Corporate Governance in Telecommunications

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Synopsis

The world is changing faster than anyone could expect and people are struggling to keep up with the pace of this change. Shareholders are the ultimate owners of the companies and the management are just agents and work for a salary paid by the shareholders. However does management actually act as agents and work with integrity and responsibility is an unanswered question.

When management takes over the company they also work for their personal benefits, such as money and fame. This makes them take high risks and involve in fraud. Major corporate collapses all over the world reflected this and the corporate governance came in to existence since then. ‘Corporate Governance’ can be simply interpreted as ‘the way the companies are managed’.

This research study is based on an analysis of the different corporate governance systems followed by the Telecommunication Companies in United Kingdom (UK) and their overall performance is analysed against their financial performance and the corporate governance systems they follow. Three of the major Telecom companies in UK, British Telecom, Vodafone & Car phone Warehouse are selected for this analysis. The financial data for the past 5 years is analysed as the financial performance affects the performance of the firms more than any other factor.

The study also covers various theories of corporate governance. The type of corporate governance varies from country to country based on their legal & ownership structures In the recent years the importance of corporate governance has become a key feature in every organisation than in the past years. This is mainly because of the collapse of giant corporate in several parts of the world. Some of the most famous corporate governance failures occurred in companies such as Enron, World com and very recently in Satyam Computers in India. The study also covers briefly these scandals to compare how an efficient corporate system should be managed and performed. The analysis also compares the existing system with the empirical research to rate the best corporate governance system.

As the analysis is based on the corporate governance systems in UK, the research has also briefly discussed the Corporate Governance reports published in UK. These reports are the Cadbury report, the Greenbury report, the Hampel report and the combined code along with some of the international standards of corporate governance by Organisation of Economic and Cultural Development (OECD).

Acknowledgement

This dissertation is the result of my work at the London School of Commerce and University of Gloucestershire for Masters in Business Administration programme.

My special words of appreciation go to my supervisor Dr. V. K Shenai who provided me continuous support and guidance for completing this dissertation successfully and making each class more meaningful. I felt deeply honoured and excited to get

Dr. Shenai as my supervisor. He has always been a source of inspiration and encouragement.

I also would like to render my deepest appreciation to my parents and siblings who have given me tremendous motivation in life and in completing this research study and the Masters program. I believe the best award of my work is to make them proud of myself.

I would like to thank London School of Commerce for providing us the opportunity to learn about various systems in United Kingdom(UK) via this dissertation and also making the one year Masters a very valuable and interesting one.

Finally I would like to thank all my friends and my lecturers who supported directly and indirectly in completing this dissertation.

Chapter 1: Introduction

‘Corporate Governance’ has become one of the most spoken words all over the world in the business community. It has been now established, that a country’s economy depends on the drive and efficiency of its Corporate Governance, which is the way the companies are managed. Basically Corporate Governance is a set of rules and regulations set by the regulatory bodies to force the companies to follow the correct procedures to ensure the companies remain successful and the shareholder’s investments are safe. Competitions among the firms are high and almost all the businesses are competing for the same share in the market. The ego is high in the top management and the challenge the top management have is to strike a balance between money, fame and duty.

According to Collier (2005) corporate governance is defined as ‘The system which companies are directed and controlled. Board of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the board include setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting.

This definition covers almost all the principles of the Corporate Governance. However the question stands as to whether all these principles are followed by the companies and how effective they are in managing the companies and how effective corporate governance changes the performance of those companies.

Aim of the research study

The aim of this research study is to find how the performance of the telecommunication firms is affected by the corporate governance systems followed by them. Corporate Governance scandal is becoming as a major issue as it is creating unstableness in the economy in many countries. Many companies around the world in both developed and developing markets are considering Corporate Governance as a vital factor because of the meltdown of famous organisations. The privatisation has changed the ownership structure of the organisation in the emerging markets. These organisations seek a proper governance structure to keep the internal finances & resources under control.

In the recent past there were few high profile failures in the business world. The prime examples would be Enron and WorldCom in United States & Satyam Computers in India. Most of these major corporate failures are not purely cyclical events, but also to systematic weaknesses. These corporate failures have been given wide media coverage and this has stressed the importance of Corporate Governance.

With the globalization more countries got interconnected and have started doing businesses involving capital financial resources “ The more the corporations finance themselves via global markets, the more questions of Corporate Governance become an issue of interest for those involved in Capital Markets”(Crane et al,2007). When we consider the countries in Emerging Economies, for example India there is a dynamic growth in the economy and recently there is a huge rise of the big players in the markets and lots of investments both local and overseas has been invested into the businesses. This has made the corporate governance a key.

