ii

Contents

IV Preface

1 Introduction

2 Objectives

3 The Principles

Appendix 1: The Principles

5 Principle 1: Performance Orientation

6 Principle 2: Nomination and CompensationCommittees

8 Principle 3: Disclosure

10 Principle 4: Audit Committee

13 Principle 5: Code of Conduct

14 Principle 6: Conflicts of Interest

15 Principle 7: Environmental and Social Commitment

17 Principle 8: Conduct of the Board of Directors

21 Principle 9: Responsibilities of Investors

25 Principle 10: The Role of Directors in TurnaroundSituations

27 Appendix 2: Definitions of DirectorIndependence

32 Appendix 3: Case Study

38 References

42 Acknowledgment

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Preface

One of the root causes of the Asian financial crisiswas the failure in corporate governance. The socialcosts in terms of the resulting unemployment anddistress were severe. Consequently, there has been asurge of interest in the principles of good corporategovernance.

Asian business and other leaders wish to minimize therisk of indifferent governance in the future. Whileseveral governments and corporations have takensteps to enhance the enabling environment forcorporate governance, the financial pages of thebusiness press continue to report instances ofsignificant corporate governance shortcomings inpractice. Against this backdrop, it was felt that a set ofprinciples at the heart of good corporate governanceshould be enunciated. From our own interactions withAsian private sector corporations, we have felt theneed for specific pointers on implementing goodcorporate governance. This publication aims to serveas a guide for those who wish to embark on a programto strengthen governance practice in theirorganizations.

This booklet could also be helpful to investors, themedia, and other stakeholders in understanding theessence of good corporate governance. Knowledge ofthe key principles would enable them to distinguishbetween companies that comply superficially withgood practice standards and those that have agenuine commitment. Private sector enterprises willincreasingly discover that traditional financialperformance will be insufficient to attract investors ona sustained basis and will need to demonstrateconduct consistent with the principles of goodcorporate governance.

The Asian Development Bank expects to work withinstitutional investors, business enterprises,multilateral institutions, and bilateral agencies thatshare these beliefs and principles. From the vantagepoint of institutional investors, good corporategovernance is a key risk management tool that canhelp preserve scarce capital in ways compatible withtheir values. The winners among the Asia and Pacificprivate sector will be set apart by their use ofcorporate governance as a competitive weapon. A keytenet of good corporate governance is that companiesbe run in the long-term interest of shareholders.Companies adhering to this principle will not onlybenefit their shareholders and other stakeholders, butalso the wider economy and the environment.

Countries differ with respect to factor endowments,stage of development, the size of economies, the sizeof companies, extent of budgetary resources availablefor governance, the level of professional education,and the state of legal infrastructure. Accordingly, auniform approach to the application of the principlesmay not be feasible. Considerable adaptation of theprinciples to local conditions may be unavoidable.What is more important is that the principles beapplied in a manner that captures the essence ofsound corporate governance. The principles of goodcorporate governance are necessary, but notsufficient, conditions for economic or financialsuccess. However, the principles do not detract fromsuccess and indeed bolster the prospects for successin the marketplace. As more experience is gained andfeedback received, suitable revisions will be made infuture versions of this paper.

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Abbreviations

ADB Asian Development BankAGM annual general meetingCEO chief executive officerED executive directorEVA Economic Value Added (a trademark of

Stern Stewart & Co)ICGN International Corporate Governance Network

ICSA The Institute of Chartered Secretaries andAdministrators

NED nonexecutive directorNYSE New York Stock ExchangeROE return on equityROI return on investmentSEC Securities and Exchange Commission

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Hermes PensionsManagementwww.hermes.co.uk

Hermes Pensions Management is one of the largestpension fund managers in the City of London.Hermes is owned by the British Telecom PensionScheme, which is also its largest client. Being ownedby a pension fund gives Hermes a unique insight andclose alignment to the needs of other long-terminvestors and pension funds.

Hermes’ clients hold over 1% of the valueof nearly all of the largest 800 quoted companies onthe London Stock Exchange and also have indexand active holdings in over 2,000 public companiesworldwide, including over 100 companies innon-Japan Asia. Through its long-term holdings inindex stocks, Hermes is necessarily exposed tounderperforming assets and for this reason itplaces great emphasis on exercising its stewardshiprights in all the companies in which it invests. Asa result, it is at the forefront of the corporategovernance movement in the United Kingdom.Furthermore, it has taken these principles to the nextlevel by being the first major investment institution inthe world to have established both UK and Europeanshareholder engagement funds. After identifyingcompanies underperforming their indices, Hermes’intervention and involvement as long-termshareholders aims to release the latent value thatexists within the company.

Asian DevelopmentBankwww.adb.org

The Asian Development Bank (ADB) is a multilateraldevelopment financial institution dedicated toreducing poverty in Asia and the Pacific. Establishedin 1966, it is now owned by 61 member governments.It is rated triple-A by all the major rating agencies.ADB extends loans to eligible governments in theAsia-Pacific region and in Central Asia. In addition,ADB extends loans to, and invests equity capital in,private sector enterprises. ADB strives to promoteentrepreneurship, the quality of governance, andenvironmental and social development in itsborrowing member countries.

ADB plays a catalytic role in helping mobilize stableand responsible domestic and international capitalfrom institutional investors for investment in businessenterprises operating in its target markets. Inaddition, ADB works in partnership with its borrowingmember countries to help create an enablingenvironment for the development of the infrastructuresector, and the financial and capital markets.

1

Introduction

1. Corporate governance is a major concern in theAsia and Pacific region, especially in the aftermathof the 1997 Asian financial crisis. The size andfrequency of recent corporate governance debaclesshow that poor governance is not only a formidablehurdle to surmount but is also at the forefront ofeconomic development issues. A dilemma hasarisen from recent experience: it is possible forcompanies to appear to comply with the requisitecorporate governance rules without complying withthe principles and spirit of good governance.

2. Accordingly, it will be helpful to investors, themedia, and other stakeholders to be armed with thecorporate governance analytical principles, skills,and tools that will enable them to distinguishbetween companies that comply superficially orcosmetically, and those which have a genuinecommitment. Enterprises will increasingly discoverthat traditional financial criteria will be insufficient toattract investors and will need to demonstrateconduct consistent with the principles of goodcorporate governance.

3. Enterprises in Asia and the Pacific that genuinelyembrace, adopt, and adhere to the principles couldderive a multitude of benefits such as the availabilityand lower cost of capital, the ability to attract toptalent and business partners, greatercompetitiveness, better financial performance andmore transparency, and a more favorable impact onemployment and the environment.

4. Corporate governance usually refers to theconduct of the board of directors. Recent eventsin the Asia and Pacific region and revelationselsewhere have shown that the practice of high-quality corporate governance is indispensable forbuilding investor confidence and for sustainedgrowth. Enterprises that strive for governanceexcellence will gain a long-term advantage.A review by Colin Melvin, Director, CorporateGovernance, Hermes Pensions Management Ltd.,of the evidence for a link between corporategovernance and investment performance showsthat a key driver of corporate performance isinvestor activism. Mckinsey & Co. found that,other things being equal, investors reward well-governed companies by paying a premium fortheir shares.

5. The Asian Development Bank (ADB) hastaken a wide range of steps to improve corporategovernance in the region. ADB’s aims include thepromotion of corporate enterprises and financialinstitutions in its developing member countries tohelp accelerate economic growth and prosperity.ADB has invested in over 100 private sectorenterprises and financial institutions in the Asia andPacific region over the last 2 decades and hascoinvested with governance-conscious institutionalinvestors. This experience has provided ADB with aclose look at actual governance practices in itsinvestee enterprises that vary from the advanced tothe rudimentary. The lessons gleaned from thisexperience have helped shape a set of corporategovernance principles that have been crafted andtailored to the conditions of the region.

6. Ten core principles have been listed. An attempthas been made to model the principles in a mannerconsistent with global best practice. All the principlesare interrelated and tied by the common threads of aperformance orientation within the bounds ofacceptable conduct. Good corporate governancerequires an overriding commitment to a culture ofgovernance that permeates all aspects of boardand management conduct. The example and toneneed to be set at the top to embed good corporategovernance in an organization’s culture.

