CFA ESG Chapter 5 Exam Questions With Correct Answers

Corporate governance can be distilled down to what two factors, known as the two 'A's' of corporate governance? - Answer Accountability and alignment. Talk through the two 'A's' of corporate governance. - Answer Accountability: Who's on the board, who are they responsible/accountable to, and do they produce a set of accounts which are true and fair. Corp governance focuses on board structure, director independence and accurate accounts, as well as who will take responsibility. Alignment: arises from the agency problem, therefore, requires appropriate incentives and chains of accountability to ensure alignment. What has given rise to corporate governance codes? - Answer Corporate failures and scandals, where companies failed through theft or financial reports didn't reflect at all truth and fairness. What was the world's first formal corporate governance code? - Answer Emerged in the UK in 1992, The Cadbury Committee was brought together by the LSE, Financial Reporting Council, and the accounting profession following the Caparo and Polly Peck scandals. It is still considered best practice today and is incorporated globally, grown from concepts of accountability and alignment. What were the Caparo and Polly Peck scandals? - Answer Caparo tried to buy Fidelity, only to discover that their profits were massively overstated. Share price of PollyPeck had been pumped up on misleading financial reporting. What did the Cadbury Committee propose that is still around today? - Answer That every public company should have an audit committee that meet twice a year, and their core theme that no individual should have 'unfettered powers of decision', so roles of Chairman and CEO should not be combined. What UK model is followed around the world on corporate governance? Comply ... what is the issue with this? - Answer Comply or Explain. Issue is that it is voluntary at the moment, but there is a move to make this regulatory. What is the differences between a single and two tier board? - Answer Single: mix of exec and non-exec directors, in Japan exec directors are dominant, France and US there is a combined Chair and CEO, UK recommends for them to be split. Two: Wholly non-exec supervisory board that oversees the exec board, non-execs may not be independent by being large shareholders, this is adopted in Germany, Netherlands, Scandanavia, China. Is one method of corporate governance considered better? Who has set out best practice for this area? - Answer No one model of corporate governance is considered better than others. Best practices incorporated in International Corporate Governance Network (ICGN) and Organisation of Economic Co-Operation and Development (OECD). What is the Greenbury Report? - Answer UK report came out because of the shocking levels of pay at newly privatised companies, it pushed for increased visibility of renumeration structures. What is the Sarbanes-Oxley Act 2002? - Answer US act following the Enron, Tyco, and WorldCom scandals all to do with financial reporting. It created the Public Company Accounting Oversight Board (PCAOB) establishing a standard for audit independence and challenge. Which US act post the financial crisis led to greater standards and oversight of banks? - Answer The Dodd-Frank Act. Following scandals around Olympus and Toshiba, what then emerged in Japan? - Answer The Japanese Corporate Governance Code 2015, revised in 2018 on board independence. What is the definition of shareholder engagement? - Answer Shareholder engagement is the active dialogue between companies and their investors. For minority shareholders there must always be protections against exploitation by the dominant shareholders. What are the two protections? - Answer Application of class tests and pre-emption rights. What is the application of class tests? - Answer Application of class tests is if the business wants to carry out a really big transaction, which would constitute more than 25% of the value of the business then you have to put it to a vote to all of the shareholders. What are pre-emption rights? - Answer If a business wants to release more shares, they have to give their existing shareholders the right to buy these on a pro rata basis. Why do minority shareholders feel begrudged by dual shareclasses? - Answer Dual share classes are usually split where one share class is held by founders/early investors and will have more votes per share than the other share class. The LSE has stopped this, but it happens in the US. What American state is home to more than 50% of the publicly traded companies in the US? - Answer This is where the companies are incorporated, and the state is Delaware. It essentially has the most relaxed and accommodating corporate laws. How many principles and overarching themes does the UK Corporate Governance Code 2018 have? Name the themes. - Answer 18 principles and 5 themes. The themes are Board leadership and company purpose; division of responsibilities; composition, succession and evaluation; audit, risk and internal control; remuneration. What else does the code set out? - Answer The expectations and duties of the three principal board committees: Audit Committee, Nominations Committee, Remuneration Committee. What do each of the three committees do? - Answer The audit committee organises and manages the auditors. The nominations committee appoint everyone in the C suits (so like CEO, CFO, etc...), Remuneration committee sets executive pay. Who forms these committees? - Answer In the UK, the expectation is that the audit and remuneration committees will be populated solely by independent NEDs. The nominations committee will be majority independent NEDs but is different because it is good to have someone like the previous CFO in the nominations committee because they know what the job requires. What is the Guide to Board Effectiveness? - Answer It applies the same structure as the Corporate Governance Code, under the same 5 themes, but provides guidance and questions to assist board members when considering whether they are being fully effective in their roles. Of the 5 themes, which does the Guide to Board Effectiveness really focus on? What does that theme cover? - Answer The first theme, board leadership and company purpose - essentially focusing on culture, strategy and maintaining appropriate relationships with key stakeholders. What is a key type of diversity that boards need to have? why is this important? - Answer Diversity of thought. It is essential to avoid groupthink, which can lead to a lack of questioning and challenge. More diverse boards are suggested to produce greater financial returns.