listed or unlisted. It is important to note that the Guidelines constitute principles only and not an exhaustive statement of the law, their intended purpose being to assist directors in understanding their responsibilities by making the principles of law and equity more accessible. Copies of the Guidelines should be given to all directors.

Other Corporate Governance Initiatives

Other important initiatives introduced by the Hong Kong government and regulatory authorities to improve corporate governance include the implementation of the Securities and Futures Ordinance ³ in April 2003 which, in relation to listed companies, introduced an enhanced regime for the disclosure of interests in their securities, significantly extended the market misconduct regime and the possible sanctions and increased the investigatory powers of the SFC. The SEHK has also introduced further amendments to the Listing Rules tightening the regulation of sponsors of

listing applicants and independent financial advisers to listed issuers which came into force on 1 January 2005. The government of Hong Kong also proposes to amend the Securities and Futures Ordinance to extend the market misconduct regime to cover breaches of the more important Listing Rules (e.g. the requirements relating to financial reporting, disclosure of price-sensitive information and obtaining shareholders’ approval for certain notifiable transactions) and to provide sanctions for such breaches, so giving “statutory teeth” to the Listing Rules. Increased remedies for shareholders of listed and unlisted companies (including a right to bring a derivative action on behalf of a company) have been included in the Companies (Amendment) Ordinance 2004. The relevant provisions are expected to come into force in 2005.

The Companies Ordinance ⁴ clearly holds directors of companies responsible for the company that they govern. This role includes a significant mandate for improving the performance of a company through strategic planning and monitoring of senior management action. Boards are also directly responsible for their own conduct.

Is Good Governance Restricted to Corporations?

In popular language, “governance” and “corporate governance” have become synonymous.

We believe that they are not. We believe that the J. Wolfensohn definition applies to any governing body. Although the Code applies only to listed public companies, the effective management of boards in all organisations, including private companies, not for profits, government bodies and partnerships, is essential to the development of the business. The information in this booklet applies to this range of organisations.

Much of the literature focuses on the regulatory, legal and accounting aspects of corporate governance. These are extremely important and should not be underrated. Unfortunately this focus and some of the courts’ decisions over the last 10 – 15 years have made many directors risk-averse. This attitude negates the very reason that limited liability companies were developed in the first place. Board members must balance business growth and development and the concomitant risk-taking with risk management. The realisation that a risk-averse mentality could frustrate corporate enterprise led to changes in jurisdictions such as Australia, though not yet seen in Hong Kong, to the law encapsulated in the so-called Business Judgment Rule.⁵

At the same time, if boards are to be truly effective, there is a need to go beyond the statutory requirements and look at the effectiveness of the governing body.

The Board’s Governance Roles

Kiel⁶ lists the dual roles of the board to be:-

1. ensuring compliance (through monitoring of the company) and self regulation of the conduct of board members individually and collectively as the board; and
2. improving the performance of the organisation it is charged with overseeing through strategy formulation and policy making

Recent Australian court decisions have emphasised that directors should bring “an informed and independent judgment” to bear on the various matters that come to the board for decision.⁷ It is likely that Hong Kong courts will adopt a similar attitude.

In our view, in order to fulfil its governance roles the board is responsible for:

1. Strategic direction – setting major goals, policy, framework and strategies
2. Selection, remuneration and performance review of the CEO
3. Monitoring adherence to governance compliance and risk management policies and practices
4. Advocacy and network on behalf of the organisation to assist in achieving its strategic goals, including communication with key stakeholder groups
5. Monitoring organisational performance

Establishing a Corporate Governance Charter

Each organisation needs to establish a charter based on a philosophy which is appropriate to that organisation. Issues include:

• How “hands-on” will the board be in relation to the management and oversight of the company?
• What will come to the board and what will be delegated?
• The board’s role in strategic planning processes including the important relationship it has with all stakeholders
• The relationship with the broader community

A survey conducted by SACS Executive Solutions in Australia comments on the importance of the board having a philosophy with which it approaches governance issues which transform into various style and values issues. The most important criteria for board members were ethics, openness, honesty, trustworthiness and transparency with high levels of integrity (100%). This was immediately followed by an 80% figure for courage to challenge the status quo and have an independent mind, whilst at the same time being a team player.