7. This paper condenses the principal attributesof good corporate governance. Each principleaddresses a particular facet of corporategovernance. These relate to key board committees,the conduct of board members and others, theenvironment, the role of directors in turnaroundsituations, and the responsibilities of investors ininfluencing corporate governance. The principlesrecognize that effective corporate governancerequires the partnership of the board withshareholders and management as well as theinterface with an array of stakeholders such asemployees, the media, creditors, and suppliers.Accordingly, some principles also encompass theconduct of shareholders and management and themanagement of the relationship with other entitiesthat have a stake in the success of an enterprise.

8. Each principle is accompanied by a commentarydescribing tips and guidelines helpful to directors

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and others who aspire to implement the principles.Detailed guidance on concepts and models can beaccessed by referring to the extensive set ofreferences listed at the end.

9. ADB expects to work with those institutionalinvestors and private enterprises that share thesebeliefs and principles. From the vantage point ofinstitutional investors, good corporate governance isa key risk management tool that helps preserve andgrow capital in ways compatible with their values.The winners in the Asia and Pacific private sectorwill be set apart by the practice of high-qualitycorporate governance as a competitive weapon.A key tenet of good corporate governance is thatcompanies be run in the long-term interest ofshareholders. Companies adhering to this principlewill not only benefit their shareholders, but also thewider economy.

Objectives

10. The objectives of the principles are to assist

(i) enterprises design and implement theirown corporate governance guidelines bybenchmarking their practices against theseprinciples;

(ii) domestic and institutional investors, fund managers,as well as ADB, in their quest for excellence in corporategovernance in investee enterprises; and

(iii) governments in designing corporate governanceregulations.

3

The Principles

Principle 1: Performance Orientation

11. The principal objective of businessenterprises is to enhance economic value for allshareholders by making the most efficient use ofresources. A company that meets this shareholdervalue creation objective will have greater internallygenerated resources, improving its prospects formeeting its environmental, community, and socialobligations; pay taxes; reward, train, and retainkey staff; and enhance employee satisfaction. Akey focus area is a company’s human capitalstrategy, which is a lead indicator of corporatesuccess.

Principle 2: Nomination and CompensationCommittees

12. A key success factor is the quality of leadershipof an enterprise. A nomination committee with awritten mandate and terms of reference consistentwith good practice may ensure the selection ofdirectors and a chief executive officer (CEO) of thehighest caliber. Comprising mainly of independentdirectors, the committee should have a writtendefinition of independence, inclusive of bothsubjective and objective criteria. A compensationcommittee should set the compensation policy fordirectors and senior management, commensuratewith performance measured against comparableindustry benchmarks and key performanceindicators such as economic value added.

Principle 3: Disclosure

13. To ensure transparency, companies’ annualreports should disclose true and fair accountinginformation prepared in accordance with applicablestandards; consider substance over form in thepresentation of accounts; disclose and discuss allmaterial risks; disclose and explain the rationale forall material estimates; show manner of compliance, orexplain deviations, if any, with applicable corporategovernance codes; discuss goals, plans, andprogress; and provide access to the register ofshareholders showing beneficial ownership. Inaddition to annual disclosures, enterprises shouldcomply with applicable continuous disclosurerequirements. Disclosures should be timely andadequate to enable investors, third party analysts, or

rating agencies to assess the quality of corporategovernance and the true financial condition of theenterprise.

Principle 4: Audit Committee

14. Audit committees with the following attributesare more effective: composed solely of independentdirectors, at least two of whom should have therequisite knowledge of accountancy, financialanalysis, and financial reporting; at least onemember should have a good understanding of thebusiness of the enterprise; have a written mandateand terms of reference; engage only independentexternal auditors who should be answerable to thecommittee; and require that a suitable system ofinternal control and risk management is embeddedinto the fabric of the company; and focus on thesubstance of underlying transactions.

Principle 5: Code of Conduct

15. All enterprises must have a written code ofbusiness conduct and establish systems to ensurethat it and all applicable laws are followed in letterand spirit.

Principle 6: Conflicts of Interest

16. Directors owe a fiduciary duty to the companythat requires them to act in the best interest of thecompany. Actual and potential conflicts of interestshould be identified, disclosed, and explained insufficient detail to enable valid judgments to bemade on their adverse impact. The persons who areconflicted should not participate in discussion anddecision of the issue in question, nor be entitled tovote on any resolution where they are conflicted.Related party contracts should be disclosed in theannual report.

Principle 7: Environmental and SocialCommitment

17. There is an inextricable relationship among theobjectives of corporate performance, socialdevelopment, and environmental protection.Enterprises, to be sustainable, will need to recognizeand effectively deal with this triad of concerns, which,at times, may conflict with each other.

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Principle 8: Conduct of the Board of Directors

18. Directors are expected to preserve and enhanceshareholder value. Their effectiveness can beenhanced if they are legally empowered, have therequisite qualifications for the board committees onwhich they sit, make the needed time commitment,given the appropriate directorship training, aresuitably compensated, receive proper notice ofmeetings, have the right to propose agenda items,consult each other privately in the absence ofmanagement and executive directors, and providedwith appropriate information to enable them toperform their monitoring role and evaluate theperformance of directors. They should be proactiveand diligent.

Principle 9: Responsibilities of Investors

19. The pursuit of good corporate governance ininvestee enterprises is a risk management tool.

Institutional investors, general partners, and fundmanagers have a fiduciary duty to actively monitorand vote on issues vital to the success ofenterprises in which they invest as guardians of thesavings entrusted to them. Enterprises will find ithelpful to communicate with them, deliver in a timelymanner true and fair disclosure reports, and removeimpediments from voting by all shareholders bytaking advantage of modern communications andfollow a one-vote for one-share policy. The fairtreatment of minority shareholders must be ensuredand large institutional investors should lead thepursuit of shareholder rights.

Principle 10: The Role of Directors inTurnaround Situations

20. Directors of troubled companies must play aproactive role in turnaround situations, but avoidpreferential treatment of creditors, or trade when thecompany is insolvent.

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Appendix 1

Principle 1: Performance Orientation

1. The principal objective of business enterprises isto enhance economic value for all shareholders bymaking the most efficient use of resources. Acompany that meets this shareholder value creationobjective will have greater internally generatedresources, improving its prospects for meeting itsenvironmental, community, and social obligations;pay taxes; reward, train, and retain key staff; andenhance employee satisfaction. A key focus area isa company’s human capital strategy, which is a leadindicator of success.

2. The pursuit of sustainable, long-term shareholdervalue is of paramount importance. Managementsshould prepare long-term goals in terms of shareholderreturn objectives as well as strategies and businessplans for review by the board. Their implementationshould be monitored by the board and compared withthe performance of competitors. If performance isanticipated to fall short of goals, early correctivemeasures should be considered by the board.

3. While shareholder return goals should be set interms of metrics that are based on standardaccounting techniques, it is critically important to setlong-term goals also in terms of economic profit asdistinct from measures based on accountingmethodologies. Popularly used metrics based onaccounting concepts are return on equity (ROE) andreturn on investment (ROI). Project investmentcriteria should be based on the net present value ofcash flow technique. Metrics using accountingmeasures are necessary but the pursuit andrecognition of economic profit must always beparamount in judging corporate success. The metriceconomic value added1–a measure of economicprofit–should be monitored and be used to make

capital allocation, investment and compensationdecisions. Economic value added (EVA) equals theexcess of returns on capital employed over theopportunity cost of debt and equity.

4. The shareholder value mandate should be tightlywoven into the fabric of a company’s managementprocedures, organization structures, budgets,incentive programs, recruitment, and corporateculture. To ensure a high degree of shareholderalignment, the same metrics that correlate to valuecreation and are monitored by the board should beused for planning, reporting, and compensation.Human capital is the resource that plays a pivotalrole in the success or failure of a corporation.Boards must evaluate and have an input in humancapital strategies through the promotion of astrategic, as opposed to a transaction orientedhuman resources department.

5. The decision to invest surplus capital in mergerscan reduce shareholder value. Boards should makesuch decisions with particular care and, if necessary,return surplus capital to shareholders, rather thandeploy it in value destroying activities. Common flawsare overpaying, or, acquiring businesses incompatiblewith the core competencies of the company.Conversely, the directors of a target company shouldbe mindful that they do not reject a good offercontrary to the interests of its general body ofshareholders. An active merger and acquisitionmarket provides an impetus to good governance.Barriers to mergers can lead to complacency amongentrenched underperforming managements andboards, leading to the suboptimal use of capital.