Moreover the recent demise of one of the biggest IT Companies Satyam Computers and the fraud which has caused the fall of the multimillion dollar company has raised serious questions of the existence of the Corporate Governance and the effectiveness of it. The concern is whether Corporate Governance is being totally ignored or no strict rules are being imposed and monitored by the regulatory authorities. The above empirical research is used to critically analyse and fulfil the aim of the research study.

Objectives of the Research

The objective of this research is to analyse the existing Corporate Governance arrangement in the Telecommunication Industry in UK and how an effective Corporate Governance affects the performance. This analysis will provide an insight of the importance of Corporate Governance for the companies in general and Telecommunications companies in specific.

UK is considered as one of the countries which have the best Corporate Governance Systems. “The publication of the Cadbury report (1992) represented the first result of introspection by boards and shareholders following economic decline in the early 1990s” (Solomon et al,). Various reports have been produced by regulatory bodies at different Stages in UK to initiate & reform corporate governance in UK. Some of them were the Cadbury report 1992, Greenbury report 1995, Hampel Report 1998, the Turnbull Report 1999, the Higgs Report 2003 & The Smith Report 2003. One of the greatest frauds in United States (US) was the Robert Maxwell’s power of abuse in the 20th century. Following Major collapses of the biggest companies in US, UK and other countries brought the awareness & need for an effective Corporate Governance system. These scandals were mainly created because the power was not segregated and laid in one person’s hand or there were no independence within the management.

“The country’s economy depends on the drive and efficiency of its companies. Thus the effectiveness with which their boards discharge their responsibilities determines Britain’s competitive position” (Cadbury, 1992). According to McGregor (2000) the function of corporate governance is to rule, lead, create and maintain structure and systems and to monitor performance. How people govern depends on their beliefs, their ability to make decisions as well as their capacity to ensure effective implementation of decisions. The various Corporate Governance reports in UK are analysed and discussed to check whether the Telecommunication firms in UK are following them and having a good Corporate Governance system in place.

Relevance

“Effective corporate governance reduces “control rights” stockholders and creditors confer on managers, increasing the probability that managers invest in positive net present value projects” (Shleifer and Vishny, 1997). The performance of an organisation an increase when it is better managed. To make a relevance to the analysis various corporate governance systems are studied and theories are discussed in this dissertation.

Policy makers, theorists and practitioners consider that it is worth pursuing & taking initiatives in Corporate Governance reform. But still some believe it is not.”They consider that the many initiatives aimed at ‘improving’ corporate governance in the UK have simply slowed down decision making and added an unnecessary bureaucracy and red tape” (Solomon et al.,2004).Nevertheless there is a growing perception in the business world that good corporate governance is associated with prosperous companies. This dissertation researches various telecommunication suppliers in UK and analyses how their corporate governance has affected the organisational performance. In measuring the performance of the organisations the corporate governance is rated against the share prices, Return on Equity, Turnover of the company and net profit are considered to be very good measures.

Structure of the dissertation

In the balance chapters the brief introduction will be further analysed to find a solution for the research problem.

Chapter 2 will be covering the corporate governance theories and the empirical research to compare the existing corporate governance systems and the failures. The chapter further discusses about the various reports followed in UK corporate Governance systems.

In Chapter 3 it is discussed about the various aspects of the Telecommunication Industry in UK and how the industry has evolved over time. A brief history of the Telecommunication Industry is also covered.

Chapter 4 explains the research methodology that is used in this study and how the research is planned.

In Chapter 5 the Corporate Governance structures followed by the selected Telecom companies and the financial facts related to their performance are analysed. The summary of the analysis is listed in this chapter.

In Chapter 6 the finding from the analysis is discussed and the implication in answering the research question is also discussed. A comparison study of the existing theory and previous empirical research is also discussed in this chapter.

The Chapter 7 concludes with the evaluation of the hypothesis and the limitations of the current research. The recommendations for further work are also discussed in this chapter.

Chapter 8 covers my point of view of the topic and how I decided to select this topic, my learning results from this research study, how useful I found the guidance etc.

Chapter 2: Literature Review

2.1 Corporate Governance Theories

Development of corporate governance is a global occurrence and as such is a complex area including as its legal, cultural, ownership, and other cultural differences” (Mallin, 2005). The theories vary from country to country based on their economic status, corporate structure & ownership of the groups. The selection process also depends on whether the company is mainly concerned on the shareholder value or on the stake holder values. “The purpose of corporate governance is to persuade, induce, compel and otherwise motivate corporate managers to keep them alert when they make invests” (Macey, 2008). The corporate Managers should decide what to do and what not to do. When governing a corporation if more governance is done by social norms there will be less heavy lifting by contracts and laws.