Also important was being attuned to the community’s value system. “How would this look on the front page of the newspaper?” is only one element. Ethical governance and social responsibility are pivotal areas for an effective board.

Various authors on governance have put together sample charters on governance⁸. Whilst they are useful, each requires tailoring to meet the specific needs of the organisation. There is no sense in taking a pro forma and thinking it will apply in all cases. Indeed, to do so in some circumstances could lead to a major diminution in effectiveness of the board. Each board needs to develop its own charter.

THE IDEAL BOARD MEMBER

In this section we shall cover:

• Selection, Retention & Succession Planning
• Essential Skills
• Roles & Responsibilities

Selection, Retention & Succession Planning

Selection

For a board to be effective, there needs to be appointment of people with the requisite skills and values. As such, there needs to be a skill matrix produced and maintained for each organisation. For example, a board may find that it needs members with skills and experience in the legal, financial, marketing and strategic and business-planning fields in addition to industry based experience. Recruitment must also be aligned to correspond with gaps in skill base from time to time.

SACS Executive Solutions interviewed thirty prominent directors, whose experience covers public, private and voluntary sectors. Managing Director, Andrew Marty, titled this research the “Human Resources Aspects of Governance.”⁹

The survey found that board members should possess strong general knowledge and experience of the industry sector in which the business is involved as well as high levels of education and a grasp of legal and statutory issues associated with the entity in the business sector.

In addition, broad business experience and a personal understanding of the role of boards were considered to be very important. Interestingly, a knowledge of the board member’s own limitations was in the top six knowledge and experience factors mentioned, which may reflect a response to some of the high profile mistakes and omissions made by board members in recent times.

Interestingly, it was seen as being less important, whilst not unimportant, that the person have specific experience within the industry sector in which the business is involved. In general, broad levels of experience in business, life experience and general technical knowledge associated with legal and statutory issues seem to be the most important issues mentioned.

The above provide challenges for most organisations, even though there are well developed human resources policies within such organisations as a whole. Often such policies are not applied to the board.

Letters of appointment which make it clear to board members what the corporation expects of them are useful. Letters of appointment should contain the following matters:

• Terms of appointment
• Time commitment envisaged
• Powers and duties of directors
• Any special duties or arrangements attaching to the position
• Circumstances in which the office of director becomes vacant
• Expectations in regard to committee work
• Remuneration and expenses
• Superannuation arrangements
• Disclosure of interests and independence
• Fellow board members
• Policy governing dealing in securities
• Induction training and continuing education
• Access to independent professional advice
• Indemnity and insurance arrangements
• Confidentiality and rights of access to information
• A copy of the constitution

Retention

Having recruited a board, it is important to retain good people. Here the chairman plays an important role in effectively communicating with each board member, encouraging and challenging them to provide a real contribution. Board members also need to be supported by provision of quality and timely information by management.

Succession Planning

A level of stability for board membership assists in taking a longer-term perspective on organisational strategic issues.

The same skills matrix established to admit board members can assist in planning succession to ensure that an appropriate level of expertise is maintained.

Progressive turnover of board members is desirable for continuity.

Special attention needs to be paid to succession planning for key board positions such as the chairman, deputy chairman and heads of each major committee.

Essential Skills

It is interesting to compare in Table A Pease & McMillan’s¹⁰ views on the skills essential to make for an effective director with those core competencies identified in the SACS survey (the percentages shown against each equate to the percentage of the thirty directors responding to the survey):

Table A

Pease & McMillan Essential Skills	SACS Core Competencies
Communication and people skills	Strong communications skills (93%) Ability to establish quality relationship/people skills (67%) Sound written communication (30%) Good public speaking skills (17%)
Analytical and critical thinking ability	Strong analytical and problem solving skills (60%)
Long-term vision	Ability to think strategically (50%)
An understanding of broad economic issues	Basic financial analytical abilities (43%)
Leadership skills	Ability to influence and persuade others (23%)
Sensitivity and the willingness to listen to the needs of interested parties	Ability to listen meaningfully (20%) Ability to gain respect and act as a mentor to management (10%)
The ability to function well in meetings and in small groups	Ability to relate to a wide range of people (10%)
Objectivity and the ability to take a broad view	Clear thinker and strong critical reasoning skills (13%)
Responsibility and a willingness to be accountable	Ability to understand and relate to stakeholders (10%)
A broad knowledge of business	Basic economic skills, i.e. an understanding of the broader environmental economic factors, which affect commercial business success (10%)
Creativity and lateral thinking ability

In summary, the conclusion one draws from the above table reinforces the view that board members must be leaders who have good communication, business and financial skills. They must have empathy and possess high moral standards.