6. Reforms: Governments need to consider theremoval of impediments to mergers andacquisitions.

6

Principle 2: Nomination and CompensationCommittees

7. A key success factor is the quality of leadership ofan enterprise. A nomination committee with a writtenmandate and terms of reference consistent with goodpractice may ensure the selection of directors and aCEO of the highest caliber. Comprising mainly ofindependent directors, the committee should have awritten definition of independence, inclusive of bothsubjective and objective criteria. A compensationcommittee should set the compensation policy fordirectors and senior management commensuratewith performance measured against comparableindustry benchmarks and key performance indicatorssuch as economic value added.

8. The effectiveness of a nomination committee canbe enhanced with a written mandate listing itsresponsibilities.3 The main functions are:

(i) Engage the most competent directors and aCEO by adopting a process designed toproduce the desired result without bias. Ifnecessary, the committee should employ anexternal search firm.

(ii) Be responsible for succession planning.

(iii) Make recommendations to the board on theappointment and term of directors and seniorexecutives bearing in mind the need for abalance of skills on the board. Ultimately,directors should be elected by shareholders.Some observers believe that to maintainindependence, major family shareholdersof family-run firms should not be entitled tovote on the nomination of independentdirectors.

(iv) Define independence including bothsubjective and objective criteria and monitordirector independence on a regular basis.The totality of circumstances should beconsidered in determining whether a boardmember is independent. Those who haverelationships that might interfere with theexercise of independent judgment should beexcluded. Various definitions of directorindependence are given in Appendix 2.

(v) Institute a process for monitoring directorperformance. Regular performance reviews ofdirectors and of the board as a whole shouldbe made, with independent directors meetingat least once annually in the absence of otherdirectors. Director performance should bejudged relative to the goals of the enterpriseon issues they are directly responsible for.

(vi) Oversee the preparation of annual disclosurestatements that directors are required tomake.

9. Several traits are important in a director, one ofwhich is the ability to add value to the enterprise.The selection must be made on merit devoid ofpolitical considerations and influence. According toMervyn King and Geoffrey T. Bowes, “goodcorporate governance hinges upon the competenceand integrity of directors and the board.” In selectinga director, the following factors and traits ofcandidates should be considered:

(i) relevance of the candidates’ experience andknowledge to the enterprise, as well asmanagerial and leadership experience;

(ii) knowledge of the industry, investeecompany, and countries where the enterpriseconducts its business;

(iii) record of diligence, integrity, and willingnessand ability to be independent and objectiveas well as to serve actively as a director;

(iv) the frequency of absences at boardmeetings and the ability to make the timecommitment to serving on the boardconsidering his/her regular duties andmemberships of other boards and the abilityand willingness to act quickly in a crisis–ingeneral, more than three to four directorshipscould be burdensome;

(v) limited insider relationships and links withcompetitors;

(vi) a track record of success in business withfamiliarity and experience with the role of aboard member; and

7

(vii) a knowledge of relevant special issues suchas environmental issues in the case ofcompanies where such issues are ofimportance. If financial derivatives areimportant, then at least one board membermust be literate and experienced inderivatives. Younger candidates should alsobe considered if they bring new skills orideas of value to the enterprise.

10. Those who may not normally be considered inprivate sector boards are current governmentofficials or regulators or those who have beenlegally disqualified. Directors should be subject tore-election at intervals of no more than 3 years.Directors that have served for 10 years or moreshould be not be regarded as independent.

11. Compensation Committee: The compensationof directors and senior management must bealigned with the interests of shareholders. Thecompensation of directors must be commensuratewith the important responsibility that is entailed bythe strict legal duties, potential liabilities, and theneed to devote extra time and effort duringemergencies. It should reflect the heightenedresponsibilities that directors are now expected toshoulder. The committee should set thecompensation of the CEO. The performancebonus should be earned only if there is

outperformance by reference to key performanceindicators and by comparing corporateperformance with industry benchmarks. Careshould be taken to avoid interlockingcompensation committee memberships withboards of other companies. If externalcompensation consultants are used then theseshould be independent and must be selected,appointed, and be answerable to independentboard members. References for the committee arethe Principles of Best Practice on ExecutiveRemuneration published by ICGN and 20Questions Directors Should Ask about ExecutiveCompensation, available at the web site of theCanadian Institute of Chartered Accountants.

12. Reforms: Stock exchange listing rules andbanking regulations should (i) require companiesand financial institutions to have nomination andcompensation committees comprising of a majorityof independent directors; (ii) promulgate a definitionof director independence; and (iii) require disclosureof the board meeting attendance record of boardmembers and other board memberships of boardmembers. Governments should enact legislation todisqualify errant directors whose track recordshows their lack of competence in discharging theduties of directorship. An example of such legislationis the United Kingdom’s Director DisqualificationAct 1986.

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Principle 3: Disclosure

13. To ensure transparency, companies’ annualreports should disclose true and fair accountinginformation prepared in accordance with applicablestandards; consider substance over form in thepresentation of accounts; disclose and discuss allmaterial risks; disclose and explain the rationale forall material estimates; show manner of compliance,or explain deviations, if any, with applicablecorporate governance codes; discuss goals, plans,and progress; and provide access to the register ofshareholders showing beneficial ownership. Inaddition to annual disclosures, enterprises shouldcomply with applicable continuous disclosurerequirements. Disclosures should be timely andadequate to enable investors, third party analysts, orrating agencies to assess the quality of corporategovernance and the true financial condition ofthe enterprise.

(i) Disclosure of Major Risks and AccountingEstimates: Published accounts and annualreports should be required to disclose themajor risks, the major items that have beenestimated, and deviation, if any, fromapplicable accounting, auditing, andcorporate governance standards. Segmentresults should be disclosed as well as thedegree of exposure to the risk of adverseimpact from fluctuations in exchange rates,interest rates or other market prices, ifmaterial. Any information that a reasonableperson would expect, if it were generallyavailable, to have a material effect on theprice or value of securities should bedisclosed. The essence of theManagement’s Discussion and Analysis is toprovide a narrative description of thefinancial statements that conveys the contextin which they should be viewed.It should include other information aboutfinancial performance and trends and riskswith possible future consequences includingthose arising from off-balance sheetarrangements. Banks should also complywith the disclosure practices recommendedby the Bank for International Settlements(see www.bis.org);

(ii) Disclosure of Corporate GovernanceSystem: Annual reports should articulate thecompany’s corporate governance system aswell as compliance, or explain divergence,if any, with the stated system, or, applicablecorporate governance codes. The corporategovernance system and annual reports inEnglish should also be accessible on theweb site of companies that have websitessee Best Practices for Online GovernanceDisclosure, Dominic Jones, The CorporateBoard, at www.blunco.com. To allowshareholders to monitor the provision ofnonaudit services, the company shoulddisclose in its annual report and proxystatement an auditor independence policyand the fees paid by the company for eachcategory of nonaudit services;

(iii) Corporate Boards: Corporations shoulddisclose upon appointment to the board andthereafter in each annual report or proxystatement information on the identities, corecompetencies, professional or otherbackgrounds, factors affectingindependence, and overall qualifications ofboard members and nominees so as toenable investors to weigh the value they addto the company. Information on theappointment procedure should also bedisclosed annually;

(iv) The annual report and proxy statementshould also include a copy of the auditcommittee charter, contain a statement bythe audit committee that it has complied withthe duties outlined in the charter, confirmthat the audit committee pre-approvedcontracts for nonaudit services, and containa statement by the audit committee that itbelieves that the external auditor’sindependence has not been impaired by theaudit firm’s provision of permitted nonauditservices;

(v) Internal Control Report: Each annual reportshould contain an “internal control report,”which shall: (1) state the responsibility ofmanagement for establishing and maintaining

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an adequate internal control structure andprocedures for financial reporting; and (2)contain an assessment, as of the end of thecompany’s fiscal year, of the effectiveness ofthe internal control structure and proceduresof the issuer for financial reporting. Theexternal auditor shall attest, as a stand-aloneassignment, to, and report on, theassessment made by the management;

(vi) Data that should also be readily accessibleby shareholders are: identities of majorshareholders and others that control or maycontrol the company, including informationon special voting rights, shareholderagreements, the beneficial ownership ofcontrolling or large blocks of shares,significant cross-shareholding relationshipsand cross-guarantees, as well as informationon differential voting rights and related partytransactions;

(vii) Shareholders should be given sufficientinformation about any proposal involvingstrategic modifications to the core business

of a corporation, or the dilution of theshareholding or other economic interests ofexisting investors. Shareholders should begiven sufficient information about any suchproposal, sufficiently early, to allow them tomake an informed judgment and exercisetheir voting rights. For any nonintentionalmaterial selective disclosure, a companymust make prompt public disclosure, or forany intentional material selective disclosure,a company must make simultaneous publicdisclosure.

