Lack of board oversight
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The failure of non-executive directors to adequately challenge the executive decisions made by the board on behalf of the company’s shareholders.
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Unchallenged CEOs increase the risk of mismanagement. For example, in 2018 and 2019, Boeing’s 737 Max airplane was involved in crashes, killing 346 people. The accidents are now known to have been caused by a software fault. However, further investigations indicated that the board was aware of the software issues for some time. Their failure to act stemmed from the leadership of the former CEO.
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One way to mitigate this risk is to split the role of chairman and CEO. Another is to empower non-executive directors, giving them the tools to restrain or restructure a poorly performing board.
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Unjustified remuneration
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The practice of paying company executives unreasonably high salaries and bonuses relative to the median worker.
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In 2020, CEOs were paid 351 times as much as a typical worker. On average, a CEO at one of the top 350 firms in the US was paid $24.2 million on average. If left unchecked, excessive pay differentials between business leaders and ordinary people may contribute to social unrest.
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Since executive pay is commonly tied to short-term profits—which can be manipulated—one way to make CEO pay ratios fairer is to link compensation to ESG goals. Adopting executive pay ratios is another method.
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Avoidance of regulatory security
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The creation of a corporate structure or corporate culture that makes it difficult for the authorities to properly investigate a company’s activities.
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Opaque corporate structures can obstruct regulatory scrutiny. For instance, Alibaba’s holding company is registered in the Cayman Islands, listed in the US and Hong Kong, and has over 90% of its operations in China. This allows management to play regulatory arbitrage. Their assets and operations are in legal jurisdictions where the Securities and Exchange Commission (SEC) has no authority to conduct investigations.
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Implement simple and more transparent corporate structures with full segregation of duties to ensure that all areas of the business can be scrutinized both internally and externally.
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Lack of adequate pension provision
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The failure to ensure that pension commitments to employees are properly funded.
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Many organizations do not adequately fund their pension schemes. The risk is that if a company fails, its employees may not only lose their jobs but also their pensions.
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Implement a policy of fully funding employee pension schemes. Giving greater enforcement powers to pension trustees would also help.
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Lack of diversity at board level
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The failure of a board to ensure it receives regular input from people with diverse backgrounds, whether by income, job function, gender, race, age, sexuality, or religion.
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According to the 2021 Missing Pieces Report, of those holding board seats in the top Fortune 500 companies, 74% were men, of which 62% were white. There is a risk that a lack of diversity at the board level can promote groupthink.
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Ensure a broader representation of diversity at the board level. Companies that do this are more likely to be in tune with their employee base, a broad range of stakeholders, and society.
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Lack of shareholder representation
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The failure to take account of the views of the majority of shareholders in the running of a company.
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The shareholder structure of some companies can give too much power to certain groups of shareholders.Dual-class share structures, for example, give one class of shares greater voting rights than others. Meta (previously Facebook) and Alphabet have such structures, which means that the shares held by the founders carry higher voting rights than other shares. This makes the founders less accountable to the owners of the business.Some corporate structures are biased toward foreign investors. For example, Chinese companies listed in the US have a variable interest entity (VIE) structure, whereby foreign investors do not own the underlying operating assets of the Chinese company they are investing in. Instead, those operating assets are owned by Chinese nationals who have no legal obligation to recognize these foreign shareholders as rightful owners. Alibaba and Baidu are two Chinese companies with a VIE structure. The risk is that VIE structures could be ruled illegal, making the shares held by foreign investors worthless.
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Best practice governance requires clear and transparent shareholder structures where each equity share carries equal voting rights under the law.
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Share-based incentives
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A way of paying the employees, executives, and directors of a company with ownership shares in the business.
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Share-based incentives typically reward short-term profit-maximizing performance. Over the last three decades, share-based incentives have been on the rise, but poorly set up schemes can cause significant societal damage. One of the causes of the 2007 banking crisis was the short-term profit targets of investment bankers. Many executives were encouraged to take ever-greater risks to generate ever-higher profits. They were awarded share-based incentives based on the profits they generated, while the risks they took were ignored. The result was the biggest financial crisis since the 1930s.
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Rewrite share incentive plans to align employee actions to ESG targets.
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