Roles & Responsibilities

SACS research identified the following key result areas for boards. In order of importance, they are as follows:-

1. Preserve and advantage the investment entrusted into their care by shareholders and stakeholders – measured by success of the company (83%).
2. Challenge, approve and monitor strategies set by management and the CEO (70%).
3. Protect the legal entity by ensuring an effective risk management strategy is in place, and deliver a culture of compliance with the legislation (60%).
4. Act responsibly and be accountable to shareholders, and communicate with the stock exchange (33%).
5. Create a clear and explicit vision for the future of the entity, and have that underpinned by aims, strategies and processes which achieve the organisation’s strategies and aims and, ultimately, vision (33%).
6. Achieve points of the strategic plan which have been set for that year (17%).
7. Deliver transparent reports to shareholders and the community (ask yourself “how is this going to look on the front page of the newspaper?”) (10%).

Individual Board Member’s Key Results Areas

The SACS survey also identified four key result areas for individual board members:

1. Demonstrate a good understanding of the business. The board member needs to have an interest in the business being conducted by the entity and become familiar enough with this business to advantage decision making on strategic issues (27%).
2. Diligently engage with issues brought to the board and offer constructive input. Board members should be active, positive, and engaged participants (20%).
3. Effectively manage their particular portfolio. The comment relates to the fact that many board members are appointed to boards due to a portfolio specialisation – law, finance, engineering etc. The individual must ensure that his/her specialist expertise is brought to bear on any decisions taken by the board (13%).
4. Contribute to the setting of strategic directions of the organisation. Each board member should have an active involvement in the development of strategy. The capacity to contribute in this way is a key success factor of board membership (13%).

The Role and Effectiveness of the Chairman

In addition to skills, experience and values as a board member, in common practice the chairman of a board has additional responsibilities. In a recent Australian case¹¹ relating to the collapse of One-Tel, a large Australian telecommunication company, the Australian Securities and Investments Commission contended that a chairman has a higher duty of care than ordinary directors. The chairman, Greaves, made an interlocutory application to strike out the allegation. The Court ruled that ASIC had a “reasonably arguable cause of action against the chairman” and therefore declined to strike out the cause of action as it related to Greaves. The question of whether or not a chairman does indeed have greater responsibility in law, at least in Australia, will be determined by the outcome of that case. Even though any outcome reached by an Australian court would not be legally binding on a Hong Kong court, it may prove to be persuasive when this question does come up before a Hong Kong court.

The additional responsibilities which relate to the effective operation of the board include:

1. Choosing the right people for appointment to the board in conjunction with a Nomination Committee
2. Effectively leading the board and acting as a facilitator of relationships within the board and ensuring there is a corporate culture within the board itself in keeping with achieving objectives
3. Ensuring board members achieve key result areas
4. Ensuring that the board provides shareholders with sufficient information to allow them to make informed decisions about issues
5. Acting as a conduit between the board and the CEO
6. Promoting and facilitating constructive, debated Board meetings by effectively managing different views and opinions
7. Making use of his/her special skills such as:-
   1. meeting management skills
   2. time management skills
   3. ability to demonstrate quality leadership
   4. ability to bring the board and management together to work as a team
   5. ability to construct and manage agendas

THE EFFECTIVE BOARD MEMBER

In this section we will deal with:

• Performance Management
• Relationship Management
• Support Services
• Making Meetings Work

Performance Management

In order to ensure that board members, including the chairman, operate effectively requires some form of evaluation system. The research points to the need for effective people management at board level. Indeed, better management of such issues can be a differentiator and provide competitive advantage.

A clear distinction needs to be made between performance on the one hand and conformation/compliance on the other. Board members can readily discharge their compliance obligations by adhering to the minimum legal requirements; for example, by attending the requisite number of meetings. Compliance is necessary – but it is not sufficient for effectiveness.