(viii) The appropriate officers of the enterprise orthe board of directors should affirm on aregular (at least annual) basis, the accuracyof the company’s financial statements andthe adequacy of its internal controls.

14. Reforms: Introduce international accountingstandards. See Report of the Disclosure andAccounting Standards Committee, Singapore andCorporate Disclosure in Annual Reports, A Guide toCurrent Requirements and Recommendations, HongKong Society of Accountants.

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Principle 4: Audit Committee

15. Audit committees with the following attributesare more effective: composed solely of independentdirectors, at least two of whom should have therequisite knowledge of accountancy, financialanalysis and financial reporting; at least onemember should have a good understanding of thebusiness of the enterprise; have a written mandateand terms of reference; engage only independentexternal auditors who should be answerable to thecommittee; require that a suitable system of internalcontrol and risk management is embedded into thefabric of the company and focus on the substance ofunderlying transactions.

16. Charter. The audit committee should havewritten terms of reference that has been approvedby the full board. The committee should beappointed by the full board. The Audit Committee4

plays a vital role in ensuring the integrity of anenterprise. It has the following four critical functions,with decisions being made by the full board:

(i) engaging, communicating with, and providingoversight of external auditors;

(ii) ensuring the adequacy and effectiveness ofa system of risk management and internalcontrols;

(iii) ensuring that there is proper disclosure ofthe accounts giving a true and fair view, andfavoring substance over form; and

(iv) communicating with internal auditors.

17. Each audit committee member should be“independent”, i.e., not receiving, other than forservice on the board, any consulting, advisory, orother compensatory fee from the company, and asnot being an affiliated person of the company, anysubsidiary thereof or be related to any person inthe company.

The following is a list of some of the practices ofeffective audit committees:

(i) Frequency: Meet with an appropriatefrequency (e.g. six times a year) and under

event-driven situations and to investigate theemergence of serious issues;

(ii) Internal and External Auditors: Review theinternal audit annual work plan and provide adirect channel of communication betweenthe external and internal auditors and theboard and assist the board in ensuring thatthe external audit is conducted in a thoroughand objective manner;

(iii) Auditor Performance: Review annually theperformance of the external auditors andthe extent of their nonaudit services, andthe value for money obtained from auditors’fees for both statutory audit work andnonaudit work;

(iv) Auditor Independence: Review, at leastannually, the auditors’ independence. Theindependent members of the committeeshould evaluate the conflicts of interest ofauditors. Factors that may help contain thisrisk are: the auditors should not be beholdento management, there should be limits onnonaudit fees, the compatibility of nonauditservices with the auditors’ independence,absence of economic interests of auditorssuch as ownership of shares in the companyto be audited that are not sold within 90 daysof the auditor’s appointment, need for therotation of audit firms and audit partners, adistance between auditors and companymanagements, absence of mutualemployment relationships between the auditfirm and the company to be audited, theappointment of auditors by the auditcommittee instead of management,limitations on nonaudit fees, broadening theuniverse of firms eligible to perform audits,and annual declarations by auditorsconfirming that they have maintained theirindependence (see the note below on auditorindependence policy);

(v) Auditor Appointment: The committee shouldrecommend the appointment andcompensation of external auditors to theboard and the shareholders and shouldconsider to competitively tender auditor

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selection, although the level of their fees neednot be the primary or sole criteria. As acondition of appointment, auditors should berequired to maintain and perform inaccordance with a quality control standard.The board should be designated as the clientof the external independent auditor;

(vi) Minutes: The minutes of the committee’smeetings should be circulated to the fullboard after each meeting;

(vii) Private Meetings: The chairman, the chiefexecutive officer, and the finance directorand other members of the seniormanagement team, together with theexternal auditors, can normally attendmeetings of the committee, except when thecommittee wishes to meet alone. Thecommittee should also confer privately withboth external and internal auditors on aregular basis;

(viii) Internal Controls: The committee shouldidentify any significant weaknesses orfailings, or a breakdown of checks andbalances, and determine whether suitableremedial action has been taken. If failingsare identified, the committee should considerwhether the findings indicate a need for moreextensive monitoring of the system ofinternal control. The committee shallestablish procedures for the “receipt,retention, and treatment of complaints”received by the issuer regarding accounting,internal controls, and auditing. Auditcommittees should certify that the companyhas adequate and effective internal controls.Best practice standards as laid down inreports such as the Turnbull Report,5 or theCommittee of Sponsoring Organizations(COSO) report, should be adhered to;

(ix) Risk Management: The committee shouldrequire the adoption and implementation ofan appropriate risk management systemand require that competent professionalsundertake risk-prone activities or productsand that they are provided with the requisitetraining and resources for performing their

tasks appropriately. If the business involvestrading or otherwise dealing in derivatives toa significant extent, at least one committeemember should have knowledge andexperience of derivatives. The risk of afunding shortfall in a defined benefit pensionscheme should be addressed. If pensionissues are significant, then a pensioncommittee should be established (seepension governance at www.watsonwyatt.com). In the case of financialinstitutions, a risk management committeeof the board should be established;

(x) Information: The information provided bymanagement and the independent auditorshould fully inform the committee aboutany financial irregularity, regulatoryinvestigations, potential liabilities and risks,and any other sensitive information thatrequires disclosure;

(xi) Compliance: The committee should ensurethat the enterprise has the systems formonitoring compliance with the Code ofBusiness Conduct, relevant laws, and the enterprise’s conflict of interest policy.It should monitor infractions and relatedremedial action. Monitoring a company’sconflicts of interest policy should be theresponsibility of the committee. Boards thatfail to establish effective corporatecompliance procedures may facesubstantial liability. Those who do may betreated more leniently by the courts.Auditors should be required to maintain allaudit or review work papers for 7 years ormore as mandated by law. Companies canadopt a corporate governance self-ratingsystem (see http://www.sec.gov.ph/sec-memo-5,s2003.pdf);

(xii) Report: The audit committee should submitan annual report to the board and itsshareholders on its activities and findings.The committee should follow-up on itsinquiries and recommendations;

(xiii) Advisors and Funding: The committeeshould have the authority to engage

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independent counsel or other advisors,as it determines necessary to carryout its duties. The company shouldprovide appropriate funding to thecommittee; and

(xiv) Audit Committee Effectiveness andPerformance: The board should evaluatethe performance of the Audit Committeeand its effectiveness using criteria such asthat in Audit Committee Effectiveness–Self-Assessment Tool designed by BradDavidson and Clarence Ebersole.

18. Auditor Independence Policy: The Council ofInstitutional Investors (http://www.cii.org/corp_govenance.asp) has recommended thefollowing auditor independence policy:

(i) An external auditor should not perform anynonaudit services for its audit clients, except:

• services that are required by statute orregulation to be performed by a company’sexternal auditor, such as attest services;and

• services related to tax return preparation,provided that such services should notinclude (a) the provision of adviceregarding the structuring or anytransaction, (b) serving as the company’sadvocate or representative in the tax auditprocess, (c) unless, however, theseservices are in connection withacquisitions or divestitures of companysubsidiaries or business, and accountingand tax services provided in connectionwith an acquisition or divestiture.

(ii) Under no circumstances should a company’sexternal auditor provide:

• nonaudit services prohibited by relevantregulation;

• financial information systems design orimplementation services;

• internal audit consulting services; or

• management consulting services.

