QUALIPORT
Fool's Guide To Corporate Governance

By Maynard Paton (TMFMayn)
August 8, 2002

The economic downturn has revealed all sorts of boardroom misdemeanours recently. As such, judging how a company meets corporate governance guidelines is an important consideration for private investors. Spotting directors whose primary focus is remaining in a cosy well-paid job can help shareholders avoid trouble.

Combined Code

Derived from the Cadbury and Greenbury Reports, UK corporate governance is encapsulated in what's called the Combined Code. The Code outlines the "principles of good governance and the code of best practice" for the country's boardrooms.

The Code covers four separate areas for listed companies:

1. Directors;
2. Directors' remuneration;
3. Relations with shareholders, and;
4. Accountability and audit.

Each area consists of a number of 'best practice' principles and code provisions. Although the Combined Code is voluntary, listed companies must include a statement on corporate governance in their annual report and highlight any deviations.

The importance of the Code is simple. Boardrooms not observing the recommended principles may not be running their business with shareholders in mind. Pensions Investment Research Consultants (PIRC) and the National Association of Pension Funds (NAPF) regularly provide updates on companies that appear to have poor corporate governance.

Today's Qualiport will review the Code's more important points that concern the formation of company boardrooms. On Monday, directors' remuneration and accountability will be considered. To see how effective the Code is, the sixteen companies that make up the Qualiport's watch list will be put to the test.

Directors and company boards

Here are the Code's main points that relate to directors and the formation of company boards:

A.2 Chairman and CEO

Principle:

There are two key tasks at the top of every public company -- the running of the board and the executive responsibility for the running of the company's business. There should be a clear division of responsibilities at the head of the company which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision.

Provision:

A decision to combine the posts of chairman and chief executive officer in one person should be publicly justified. Whether the posts are held by different people or by the same person, there should be a strong and independent non-executive element on the board, with a recognised senior member other than the chairman to whom concerns can be conveyed.

A.3 Board Balance

Principle:

The board should include a balance of executive and non-executive directors (including independent non-executives) such that no individual or small group of individual can dominate the boards' decision taking.

Provision:

The majority of non-executive directors should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement.

(Note: The difference between a non-executive director and an independent non-executive director is debatable. Generally speaking, the only formal difference is where the non-exec has had previous executive responsibilities at the company, and therefore cannot be deemed independent. However, the likes of PIRC adopt their own 'independent' guidelines for their reviews. PIRC highlight 'connected' non-execs through excessive pay or extensive boardroom tenures.)

A.5 Appointment to the Board

Principle:

There should be a formal and transparent procedure for the appointment of new directors to the board.

Provision:

Unless the board is small, a nomination committee should be established to make recommendations to the board on all new board appointments. A majority of this committee should be non-executive directors.

A.6 Re-election

Principle:

All directors should be required to submit themselves for re-election at regular intervals and at least every three years.

Real life

The reasons behind the points should be quite clear. By having split chairman and chief executive roles, a senior non-executive, a notable independent board presence, new appointments independently judged and regular re-elections, the chance of an unscrupulous, power-mad executive ruining shareholders should be minimal.

Here's how the Qualiport's watch list measures up on the various points. For the record, the study was based on the latest annual report for each company. Subsequent boardroom changes have not been accounted for.

Split chairman

Firstly, the question of balance of power between chairman and chief executive:

Company              Split chairman/      Comment on
                         CEO?              chairman

Allied Domecq             Y            non-exec, £200k fees
Carpetright               N            exec chairman & CEO
DFS Furniture             N            exec chairman & CEO
Emap                      Y                   -
Gallaher                  Y   non-exec, not 'independent', £200k fees
Games Workshop            N            exec chairman & CEO
Imperial Tobacco          Y            non-exec, £180k fees
Johnston Press            Y                   -
Lloyds TSB                Y            non-exec?, £355k fees  
London Stock Exchange     Y         non-exec, not 'independent'
Metal Bulletin            Y                   -
PizzaExpress              Y            executive chairman
Renishaw                  N            exec chairman & CEO
SSL International         Y            non-exec, £120k fees
Ulster Television         Y                   -
Ultraframe                Y                   -