A board performance management process needs to start with a list of specific goals and targets relevant to each board member. Some will be general for all board members and others will need to be specific, based upon the expertise that individuals bring to the board. The board needs to ensure that part of its governance planning includes the setting of goals and performance management of each of its members, including the chairman.

Once goals are established, there are a number of ways in which performance can be assessed. For example:

1. Goals are produced and annually the chairman consults each board member about their view on each other board member. The chairman then combines this with his or her own perspective and has a one to one performance review with each board member. For the chairman, two nominated board members obtain information from their fellow board members and have a private discussion with the chairman.
2. The board undertakes a separate meeting in camera to discuss board member and the chairman’s performance. This should be against a pre-determined set of criteria.
3. An independent consultant is engaged by the board to collect information from within and outside the board and a report is generated.

Each of the above may be suitable in various environments. However, perhaps option 1 is the most useful starting point as it has the advantages of confidentiality and the most potential for frank, open discussion.

Options 2 and 3 may produce more clinical rather than effective outcomes.

It is important to note that in relation to voluntary boards, all board members need to be totally committed to an appraisal program. As these are unpaid positions, there is a risk that board members may just leave rather than subject themselves to a formal appraisal process. The whole issue of performance management for board members needs to be very carefully and sensitively handled so it is seen as constructive, rather than destructive.

Relationship Management

The Chairman and the Board Members

The chairman is the leader of the board, and leadership skills (refer page 16) are essential for an effective board.

The chairman may or may not be an executive director. In practical terms, each organisation needs to determine this matter based on its:

• Size
• Shareholder profile
• Board member skills

We offer the following few points of advice:

1. The chairman needs to be well informed, and act as a sounding board for other board members so they have confidence in the chairman.
2. The chairman should solicit board members’ comments and the board members should actively seek out the chairman, providing their ideas, feedback and views.
3. New board members should be supported and mentored by the Chairman to ensure they are properly inducted and participate in ongoing professional development.
4. The chairman should, when necessary, counsel board members. All should participate in an agreed board performance evaluation mechanism and process.
5. For new board members, the chairman should lead the Board Nomination Committee in a process to select. Selection should be based on the existing and desired skills matrix of the board itself. The Nomination Committee will identify perceived gaps, and hopefully select to encourage:
   1. Diversity
   2. Constructive teamwork
6. The Chairman be non-executive.

The Chairman and the CEO

The new Code for listed companies requires segregation of the roles of chairman and chief executive and the division of their responsibilities to be clearly set out in writing.

Effective governance necessitates a working relationship between the chairman and the CEO which is characterised by:-

• Openness
• Honesty
• Consultation and communication
• Trust

This is perhaps the most important relationship in any organisation.

Here are a few tips.For both: Don’t play games with each other. The stakes are too high. For the chairman: Build an effective relationship with your CEO. Be a sounding board for the CEO, on behalf of the board members, to advise likely board opinion on particular issues and the time they should come before the board. Be honest and constructive with the CEO on issues to be addressed. When an issue comes up, discuss it constructively and how it might be dealt with Engage in an ongoing and constructive process of performance feedback for the CEO. Adopt a “no surprises” approach. Establish clear expectations. Do not leave it for the annual review. Ensure that annual reviews are a balance of positive and constructive feedback for improvement. Through regular briefings from the CEO, be on top of major management and strategic issues, but stay out of managing, in detail, the issues themselves. This will enable you to answer other board members’ queries and promote confidence within the board. Solicit information on the way in which the organisation is running overall, how board members and senior management are performing, and constructively advise the CEO. Advice can be obtained both from within and external to the organisation. Defend the CEO from unfair or unreasonable criticism from within the board, particularly at meetings. Ensure, however, that valid issues are properly raised and dealt with constructively. Actively participate in the selection of any new CEO and, where possible, involve your successor. It is important that the chair be confident of being able to develop an effective and trusting relationship with the new appointee. Issues such as personality, value system, organisational fit and the chair’s personal level of comfort with a new CEO are very important in determining how effective a relationship with a new person will be.