(iii) To ensure that the provision of permittednonaudit services does not compromisethe external auditor’s independence,a company’s management and the auditcommittee of the board of directors shouldformulate an auditor independence policyand compliance should be monitored bythe board of directors. The auditcommittee’s preapproval should berequired for any contract for nonauditservices in excess of $50,000 to beentered into with the company’s externalauditor.

19. Reforms: Governments and stock exchangesin the Asia and Pacific region should ensure thatthe fiduciary duties of audit committee membersand other board members as well as those ofexternal independent auditors are embedded inthe law and in stock exchange listing rules.There should be strict rules requiring auditorindependence. Regulations for penalties andauditor and audit committee liabilities should beintroduced or clarified. Consideration should begiven to establishing a body to regulate auditfirms.

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Principle 5: Code of Conduct

20. All enterprises must have a written code ofbusiness conduct and establish systems to ensurethat it and all applicable laws are followed in letterand spirit.

21. A corporation’s business can be severelyadversely affected, and in certain cases, result inclosure and a total loss to shareholders due tomisconduct by the corporation, or its CEO, theboard, or its employees. Misconduct can takevarious forms such as mismanagement, improperaccounting and disclosure, inattention to productquality, valid customer complaints, bribery to orfrom customers, suppliers or others, andnoncompliance with laws, or noncooperation withregulatory authorities. This issue is of criticalimportance to all stakeholders, includinginstitutional investors. To show their seriousness indealing with this risk, all enterprises should have awritten code of business conduct to be posted on aweb site.

22. Guidelines codifying business conduct shouldbe succinct and sufficiently detailed to give a cleardirection to staff and board members and otherparties that deal with the corporation. A templatesetting out conduct guidelines can be accessed byreference to the King Report on CorporateGovernance.6 In addition, the techniques that canbe employed to help fashion implementable codescan be found on the web site of the Institute ofBusiness Ethics. An antifraud hotline can be usefulin identifying fraud, and in deterring unacceptableconduct and should be mandatory for listedcompanies.

23. Governments need to do their part in minimizingthe risk of misconduct. Governments and regulatorsshould set an example by conducting their ownoperations with transparency. They should createand implement:

(i) a “freedom of information” measure that makesall government actions open unless there is aspecific, agreed-upon necessity for secrecy;

(ii) “whistle blower” protection and rewardmechanism that prevents the use of legalintimidation to suppress legitimatecomplaints and reward whistle blowers;

(iii) a requirement for the declaration of assets ofall major public officials;

(iv) prohibitions against conflicts of interest ingovernment decision making; and

(v) transparent and fair procedures forgovernment contracts with private sector orother entities.

24. Developed economies should discourage and/orprohibit corrupt practices by companies incorporatedin their jurisdictions in their dealings with developingcountries. Any form of corruption, whether throughimproper paying or receiving of benefits, is not to betolerated.

25. Reforms: Stock exchange bodies and regulatorsshould require companies and financial institutionsto publicize their codes of business conduct.Governments should introduce “whistle blower”regulations with suitable safeguards.

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Principle 6: Conflicts of Interest

26. Directors owe a fiduciary duty to thecompany that requires them to act in the bestinterest of the company. Actual and potentialconflicts of interest should be identified,disclosed, and explained in sufficient detail toenable valid judgments to be made on theirimpact. Conflicted persons should not participatein discussion and decision of the issue inquestion, nor be entitled to vote on any resolutionwhere they are conflicted. Related partycontracts should be disclosed in the annualreport.

27. Importance. A major cause of corporate or bankfailure, or underperformance, is the existence ofconflicts of interest, including related party contractsand connected lending. Directors, management,supervisors, and staff should all be subject to writtenconflict of interest guidelines.

28. Fiduciary Duty. Directors, officers, andemployees owe a fiduciary duty to the company,and must therefore avoid any actual or apparentconflict of interest with the company. Conflicts canarise when: an employee, officer or director takesactions or has interests that may make it difficult toperform his or her work objectively and effectively;when an employee, officer, or director, or amember of his or her family, receives improperpersonal benefits as a result of his or her positionin the company; and when employees put pressureon underwriters, stock analysts or auditors, or, giveor receive tangible benefits or favors from themwithout disclosure and approval. Employees mustimmediately report such conduct. The CEO andboard members must report any suchcircumstances to the corporate governance or auditcommittees. Those seriously conflicted (e.g., thoserelated to competitors) should, in extremis, leave theboard and new board members should eliminatesuch conflicts before assuming board membership.

29. Process and Checks. All material conflicts andmaterial changes in them should be disclosed beforea contract is authorized to enable an independentand objective decision as to the benefit of thecontract, or arrangement, for the company. Theconflicted officials, CEO or directors should not takepart in making the decision and should absentthemselves while the matter is under discussion bythe un-conflicted parties. Management, directors,and auditors should pay special attention to suchcontracts to ensure that shareholder interest is notcompromised. Related party contracts should onlybe entered into on an arm’s-length basis.

30. Annual Report Disclosure of Related PartyTransactions. The annual report should discloserelated party transactions in accordance with thenew International Accounting Standard 24. Suchdisclosure should cover (i) the business purposeof the arrangement, (ii) identification of relatedparties and the ultimate controlling party of therelated party, (iii) how transaction prices weredetermined, (iv) a description of how any fairnessevaluations were made with respect to suchtransactions, and (v) any ongoing contractual orother commitments resulting from the arrangement.A material related party transaction should not beconcealed in an aggregate disclosure. An interestsregister should be kept.

31. Reforms. Governments should enact laws thatprohibit management, directors, and the CEO fromvoting when they are conflicted and these should bereflected in a company’s constitutive documents.Central banks should limit connected lending thathas, in the past, led to the failure of several financialinstitutions. Governments, or stock marketregulators, should pass regulations that preventanalysts from receiving compensation directly tied toinvestment banking fees, require brokers to revealtheir direct or indirect financial interest in companiesthey assess, and restrict analysts trading in theirpersonal portfolios.

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Principle 7: Environmental and SocialCommitment

32. There is an inextricable relationship amongthe objectives of corporate performance, socialdevelopment, and environmental protection.Business enterprises, to be sustainable, will needto recognize and effectively deal with this triad ofconcerns, which at times, may conflict witheach other.

33. Rationale for Major Governance Concern:Environmental and social issues, including laborpractices, are major board concerns due to (i) therequirement to institute environment best practicesby providers of debt and equity such as institutionalinvestors, multilateral development banks, andothers; (ii) the impact on public opinion andcorporate image; (iii) the need to enhance anenterprise’s competitive position; and (iv) theenforcement of criminal and civil penalties thatimpose liability upon directors for offensescommitted by the enterprise. An effectiveenvironment management system (EMS) serves asa key due diligence defense against enforcementand penalties and may help secure director’s andofficer’s liability insurance.

34. Commitment to Environmental Excellence:Boards of directors of enterprises need to make acommitment to excellence in environmentalgovernance and set the tone from the top.Environmental consciousness has now reached astage where denial of, or inattention to,environmental issues can be detrimental to long-term corporate profitability, competitiveness, andsustainability. Accordingly, good boards aligncorporate governance with environmental goals. Areference for directors on sustainable developmentis Value, Growth and Success–How Sustainable isyour Business: A Briefing Note For Directors,7

available at: http://www.defra.gov.uk/environment/acbe/pubs/pdf/directors.pdf.

35. Board Composition and Orientation Program:Depending on the seriousness of the link betweenenvironmental issues and corporate sustainability,boards should include at least one member who issufficiently experienced in environmental matters. In

such cases boards should also consider establishing asubcommittee dealing exclusively with environmentalissues and the management of environmental risksand provide an orientation program to all boardmembers on the methods to recognize and mitigateenvironmental and social risks.