In the countries like United Kingdom (UK) & United States of America (USA) where there is common law the ownership of the organisation is separated from the control. This provides security for shareholders’ money and encourages them to buy more shares and creates a diversified shareholder base. In the countries that follow civil law such as India & France the protection for shareholders is not efficient so there isn’t a considerable shareholder base. According to Wessel (2001) in the common law countries the legal principles are supplemented by precedent –setting case law, and provide great flexibility (Mallin,2005). But in the civil law countries the judges – who are civil servants for lifelong set legal codes with specific rules. This creates less encouragement for the investors to invest as the protection for rights is less.

A number of different theoretical frameworks have been involved to explain and analyse corporate governance. Each of these frameworks uses different terminology and view corporate governance based on different disciplines. For example agency theory paradigm arises from the field of finance & economics and transaction cost theory arises from economics and organisational theory.

According to Mallin (2005) five types of theories are applied in the real world in regards to Corporate Governance.

Agency Theory

In the Agency theory the principal delegates work to an agent and the agent handles the work. Though the agent handles the work, the principal will be monitoring and controlling the organisation and the decisions related to the organisation will be taken by the principal. In some cases the agent also should be given some power but better institutional arrangements should be followed to avoid the abuse of power and resource. Improper monitoring has created major failures in some prominent organisations in many countries worldwide.

According to this theory there should be a series of contracts between the owners and agents. When the organisation grows it needs more capital and this has to be raised from the market, hence more owners will come into the organisation. When more owners come into the picture there will be more complication hence the necessity for Corporate Governance.

Though agency theoy is a widely used method of corporate governance it is a method which is criticised much. The critics believe that agency theory doesn’t carry contractual relationships most of the time and mutual arrangements.

In Agency theory the managers (the agents) will be more interested in short run profits. “The British Telecom Industry has been notorious for short termism” (Solomon et al, 2004). The higher agency cost problems and other problems arising can be eliminated or scan be reduced if shareholder monitor the company. The Shareholders should control the AGM voting. “Voting by shareholder constitutes shareholder activism” (Solomon et al, 2004) Shareholders also have the option for diversifying things. Another way to overcome the agency problems is to have face to face meeting occasionally between representatives from investment institutions and management. “One possible solution to the agency problem is to provide senior management with incentives to pursue wealth maximising policies.”(Weir, 2001). When number of shareholders increase the agency costs will incur if poor performance is in place. The monitoring costs also increases when the number of shareholder increases.

Transaction Cost Economics Theory

This is closely related to Agency Theory and the only difference is, the Transaction Cost Economics theory views a firm as a Governance structure, whereas Agency theory views it as a nexus of contracts. In transaction theory the company management internationalise transactions as much as possible. Transaction cost theory makes the assumption of “Opportunism”.

“Opportunism has been defines as ‘self – interest seeking with guide and as the active tendency of human agent to take advantage, in any circumstances of all available means to further his own privilege (Grozier,1964). This mainly is concerned on the individual investments that are made to a certain project and identifies the characteristics. Transaction cost Economics theory has a similarity to Agency theory where the shareholders will have the power to claim their status.

Stakeholder Theory

Stakeholder theory is more substantial than the agency theory and other Corporate Governance theories. Stake holder theory considers a wider group than just shareholders. The wider group involves the employees, customers, creditors, debtors, government and local communities. “Stakeholder theory has broadened the groups to whom the firm is held accountable” (Jose et al., 2008). The shareholder values are respected in this method by efficiently using the resources of the organisation and making shareholders’ aware of it. According to Clarke (2004) as the firm-specific skills become an important part of the firm’s valuable assets, and as corporate managers are increasing it is important to adapt to stakeholder perspectives.

But however the purpose of good governance is always to increase the shareholder value. The increasing number of the relationships between customers, investors, employees and suppliers are emphasising the corporate managers need, to concern more on stakeholder theory than shareholder theory. But still there are several issues with this theory too. The problem with this theory is that the theory doesn’t clearly explain what the trade off is made against the interest of each group of stakeholders.”Strengthening minority shareholders’ rights will improve corporate monitoring only if shareholder are already well aware of their rights and duties as corporate owners so that they will exercise their new rights”(Nikomborirak, 1999) The managers are not clear and are not willing to be accountable for their actions. As there is wide group of people involved in an organisation it’s apparent that the expectations differ from person to person, hence the necessity for Corporate Governance.