For the CEO: Build an effective relationship with your chairman. Meet and brief your chairman regularly, being careful not to burden the chairman unnecessarily with levels of administrative detail. Focus on:- Strategic/emerging issues Current and projected performance highlights Any shareholder feedback or comments Any issue likely to have an effect on the organisation internally or in the public eye Work on, and thoroughly brief, the chairman on the detail of the board agenda; the issues, potential reactions and desired outcomes. The chairman can’t help, or be effective in dealing with business, unless well briefed. Expose the chairman (and board members) to the organisation’s operations through tours, briefings etc as part of a defined board member education/ development program. An understanding of the business by the board will dramatically increase its effectiveness. Actively seek your chairman’s advice on major issues. Use your chairman as a sounding board. As the CEO would like to have no surprises from the chairman, the same applies to the CEO. Keep the chairman informed. Wherever possible, participate in the appointment of a new chairman. Regrettably, few CEOs do. Remember relationships are two way, and it is just as important that a CEO be able to work with a new chairman as vice versa.

It is recognised that the CEO will not select the new chairman, but it is highly desirable they should be involved and make comment on their ability to establish an effective working relationship with a new person.

Support Services

The SACS survey identified that the directors consulted believed attending formal training in the area of governance was essential.

Under the new Code for listed companies, all directors are required to receive a comprehensive and tailored induction on appointment and continuous professional development thereafter. In this regard boards would be well advised to take advantage of the many excellent courses that are conducted on the roles and responsibilities of board members by various bodies. The Hong Kong Institute of Directors conducts a number of them on a regular basis.

It is also a minimum requirement under the new Code for listed companies that a board member should be entitled to seek independent professional advice at the listed company’s expense in appropriate circumstances.

Board members should also be protected by suitable Deeds of Access, Insurance and Indemnity and should be offered the opportunity to seek professional advice in regard to such matters. The provision of indemnities and insurance for directors is governed by section 165 Companies Ordinance which is discussed in Part III under “Indemnities and Insurance”.

It is worth noting that some organisations are now re-engineering their board support services – including pre and post-meeting processes – to more effectively service the needs of their board members. Charltons is able to arrange further advice on these best practices.

Making Meetings Work

Meetings must be carefully planned, and nothing should be left to chance. The chairman plays a key role in this regard. The first matter to consider is the agenda for the meeting. This should be settled between the chairman and CEO/managing director. They should agree on what they are hoping that the meeting will achieve.

Once the agenda is settled, the chairman and CEO should decide whether the normal venue is suitable or not. This will depend upon the nature of the business to be conducted at the meeting. It may be important that the board be briefed by an outside specialist. If this is so and the matter is sensitive, it may well be that the board should meet at a discreet venue. At the very least, consideration should be given to this point.

It is essential that all board members be given board papers within a reasonable time for the meeting to enable them to properly prepare themselves for discussion. It should only be in emergencies that board members are given papers at the boardroom table. Listed companies must send board papers for regular board meetings to directors at least 3 days before the meeting (Code provision A.6.1). The chairman must be “on top” of every item on the agenda so that he can control the meeting effectively. What management says or introduces at the meeting should not surprise the chairman.

The chairman should allow full and constructive debate but should always be in control. For instance, the chairman should not allow board members who are endeavouring to push a particular point of view to be repetitive, nor should he/she allow personal remarks or argumentative behaviour. All board members should constructively contribute during the board meeting. The chairman should run the meetings effectively and encourage participation and discussion by all board members and not allow particular dominant members to overshadow others and quash discussion.

If the subject matter requires decision or is introduced to gauge the board’s attitude only, the chairman should indicate this at the outset.

COMPLIANCE

In this section we shall cover:

• The Board’s Role
• Compliance Reviews
• Appropriate Committees

The Board’s Role in Ensuring Compliance with Board Members’ Duties

We have touched upon the role of the board in ensuring compliance with statutory and regulatory obligations. The legal obligations imposed upon board members as set out in Part II are the obligations and duties of individual board members. It is imperative, however, in order to be effective that the board develop procedures to ensure that each board member and all of them collectively fulfil their duties both to the letter and the spirit of the law.

The board can do this by establishing:

• Regular compliance reviews
• Appropriate committees

Regular Compliance Reviews

An effective board should establish a board Compliance Manual and have a Compliance Plan which is monitored by the board of the responsible entity (if it has a majority of independent directors) or by a Compliance Committee. Regular compliance reviews should be conducted to ensure that there has been no breach of the legal or Listing Rules’ obligations set out in Part II. The suggested Governance Committee should conduct this review.