36. Environmental Management System: Boardsshould require an effective EMS, with the followingcharacteristics and checks and balances:

(i) a clearly defined set of responsibilities withthe expectation of a proactive approach fromall links in the chain of command;

(ii) a management information system thatenables the appropriate monitoring ofperformance versus plan and compliancerequirements and identification of earlywarning signals to ensure a proactive timelyresponse;

(iii) training that diffuses environmentalknowledge throughout the organization;

(iv) the ability to anticipate changes in, andcompliance with, environmental regulations,ensure compliance with environmentalcovenants in loan agreements andcompliance with company policies andprocedures and benchmark them againstappropriate ISO standards;

(v) monitoring and acting on environmentalpolicies of suppliers, favoring those thatemploy sound environment policies;

(vi) monitoring the views and preferences ofcustomers and stakeholders and acting onenvironmental implications of productssold, and making changes in productdesign and manufacturing processes overthe life cycle of a product that isenvironment-friendly;

(vii) monitoring environmental costs–armed withenvironmental costs, enterprises can makestrategic choices such as continuing ordiscontinuing products; knowing the full

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costs of production and processes will helpminimize compliance costs, reduce operatingcosts, and relate the enterprise’senvironmental and financial goals;

(viii) instituting a multidimensional performancemeasurement system for employees, whichrewards gains made due to value-addedenvironmental ideas and performancewhere environmental performance is trulyimportant. Evaluations and rewards shouldhighlight such contributions; and

(ix) instituting an environment audit programincluding independent review for reportingto management and the board ofdirectors.

37. The guidelines of the International LabourOrganisation on labor practices should be accessed.ADB’s environmental guidelines are helpful resourcesfor the management of environmental issues.

38. There may be instances where a project, suchas a road or a power generation project, shouldproceed for the greater benefit of society, in spite ofits potential adverse effects on some people. In suchcases, the people who may be adversely affected bythe project should be consulted; compensated fortheir losses; and assisted to rebuild their homes andcommunities, reestablish their enterprises, anddevelop their potential as productive members ofsociety at a level generally at least equivalent to thatwhich was likely to have prevailed in the absence ofthe project.

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Principle 8: Conduct of the Board of Directors

39. Directors are expected to preserve and enhanceshareholder value. Their effectiveness can beenhanced if they are: legally empowered, have therequisite qualifications for the board committees onwhich they sit, make the needed time commitment,given the appropriate directorship training, suitablycompensated, receive proper notice of meetings,have the right to propose agenda items, consulteach other privately in the absence of managementand executive directors, and be provided withappropriate information to enable them to performtheir monitoring role and evaluate the performanceof the directors. They should be proactive anddiligent.

40. Value Addition: The primary duty of a board isto add to shareholder value by selecting acompetent CEO, assisting the CEO, and evaluatingthe CEO’s performance. Board members shouldmaintain a cooperative and collegial atmosphere,bring their skills to bear on the issues at hand,share ideas to enhance performance, and bringtheir network of contacts for the benefit of theenterprise. The board should let the CEO and themanagement run the enterprise. However, in crisissituations, or serious underperformance, director’sduties may call for a more proactive, hands-on,approach.

41. The Role of the Chairman: Sir Adrian Cadbury,in his book, Corporate Governance andChairmanship, points out that:

“It is the chairman’s task to turn a group ofcapable individuals into an effective board team.This demands application and an understandingof the nature and motivations, and strengths andweaknesses, of all members of the board. Itmeans spending time with each director toappreciate how they see their roles as boardmembers and in turn assisting them tocontribute as incisively as possible to the workof the board. The object is to enable boardmembers to work together as a team, in orderthat they may achieve as a group what would bebeyond them separately. This requires a talentfor listening, for leading, and for inspiring, andthe time to do so.

All this is particularly true of a unitary board.Its potential advantages are its singleness ofpurpose and its capacity to integrate insideknowledge and outside experience in theservice of an enterprise. Turning that potentialinto reality is the job of the chairman. Chairmenhave to win agreement on the purpose of theirboards and on how executive and outsidedirectors can best work together in pursuit ofthat purpose. Members of an effective boardwork together as a team, but retain theirindependence of judgment, they also balancetheir loyalties to each other and to the board.These are some of the tensions at work withina board and without the right degree of tensionboards would be too comfortable andcomplacent to do their job. It is for chairmen tomanage these tensions constructively. Therehas to be a balance on a board betweenindividuality and collegiality, and betweencontinuity and change. It is chairmen who areresponsible for finding these crucial points ofbalance.”

42. Board Structure: Some observers are of theview that, in private sector businesses, it isuseful to separate the positions of the chairmanand the CEO. The board should not be dominatedby one person. The quality of a board is enhancedif at least half of the board members areindependent of management. The board must not beunwieldy–a maximum of 11 members may beappropriate.

43. Director Orientation: Before accepting a boardmembership, directors should acquaint themselveswith the history of the company, the annual reportsof previous years, the minutes of previous boardmeetings, and any significant pending litigation. Thedirectors must acquaint themselves with thestrengths, weaknesses, and strategy of thecompany. The company should provide directorswith an orientation program with a “helicopter” viewand introduce directors to key personnel andshareholders. Directors should keep abreast of goodcorporate governance practices.

44. Time Commitment: Board members should limittheir board memberships consistent with their abilityto discharge their responsibilities diligently. Risks of

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incurring director liability may rise when the numberof board memberships increase beyond this level.

45. Governance Manual: The manual shouldcontain (i) the detailed responsibilities of boardmembers, which should be made available to themand be accessible to shareholders; (ii) a formalCharter of Expectations that each director should beexpected to sign and be committed to; (iii) the list ofmatters reserved for the discretion of the board;(iv) the list of disclosures to be made by directors;(v) the requirement to include a statement bydirectors confirming the truth and fairness of thecompany’s financial statements and the contents ofprospectuses; and (vi) the list of fines and otherconsequences if directors violate, or omit to carryout their duties, under applicable law.

46. Director Guides: Directors will find guidessuch as those prepared by the UK’s Institute ofDirectors, the National Association of CorporateDirectors (NACD) and The Canadian Institute ofChartered Accountants (CICA) helpful in dischargingtheir responsibilities. Each CICA guide includes alist of 20 questions that directors should raise (seewww.http://www.cica.ca/index.cfm/ci_id/14543/la_id/1.htm). See also Board Role in Risk Management,Mark Anson & Cindy Ma at www.nera.com and TenCommandments for Bank Directors, T.K. Kerstetter.

47. Consultation with other Board Members/Shareholders: Where warranted, particularly oncontentious resolutions, the directors should discusskey issues, in advance, with other board membersor shareholders.

48. Voting: Directors should vote in accordancewith their independent judgment. If directorsanticipate that they will be in a minority on animportant issue, they should insist that a minorityopinion is minuted.

49. Dissent: While directors should aim at building acordial working relationship with each other andmanagement, directors are entitled to dissent onimportant matters. To be effective, dissent should bein writing stating the reasons and require that thetext of the written submission be made a part of theminutes. If dissent is intended, other directorsshould be consulted and informed in advance, if

possible, to avoid the element of surprise and tocontribute to a sense of teamwork.

50. Recusal in Cases of Conflict of Interest: Adirector must always act with independence,objectivity, impartiality, and be free of bias. Where adirector is conflicted on a particular resolution, he/she should disclose the conflict and recuse himself/herself (i.e., not participate in the discussions) andoffer to exit the boardroom when the concernedmatter is under discussion.

51. Minutes: Directors should require the minutesof board meetings to be sent to all directors withinthree business days of a meeting and submit theircomments or approval. The minutes should state thereasons for the decisions taken. Tape-recordedproceedings may help in ensuring the accuracy ofminutes. Minutes are legal documents and shouldbe retained.

52. Monitoring Role: A key role of directors ismonitoring the performance of the company and theCEO and to seek remedial action as needed. Not alldata or information is critical to the success of anenterprise. Directors must be able to distinguishbetween information that is, or is not, vital forsuccess. The main focus should be on the keyperformance indicators, the lead indicators, the mainvalue drivers of the business, as well as earlywarning signals. Corrective action needs to beinitiated if performance falls behind plan.

53. A monitoring tool that directors can use is a“dashboard” (see Does Your Board Havean Effective Management System of Its Own,by Carolyn Brancato, The Conference Board).A dashboard is a visual display of indicatorsconsidered to be the key information that should bemonitored. The dashboard should report the keyperformance indicators. These are a few indicators,like those found on the dashboard of a car, whichhelp determine if a company is on track in meetingits goals. The indicators can be financial, such asprofit margins and return on equity, as well asnonfinancial such as customer satisfaction, qualitycontrol, staff departures, environmental compliance,the results of regulatory inspections, and actiontaken to comply with deficiencies noted byregulators. The information should be presented in

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an easy-to-understand format by using tables,charts, graphs, or other diagrams. A high-qualitydashboard monitoring system improves the board’sefficiency and time management.