Stewardship Theory

In the stewardship theory the directors will be the stewards of company assets and will be disposing the acts according to the interest of the shareholders. In this case the managers have to handle the assets prudently. This has created the necessity for Corporate Governance. The model has proved to be adaptable to prevailing changing situations. “The great flexibility of stewardship theory has led to the huge proliferation, diversity and complexity of corporate types and structures today (McGregor, 2000).

In this theory the companies are incorporated as different companies. The shareholders will be selecting the directors to act as stewards. The directors need to identify the interests of the shareholders. Though the directors have to consider the interests of the employees, customers, suppliers and other legitimate stakeholders, shareholders are their first priority.

Stewardship theory follows the legal model and provides precise boundaries for the company. But sometimes the stewardship theory doesn’t look like a suitable one in the modern environment as the shareholders appoint the directors. Most of the shareholders are away from the company operations and lack of transparency between directors and shareholders create discrepancies in the corporate governance systems. This will result in the various issues the companies are facing nowadays.

Hegemony Theory

According to Mallin (2005) in Class Hegemony theory the directors consider themselves as the elite of the company and make new appointments for directors thinking how well the appointments fit into those elite.

In the Managerial Hegemony the management controls the functions of the directors and weaken their influence.

In the empirical research the countries which follow the above theories, the success of the application of the theories will be discussed. The analysis further covers how the efficiency can be improved using the same theories more effectively. A shareholder activist group can be an option on top of the corporate governance” For example, the specific focus of the People’s Solidarity of Participatory Democracy (PSPD), a leading shareholder activist organisation that began its activism activities in late 1990’ in Korea, is to target family owned firms for reform”(Kim et al. 2007)

2.2 Results of various empirical research

The cross – country empirical research is considered as an important factor when comparing the corporate governance system in many countries and finding the most efficient one. Transparency is an essential ingredient for a sound corporate governance system. Many failures in the Corporate Governance Systems occur because the unfettered power stays with one person, the Chief Executive. Filatotchev and Wright collected material looking at the evolution of corporate governance practices over the life cycle of enterprises and institutions. It resulted how important it is to learn the knowledge at board level and manage the transitional stages (Mc Gregor, 2006) the world’s biggest corporate failures like Enron & World com represent the terrible weakness in the heart of Corporate Governance. Political influence also influences the type of corporate governance systems in different countries. According to the research carried out by La Porta (1998) the analysis in 27 countries to identify the controlling of the company.

Corporate Governance in Common Law Countries

India, China & Japan are taken as examples for the Common Law and the failures and successes in this emerging market are analysed based on the theory that is applied in their businesses. Many Asian countries have succeeded in its economy and technology during the past two decades. India and Japan are very good examples for a rapid economic growth in a short period. Many companies from USA & UK have outsourced most of their Information Technology (IT) activities in India. The strong governance of the companies has tied the countries strong. Corporate governance helps to manage the resources in an effective way and lowers the cost of capital by decreasing risk. Good corporate governance reduces the risks. The common law countries have much of a concentrated share ownership structure .

The ownership of companies in India are mostly family based businesses but has succeeded over the years. According to La Porta (1998) India has been ranked as 5th among 6 in providing shareholder rights (Chakrabarti, 2005). In terms of creditor rights, the Indian legal system also seems to provide excellent protection for Lenders, according to the La Porta, et al (1998) (Chakrabarti, 2005).According to BBC, India had a growth rate of 8.9% last year. India is also a country which has a highest rate of Foreign Direct Investments (Source: http://www.bbc.co.uk). From 1991 to 2008 India has got USD 99,005 million as Foreign Direct Investments.(Ref: http://dipp.nic.in). “The small and medium-sized enterprises (SME) sector in India has played, and continues to play an important role in India’s growth story” (Chakrabarti et al, 2005)

Corporate Governance in Civil Law Countries

The Civil law countries for example Anglo – American countries the Corporate Governance is mostly focused on shareholders. “The Anglo – American system is enforced through professional pronouncements or stock market listing requirements, whereas the Continental – Asian system is enforceable through law (Friedman et al, 2006). Stakeholder view is only a limited perspective in Civil law countries. The combined codes that are implemented in these countries explain the corporate governance structure. Sometimes though the corporate governance codes now established in every aspect of the economy in the Civil law countries the role of it is still ambivalent to most parties.