Establishing Appropriate Committees

Some of these board committees may seem like overkill to smaller entities. Depending upon the size of the organisation, it may not be necessary to establish each as a separate committee, but all of the areas should be covered by one or more board committees.

Governance/Compliance

This committee’s duty should be to conduct a regular audit to gauge the effectiveness of the board and its operations. This committee should ensure that there is a Compliance Manual and should monitor compliance with common law, statutory and other regulatory requirements. It should comprise some board members and independent third parties. The chairman should be one of the independent third parties.

In smaller organisations this committee could be combined with the Audit Committee.

Audit

The establishment of an audit committee is mandatory under both the Main Board and GEM Listing Rules. The committee must be made up of non­executive directors (“NEDs”) only, the majority of whom must be INEDs of the company. The committee must have a minimum of 3 members, at least one of whom must be an INED with appropriate professional qualifications or accounting or related financial management expertise. The committee must be chaired by an INED.

A detailed list of the duties and responsibilities of audit committees has been included as minimum standards and recommended best practices in the new Code to give further guidance to listed companies.

The overall responsibility of the audit committee should be to review the integrity of the company’s financial reporting. It should have direct access to management and oversee the independence and performance of the external auditors and review the relationship with external auditors.

The Hong Kong Society of Accountants has also produced “A Guide for Effective Audit Committees”, which contains a detailed list of the responsibilities of an Audit Committee. The website of the Hong Kong Society of Accountants can be found in Appendix E.

Even those organisations that are not compelled by the Listing Rules to have an audit committee should seriously consider establishing one. Audit committees “can be a more efficient mechanism than the full board for focussing the company on particular issues relevant to verifying and safeguarding the integrity of the company’s financial reporting”¹².

IT Compliance Committee

If the company depends upon information technology, and very few do not do so, it should establish an IT Compliance Committee. This could be part of the Risk Management Committee, but if the size and critical nature of the company’s IT warrants it, a separate committee should be established. The committee’s function should be to ensure that:

• The company’s IT delivers value to stakeholders
• It controls and minimises IT risk
• Privacy legislation is adhered to
• The Telecommunications Ordinance¹³ which deals with unauthorised access to computers and interference with telecommunications installation, and the Interception of Communications Ordinance¹⁴ which deals with the interception of e-mails, are not breached

Remuneration

The establishment of a remuneration committee comprising a majority of INEDs is a minimum requirement under the new Code for listed companies (Code provision B.1.1). The committee is required to have written terms of reference dealing clearly with its authority and duties. Its responsibilities include making recommendations to the board on the company’s remuneration policy, determination of remuneration packages of executive directors and senior management, pension rights, compensation payments and incentive policies. It should also make recommendations to the board on the remuneration of NEDs.

Nomination

It is a recommended best practice under the new Code that listed companies should establish a nomination committee comprising a majority of INEDs (Code provision A.4.4). The committee’s role is to ensure the appropriate size and composition (including the skills, knowledge and experience) of the board, to identify individuals suitably qualified to become board members and to assess the independence of non-executive board members.

Risk Management

This committee should comprise a suitable mix of executive (preferably CEO) and independent board members. Its role is to devise the mechanism for establishing a risk profile for the company which embraces both financial and non-financial risk. It must monitor the profile and recommend actions to minimise risk. It must ensure that board members have adequate resources and evaluate the exercise of directors’ duties in making business judgments.

SOCIAL RESPONSIBILITY

Social Responsibility and being a good and ethical business is not only “feel good”, it is “good business”. It is a key responsibility of the board and senior management.

Internally, there is a strong connection between the organisation’s social responsibility as perceived by staff, and the ability for the organisation to recruit and retain motivated people. Externally, the argument is equally pervasive, as community perception will directly impact sales and revenue.

Corporate businesses do not operate in a vacuum. Each is part of a community – local, national and often international. A corporation’s reputation for social responsibility, or being a good and ethical business, has a direct bearing on its:-

• Level of sales and revenue. The buying community will have a view on the social contribution made, or the harm done, by a corporation as part of its decision to purchase.
• The level of shareholder interest in investment. Increasingly investors are asking for “ethical” investments.
• Recruitment and retention of talented and motivated people. Surveys have shown staff want to be part of an organisation which operates ethically in the community.
• Bottom line profitability.