54. Each measure should have a “target” and an“actual” amount that focuses attention on whichareas are performing and which need attention. By“drilling down” into the numbers used to compileeach major statistic, the data can also be used toidentify early warning signals. Performance shouldbe judged relative to that of overall industry andcompetitor performance. In the case of funds andinvestment trusts, performance should be judgedrelative to other funds with similar investmentobjectives and risk tolerance thresholds.

55. A key lead indicator is the quality of humancapital. Directors need to evaluate human capitalstrategies of corporations. The consultancy firmWatson Wyatt’s2 research shows that–“superiorhuman resource practices are correlated withfinancial returns. They are a leading indicator ofincreased shareholder value. Further, we found thatsuperior human resource management leads financialperformance to a much greater extent than financialoutcomes lead good human resource practices. Wewere also able to identify certain HR practices asvalue drivers and throw a cautionary flag in front ofsome conventional practices actually associated witha decrease in financial performance.”

56. Director Liability: Directors must carry out theirfunctions with reasonable skill, care and diligence andmay be liable if they are negligent. To minimize, oravoid, liability, directors should undergo professionaldirector training; take decisions in conformity with thebusiness judgment rule; follow procedures thatensure compliance with their duty of care and duty ofloyalty; ensure that suitable director’s and officer’sliability insurance is in place; and seek legal advice.A higher standard of care is required of a director whohas particular or professional qualifications in relationto matters where those skills or qualifications haveparticular relevance.

Companies often nominate their employees asnominee directors of subsidiary, or affiliated,companies. Such nominee directors may expose thecompanies that have nominated them to vicarious

liability, if actions that constitute breaches ofdirector’s duties by nominees are authorized by theiremployer. To contain this risk, nominators shouldseek legal advice to prevent the occurence of suchimplicit liabilities.

Directors should ensure that adequate systems existto enable the timely and accurate submission ofreports and returns required by law, regulators andgovernment agencies. A similar system should existto ensure that appropriate and timely action is takento rectify deficiencies identified by regulators.

It will be helpful for directors to familiarizethemselves with the tips contained in PersonalLiabilities of a Company Director at http://www.elbornes.com/articles/persliab.htm and in,Flunking the Duty of Care, The Four Most CommonMistakes Made by Directors, Michael F. Sullivan,Brickler & Eckler LLP.8 In summary the latter articlestates the following:

“Directors can minimize the risk of a bad decisionresulting in a successful claim for breach of dutyof care by taking the following steps:

(i) document contemporaneously the analysisthat goes into decisions and therecommendations made to the board;

(ii) maintain a record which shows that theboard was familiar with the experiences of itsexperts prior to their retention, and selectand retain in a manner that will precludereceiving advice tainted by conflict ofinterest;

(iii) take enough time to assemble and analyzedata before making a decision to show boththe reality and the appearance of due care toa third party who may not have access to thesame kind of high-tech resources as theboard; and

(iv) consider cost-effective alternatives to obtainadditional insight and liability protection whenfacing an important decision.

With these guidelines in mind, duty of care litigationmay be nipped in the bud, as plaintiffs discover that

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they will be attacking a documented record ofattention to, and concern for, the corporation’sinterest.”

57. Director’s Liabilities for Unpaid Taxes.According to David J. Rotfleisch:

“Directors have liabilities under various statutes,which, for example, result in liability for wages andvacation pay, environmental liabilities, workplaceliabilities and liabilities under corporate statutes.However, it is with respect to amounts owing tothe government for various taxes that mostdirectors incur liability. Taxing authorities havebeen very zealous in recent years in going afterdirectors for unremitted source deductions, unpaidsales taxes, etc. Accordingly, every directorshould:

(i) familiarize himself with the withholding andremittance requirements;

(ii) ensure that an appropriate system towithhold and remit has been implemented bythe Corporation; and

(iii) require regular written reporting ensuring thatthe remittance procedures are functioning.”

58. Fees and Compensation: Directors are expectedto perform an important task requiring both expertiseand a substantial commitment of time. They shouldbe adequately compensated for this. To align directorand shareholder interests, part of the compensationof directors can be in the form of the company’sequity shares. In addition, directors should have theright to engage consultants or advisors whose feesshould be paid by the company. Expenses fordirector’s and officer’s insurance and for attendingboard meetings should be borne by the company.

59. Performance Evaluation: Good boards evaluatethe performance of board members. Such boardsfind that meetings are run more smoothly, theyreceive better information, and they pay moreattention to performance and strategy.

60. Reforms: Governments in the region shouldimpose fiduciary duties on directors, liabilities for notperforming the duties, and immunity in case ofcompliance with the business judgment rule.

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Principle 9: Responsibilities of Investors

61. The pursuit of good corporate governance ininvestee enterprises is a risk management tool.Institutional investors, general partners, and fundmanagers have a fiduciary duty to actively monitorand vote on issues vital to the success ofenterprises in which they invest as guardians of thesavings entrusted to them. Enterprises will find ithelpful to communicate with them, deliver in atimely manner true and fair disclosure reports, andremove impediments from voting by all shareholdersby taking advantage of modern communications andfollow a one-vote for one-share policy. The fairtreatment of minority shareholders must be ensuredand large institutional investors should lead thepursuit of shareholder rights.

62. As the largest sources of debt and equitycapital, institutional investors can influence thebehavior of managements and boards. Investorsshould use this ability to require high-qualitycorporate governance. This is a seriousresponsibility since it is in the interest of the millionsof savers, on whose behalf institutional investorsprovide stewardship. Dispersed ownership can helpif investors exercise their rights, but passivity thelack of objectivity, and conflicts of interest amonginstitutional investors can often mean that under-performance can remain unchecked.

The low percentage of votes cast is indicative of thedormancy of the voting power of shareholders.Voting rights are part of a share’s value andexercising these rights contributes to good corporategovernance. 3 to 4 weeks notice should be givenfor shareholders meetings (see A Guide to BestPractice for Annual General Meetings, ICSA).Shareholders should have equal access toinformation, be able to vote in person, or online,or in abstention, and equal effect should be given tovotes, whether cast in person, or, in abstention.

63. A good model of the conduct of responsibleinvestors can be found in reports such as“Shareholder or Shareowner” available at the website of Hermes Pensions Management Ltd. atwww.hermes.co.uk (see case study on HermesInvestment Management Ltd. in Appendix 3), theHermes’ Code of Conduct In Support of

Companies, and the pronouncements of theInternational Corporate Governance Network(www.icgn.org). Institutional investors can take thefollowing steps:

(i) seek the removal of impediments to costeffective and efficient voting as outlined inthe Global Share Voting Principles of theInternational Corporate GovernanceNetwork (see www.icgn.org). Legalrestrictions on the transfer of shares shouldbe sought to be removed;

(ii) vote on all material issues including theappointment of directors. Each directorshould stand for election on a regularbasis and, in any event, at least once every3 years and shareholders should be entitledto exercise their vote in respect of theelection of each individual director;

(iii) require prior shareholder approval for majorstrategic modifications to the core businessof a corporation, or proposals that result inthe dilution of equity, or erode the economicinterests or share ownership rights ofexisting shareholders;

(iv) engage corporate governance analysts wellversed in the best practices of corporategovernance and financial analysis;

(v) communicate their views on corporategovernance shortcomings to the boards ofinvestee enterprises;

(vi) encourage corporate governance ratings;

(vii) require the inclusion of corporategovernance covenants and conditionsprecedent in loan or investment agreements;

(viii) avoid investing in instruments such asglobal depository receipts if the investor isdenied voting rights of the underlying shares;

(ix) adopt suitable criteria to screen investeeenterprises for underperformance; and

(x) be vigilant about investee underperformance,reporting delays, poor quality accounting, or

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other red flags or early warning signals ofcorporate underperformance. In such casesinvestors should initiate steps to requireprompt remedial action.