“Good corporate governance can significantly reduce the risk of nation-wide financial crisis” (Chakrabarti, 2005). In most of the emerging countries in paper they have strong corporate governance arrangements. But in reality the system is not followed properly and in an efficient way which results biggest scandals.

Corporate Governance System in Different countries.

Every country represents a unique corporate governance system though the theories are common based on the type of their legal and ownership structure. Wide range of internal factors like the economy, legal systems, government policies, culture & history presides the corporate governance systems which each country follows.

Australia

According to (Adam, 2005) Australia follows an outsider system of corporate governance same as in UK. Still the differences in the ownership structure and the shareholder involvement in companies, differentiates the systems followed in both countries. There is a higher incidence of intercompany and family ownership in Australia which hardly prevails in UK. Most of the Australian companies have non – institutional shareholder base that is controlled by the company. Australia follows a corporate governance practice from the Bosch Report (1993).

The Bosch report is closely related to the Cadbury Report. Though the agency type of Corporate governance is followed in Australia there still exists a mixed governance system involving the stakeholders. But still “The extent to which management can act opportunistically in its relationships with suppliers and customers is limited by the relative power held by each party.”( Fleming, 2003)

Canada

The Canadian Corporate governance system was described by Daniels and Waitzer (1993) in detail emphasizing how important it is to attract foreign markets and bring confidentiality for competitive foreign investors. The research carried out by their system showed that most of the large companies were not managed by large investors. Corporate ownerships are widely concentrated in Canada and one large shareholder controls more than 20% of the voting shares. The Corporate governance is considered as an important component in Canada as it will enhance the public confidence and increases equity capital. This looks like a good argument to other countries around the world to reform corporate governance.

“Corporate Governance reform in Canada was encouraged by the publication of the Day Report(1994) and by the publication of a series of Corporate Governance standards by the institutional shareholder representative group, Pensions investment Association of Canada” (Ref: http://www.piacweb.org). The Osler Hoskin’s report gives detailed guidelines of the Corporate Governance Systems in Canada ( Obal et al, 2005)

UK

“The UK, as one of the countries in the world with the greatest degree of

Dispersion in stock ownership of listed corporations” (Armour, 2008). According to Blackwell (2001) UK is generally acknowledged as the world leader in Corporate Governance reform. The publication of the various reports reinforced the corporate governance structure in UK providing guidance in various aspects of corporate governance systems. “The publication of the Cadbury report (1992) represented the first attempt to formalize corporate governance best practice in a written document and to make explicit the system of corporate governance that was implicit in many UK companies (Solomon et al,2004).

The Cadbury report (1992) defines the best practices & monitoring mechanism in implementing the corporate governance systems. The report recommends that the public firms also should follow an internal governance system that adheres to the Cadbury code. “It subsequently became a Condition of being quoted on the London Stock Exchange that companies should Include in their annual report and explanation of the ways in which the Code was being implemented (Weir et al, 2004). The institutional investors play a big part in the monitoring of the corporate governance systems in UK. The external audit and the Financial Services Authority (FSA) overseeing the accounts are making the corporate governance systems in the UK more methodical.

According to the Combined code of Corporate Governance, good governance should facilitate efficient, effective and entrepreneurial management that can deliver shareholder value over the longer term. (Ref: http://www.frc.org.uk). Along with the other reports the Combined Code is considered as the book of guidance for the Corporate Governance system in UK companies. The Combined code defines the methodologies in each sector such as financial, director remuneration, shareholder rights, disclosure & transparency etc. The Cadbury report (1992) defines the best practices & monitoring mechanism in implementing the corporate governance systems.

United States of America

United States is considered as one of the countries which have the control of a lot of countries in the world. The internal corporate governance in US is done by the board of directors who act according to the interest of the shareholders. “The board exists primarily to hire, fire, monitor, and compensate management, all with an eye towards maximizing shareholder value.”(Denis et al, 2003). The Chief Executive Officer (CEO) is considered as the head of the institution while the shareholder has the right to select the board of directors.

The management has a strong hand to select the other members in the board. The Corporate governance in US also concerns the director remuneration, the ownership structure, ownership control etc. The higher overlap between the ownership and control in the US Corporate governance systems greatly reduce the conflicts of interest and increase the firm value. According to Denis (2003) the problem with the widely – spread US corporate governance system is that as the shareholders own a very small fraction of the shares in the firms they have very little or no incentive to expend significant resources to monitor managers or seek to influence decision-making within the firm. Ownership Structure is considered as an important factor in US Corporate Governance systems as it directly affects the firm performance. Overall US private ownership structure has increased the performanc

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