For larger organisations in particular, social responsibility is not a “feel good” thing, but good business.

Business is run by board members, CEOs and senior management. It is this group which must take on the mantle of strategic leadership in philanthropy.

It is not only cash from corporations which support community organisations. A number of overseas companies allow staff-paid time to undertake work for voluntary organisations to motivate staff and provide good corporate citizen images within the community.

More recently, literature has been produced on the importance of being strategic in relation to community philanthropy. Professor Michael Porter in the Harvard Business Review in December 2002 clearly demonstrates the link between effective strategic philanthropy and growth in bottom line profitability.¹⁵

Porter suggests that most organisations focus their philanthropic giving on:-

• Communal obligation; support for civic, educational and welfare organisations, motivated by a desire to be a good citizen
• Goodwill building; support for staff, suppliers, clients or government/community leaders, often necessitated by the quid pro quo of business and the desire to improve the organisation’s relationships¹⁶

He has highlighted the importance of moving towards more strategic philanthropy which contributes to bottom line profitability. Porter argues that where corporate expenditure produces simultaneous social and economic gains, shareholders and corporate philanthropy merges. This means that the organisation should spend money on philanthropy where it can produce economic gain to that organisation in the short, medium or long term.

Understanding a corporation’s community and strategically identifying where convergences of goals exist requires a real leadership in philanthropy from boards, CEOs and senior management.

On the planning drawing board, corporations now need an additional section – “Strategic Philanthropy and Social Responsibility”. It is only by taking a strategic approach that a real benefit will come in the form of bottom line profitability, not merely PR. This focus is a move away from the more traditional avenues of giving, namely a desire to be a good corporate citizen or building goodwill between clients, suppliers and others. By carefully analysing the elements of competitive context, a company can identify the areas of overlap between social and economic value that will best enhance its own competitiveness.¹⁷

The task is not easy, yet significant progress can be made where there is commitment by the board, CEO and senior management to constructive thought leadership and the allocation of resources.

Porter goes on to say that understanding the link between philanthropy and competitiveness can help companies identify where they should focus their corporate giving. Understanding the way in which philanthropy creates value highlights how they can achieve the greater social and economic impact through their contribution. The where and how are mutually reinforcing.¹⁸

The broad sector of philanthropy, social responsibility and not for profit organisations is going through a period of growth and change. It is important to recognise that it is a complex and specialised area where getting the best advice is as important as becoming strategic. There are a number of emerging bodies which may assist with independent advice on available philanthropic options and effective social investment. These organisations are not the traditional trusts that allocate funds from a pool. Rather, they are facilitators that can assist corporations in identifying their preferred area for social investment, then introduce them to credible organisations or projects in their areas of interest.

Having decided upon what to invest on a strategic basis, there is a need for vigorous tracking and evaluation of results. Effective boards will ensure that these criteria are built in to their board monitoring reports.

By adopting a strategic approach to giving, an organisation is truly investing in the community. In the process, the board is demonstrating within its own organisation and to the broader community a genuine leadership in philanthropy in a way which does not reduce shareholders’ long term imperatives. The board is fulfilling elements of its effectiveness charter by demonstrating it is fulfilling its social responsibilities and benefiting the organisation by doing so.

WHISTLEBLOWERS

Bob Falconer, in his paper “Whistleblowers and Corporative Governance” raises important questions when he asks:

Would the collapse of Enron and WorldCom have reached the proportions that it did if the concerns of Sherron Watkins and Cynthia Cooper had been heard and acted upon earlier?”

At the time of their disclosures, neither Watkins nor Cooper had legal protection. It is only since the US Sarbanes – Oxley Act that there is a mandatory provision for a confidential anonymous whistleblower’s hotline for use by all company personnel.