Carpetright (LSE: CPR), DFS Furniture (LSE: DFS), Games Workshop (LSE: GAW) and Renishaw (LSE: RSW) have a dual chairman and chief executive In terms of explanations, the only informative one came from DFS, who simply stated: "The Chairman of the Board remains an executive director due to his extensive expertise in the industry". PizzaExpress (LSE: PIZ) operated with an executive chairman and a separate chief executive.

Of those companies with a non-exec chairman, two were not deemed independent due to past executive duties. Another three non-exec chairmen were declared independent but received substantial (i.e. £100k+) fees for their efforts. Lloyds TSB (LSE: LLOY) failed to declare whether their chairman (another with a big pay packet) was independent.

Non-execs

Here's how each company's non-executive presence stands up to the Code:

Company                Board    Non-execs   Independent  Senior
                      members                Non-execs  non-exec?

Allied Domecq            10        5            5          Y
Carpetright               9        5            4          Y     
DFS Furniture             6        3            3          N
Emap                      9        6            6          N
Gallaher                 14        7            5          Y     
Games Workshop            5        3            3          Y
Imperial Tobacco          8        5            5          Y
Johnston Press            8        6            4          Y
Lloyds TSB               18        9            9          Y
London Stock Exchange    12        9            5          Y
Metal Bulletin            6        3            2          N
PizzaExpress             10        3            2          Y
Renishaw                  5        1            0          N
SSL International        11        7            7          Y
Ulster Television         6        3            3          Y
Ultraframe                8        2            2          Y

Carpetright, Gallaher (LSE: GLH), London Stock Exchange (LSE: LSE), Metal Bulletin (LSE: MTLB), Renishaw, PizzaExpress and Ultraframe (LSE: UTF) all lack a strong (i.e. 50% or more) independent non-executive presence on their boards. Indeed, the LSE's senior non-exec "to whom concerns can be conveyed" is not even deemed independent.

Nomination and re-election

And finally, here's how the companies measure up to the nomination and re-election guidelines:

Company                  Nomination           Re-election every
                      majority non-exec?         three years?

Allied Domecq                Y                       Y 
Carpetright                  Y                       Y
DFS Furniture                N                       N
Emap                         Y                       Y
Gallaher                     Y                       Y
Games Workshop               Y                       ?
Imperial Tobacco             Y                       Y
Johnston Press               Y                       Y
Lloyds TSB                   Y                       ?
London Stock Exchange        Y                       ?
Metal Bulletin               N                       ?
PizzaExpress                 Y                       ?
Renishaw                     N                       N
SSL International            Y                       ?
Ulster Television            Y                       Y
Ultraframe                   Y                       Y      

DFS, Metal Bulletin and Renishaw don't have nomination committees. With their boardrooms at least 50% executive, they fail the nomination test.

On the re-election point, eight companies specifically stated every director had to be re-elected every three years. Another six (indicated by a '?') appeared to have regular re-elections, but did not mention the timescales involved. Notably, both DFS and Renishaw declared their executive directors were not subject to re-election (although DFS is set to change this policy).

Summary

From the above study, probably Emap (LSE: EMA) and then Johnston Press (LSE: JPR) give the least concern for devotees of corporate governance. On the other hand, Renishaw, London Stock Exchange, DFS, Carpetright and PizzaExpress (in that order) are those where shareholders should take a closer look. Indeed, with just one non-exec on hand, Renishaw flouts every principle concerning the make-up of its boardroom.

On Monday, the Qualiport's watch list comes up against the Combined Code's principles of directors' remuneration and accountability and audit. That feature will also answer the ultimate question: "Does poor corporate governance actually make shareholders worse off in reality?"

The author owns shares in Carpetright, DFS Furniture, Games Workshop, Johnston Press and PizzaExpress.