In the interests of protecting people who wish to express concerns about improper behaviour, the UK has the Public Interest Disclosure Act (1998). Also in Australia, several Australian States have legislation impacting upon the public sector.¹⁹

Although this legislation pertains to the public sector, the private sector is increasingly regarding whistleblower protection as essential to good governance. Whether the motivation for doing so is driven by ethics or pragmatism does not matter. “It is now a clear corporative imperative.”²⁰

To be effective, boards need to ensure that whistleblowers are protected by anonymity and that they are not victimized. We do have a tendency to wish to “kill the messenger”. Boards must ensure that we do not do so. We are all aware of the anonymous quote “confession might be good for the soul but it’s bad for the career prospects”. The following matters need to be addressed:

• establish a whistleblower protection policy
• facilitate whistleblowers through an independent hotline
• provide staff education and training
• communicate the entities’ commitment to addressing reportable conduct

Boards should remember that:

“In all the known celebrated corporate collapses loyal and committed employees tried to alert management to their suspicions and concerns without success.” ²¹

Effective boards will ensure this does not happen.

WHERE TO FROM HERE?

Every board should conduct a due diligence examination of itself as measured against the matters outlined in this guide. We suggest that the best way to do this is to conduct an effective governance audit.

We do not profess to be able to provide every solution to your governance requirements. We do believe, however, that because of the background of some of our people in:

• management;
• service on public company boards; and
• the conduct of thorough due diligence investigations of corporations

we are able to identify areas that may need improvement.

Charltons can help by:

• preparing a governance charter for the board or assisting the board in this process
• tailoring this booklet and our effective governance audit checklist to meet the specific needs of your organisation
• preparing a resource guide that is specific to your organisation’s requirements
• making personal presentations to individual board members, Compliance Committees or boards with question and answer opportunities
• conducting a full audit to establish the effectiveness of a board and to identify and recommend changes, if necessary, to make the board more effective
• conducting an audit limited to legal compliance issues
• helping with discrete aspects of effective governance by advising on any of the individual matters that are dealt with in this booklet
• providing written responses to specific board or other company officers’ concerns
• providing you with checklist material to enable you to undertake your own audit
• working with your auditors to establish a compliance audit, both presently and on an ongoing basis
• devising and preparing a Compliance Manual for use by your Governance/ Compliance Committee
• providing an independent “sounding board” to the board or other company officers for compliance or other issues on an agreed or as required basis

More information about us, our people, and our capabilities can be found by visiting our website www.charltonslaw.com

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¹   Encycogov.com:The Encyclopaedia about Corporate Governance
²   J. Wolfensohn, president of the World Bank, as quoted in Financial Times June 21, 1999
³   Securities and Futures Ordinance (Cap.571) of the Laws of Hong Kong
⁴   Companies Ordinance (Cap.32) of the Laws of Hong Kong
⁵   See section 180(2) of the Corporations Act 2001 of Australia. The Business judgment rule will protect those directors who make business judgments in good faith and for a proper purpose, have acted on an informed basis without material personal interest and who have a rational belief that the decision is in the best interests of the corporation
⁶   Kiel & Nicholson Op Cit.
⁷   AWA Case (1992) 10 ACLC 933, Daniels & Ors (1995) 13 ACLC 614
⁸   Kiel & Nicholson Op Cit.
⁹   2003 SACS Executive Solutions Corporate Governance report
¹⁰   Pease & McMillan Op Cit.
¹¹   ASIC v John David Rich & Ors ([2003] NSWSC 85)
¹²   ASX Corporate Governance Council. Principles of Good Corporate Governance and Best Practice Recommendations March 2003
¹³   Telecommunications Ordinance (Cap.106) of the Laws of Hong Kong
¹⁴   Interception of Communications Ordinance (Cap.532) of the Laws of Hong Kong
¹⁵   M Porter. The Competitive Advantage of Corporate Philanthropy. Harvard Business Review Dec. 2002
¹⁶   Loc Cit p.67
¹⁷   Op Cit.
¹⁸   Op Cit p.6
¹⁹   For example the Whistleblowers Protection Act 2001 of Victoria which allows any person to make a disclosure against any public offi ce or public body.
²⁰   Falconer op.cit.
²¹   Falconer op.cit.

The Code on Corporate Governance Practices

Corporate Governance Report

Board Members responsibilities

Legal and accounting aspects of corporate governance

Corporate Governance Guidelines

Principles of Corporate Governance

Guidelines on Directors’ Duties

The Hong Kong Institute of Directors

Board Member appointments