64. To undertake the aforementioned steps,responsible institutional investors can find thefollowing helpful:

(i) enunciate their corporate governanceguidelines and principles;

(ii) join associations of institutional investorsthat champion the rights of shareholders andcorporate governance;

(iii) adhere to, and require third party fundmanagers to adhere to, codes of conductsuch as that of the Association ofInvestment Management and Research(see www.aimr.org);

(iv) engage high caliber investment, accounting,and corporate governance professionals withsuitable delegated authority;

(v) provide a suitable budget for monitoringinvestee companies and allocate staff ordelegate monitoring to a qualified,unconflicted, and trustworthy third party;

(vi) request investee companies to nominate oneindependent director as principal liaison withinvestors;

(vii) due to the different nature ofunderperforming companies, have a policyfor engaging underperforming enterprises–aseparate monitoring group for such investeesmay be considered;

(viii) investigate who the responsible parties areand whether proper disclosure was made incases where investor capital is put at unduerisk in instances of intentionalmisrepresentation, fraud, aiding, andabetting by third parties and negligence byfund managers or other violations of theirfiduciary duties; or where companies areunable to repay bond obligations, or have

underperformed due to financial shenanigans.If warranted, file claims10 to recoverinvestment monies and damages against theerrant parties, including auditors, investmentbankers, or external counsel, if they havebeen negligent, subject to conflicts of interest,or have aided and abetted the errantcompany, its directors, or managers;

(ix) appoint a lead investor to act on behalf of agroup of investors to lessen monitoringcosts. In class action suits triggered bycorporate fraud, institutional investors shouldbe prepared to act as lead plaintiffs giventhe relatively large size of their holdings andthe associated losses. The prestige ofinstitutional investors that act as leadplaintiffs gives them the clout necessary forthe defendants to pay meaningful amounts.The lead plaintiffs are more likely to have thehuman capital, the budgetary resources, andlegal departments to support litigation;

(x) consider nominating a qualified andindependent nominee director as achampion of good corporate governance inunderperforming enterprises;

(xi) require internal and external fund managersto include the quality of corporategovernance as part of their investmentcriteria;

(xii) consider subscribing to external investmentresearch services that are completelyindependent from investment banks andcompanies;

(xiii) consider investing in corporate governance-oriented funds;

(xiv) communicate closely with other institutionalinvestors on corporate governance matters;

(xv) proactively vote, or require fund managers tovote, on key issues at company annual orextraordinary general meetings;

(xvi) all investors should be required to abideby best practice standards of valuing

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investments. Reference can be made tosuch as those enunciated by the Associationof Investment Management and Research(see www.aimr.com) and the EuropeanVenture Capital Association(see www.evca.com); and

(xvii) train staff in good practices of corporategovernance, analyzing and detectingcorporate governance weaknesses, rights ofshareholders, and in uncovering financialshenanigans.

65. For institutional investors to discharge theseresponsibilities, they should be run by qualifiedprofessionals without interference from otherquarters; follow a systematic investment processrequiring appropriate due diligence; have a policy forthe retention of records, including e-mails; and adoptgood practices of governance and management oftheir own internal operations. These relate to:

(i) the composition, qualifications,compensation, and experience of theirboards and trustees and the process forselecting them;

(ii) quality of the CEO and the selectionprocess, internal risk management systems,and portfolio management policies;

(iii) conflict of interest policies;

(iv) fund performance evaluation criteria; and

(v) the criteria and procedures for engaging andremoving fund managers.

66. Good practices for the governance ofinstitutional investors can be found in (i) TheGovernance Practices of Institutional Investors,Report of the Canadian Standing Senate Committeeon Banking, Trade and Commerce, chaired by TheHonourable Michael Kirby; and (ii) InstitutionalInvestment in the United Kingdom–A Reviewprepared under the chairmanship of Paul Myners.Mr. Myners mentions that it is helpful to state somebasic principles of an effective approach toinvestment decision making, which are listed in onlytwo pages. “The Review’s proposition is not that any

fund should be required to comply with them; simplythat where a fund chooses not to comply with them,it should have to explain–publicly, and to itsmembers–why not.”

67. Consistent with their fiduciary obligations to theirlimited partners, the general partners and fundmanagers of venture capital, buyout and otherprivate equity funds, mutual funds, and investmenttrusts should use appropriate efforts to encouragethe companies in which they invest to adopt long-term corporate governance provisions that areconsistent with the principles outlined herein orin other comparable governance standards.Fund managers should disclose their votingpractices.

68. Reforms. In developing countries, where capitalmarkets are at a nascent stage and institutionalinvestors are developing, the positive influence thatsignificant investors can exert on corporategovernance could be absent. Governments shouldtherefore foster capital market development, notonly as a way to mobilize savings, but also toempower shareholders who can demand goodcorporate governance in investee enterprises.The following are some areas to be considered:

(i) Enable electronic communication betweencompanies and shareholders including thetransmission of annual reports and notices ofshareholder meetings, electronic proxyvoting, and web-casting of shareholdermeetings.

(ii) Strengthen laws relating to minorityshareholder rights including, among others,providing for low thresholds forrequisitioning shareholder meetings; highthresholds for passing shareholderresolutions on critical issues; voting ondirector appointments using the cumulativevoting technique that enables minorityshareholders to gain seats on the board;rights of shareholders to sponsorresolutions at shareholder meetings orconvene extraordinary meetings; and classaction suits and shareholder derivativeactions that enable legal actions byshareholders on behalf of companies

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and actions against auditors fornegligence. In the case of takeover bids,shareholders should have the right to beconsulted and bids should not be rejectedby boards without reference toshareholders.

(iii) Impose a statutory fiduciary duty on thetrustees, boards, and managements ofinstitutional investors.

(iv) Remove, or prohibit, undue restrictions onthe transfer of shares.

(v) Shift from a regime of asset allocation set inlaw to a regime that provides freedom toprofessional trustees in making asset

allocation decisions based on the “prudentexpert principle.” Such a shift should notoccur in isolation but should go hand in handwith the enunciation and implementation ofhigh-quality internal governance standards ofinstitutional investors.

69. The “prudent expert principle” is defined as(i) discharging duties with the care, skill, prudence,and diligence that a prudent person acting in a likecapacity with the same resources and familiar withlike matters exercises in the conduct of anenterprise of like character and like aims;(ii) diversifying the holdings of each fund to minimizethe risk of loss and maximize the rate of return; and(iii) discharging duties solely in the interest of, andfor the benefit of, the beneficiaries.

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Principle 10: The Role of Directors inTurnaround Situations

70. Directors of troubled companies must play aproactive role in turnaround situations, but avoidpreferential treatment of creditors, or trade when thecompany is insolvent.

71. According to Ed Marks, President of MarksConsulting Inc.9

“A director’s role in a troubled company is verydifferent from that of a director of a healthy business.The increased emphasis on directors assuminglarger roles in managing a company’s affairs meansthat their responsibilities and time commitments mustalso increase. Troubled companies require deeperinvolvement from their boards and the assumption ofsome risk by directors.

Director involvement begins with meeting manyof the major parties impacted by a troubledcompany and understanding their concerns.Outside turnaround consultants can helpdirectors in analyzing and developing aturnaround plan, especially if the board andcompany management have limited turnaroundexperience or have damaged their credibilitywith lenders and other constituents.

Developing, managing and monitoring aturnaround are ultimately the fiduciaryresponsibility of the board. Failing to perform thesefunctions conscientiously may leave boards anddirectors more vulnerable to lawsuits and mayeven reduce the protections of director’s andofficer’s insurance.

A director of a troubled business bestdemonstrates his or her commitment to theorganization by taking an active role in thecompany. Attending only quarterly directors’meetings is wholly inadequate in turnaroundsituations. Frequent informal meetings withmanagement, including attendance at importantstaff meetings, should augment formal directors’meetings. Generally, involvement by directorsbolsters confidence of management and staff thatsomething is being done to right the business.Understanding relationships among the major

constituents in a turnaround is a director’s firststep. Most turnarounds cannot succeed solely byrestructuring lender debt. Other majorconstituents that must be addressed in varyingdegrees by directors are suppliers, customers,employees and shareholders.”

72. Some legal regimes impose special rules on theconduct of the business of a company when it isexperiencing financial difficulties that may lead toliquidation. In these circumstances, it may be unfairand/or unlawful for a company to favor certainsuppliers or customers and to pay some debtsahead of others. Further, directors may also incurpersonal liability to creditors if they permit acompany to continue to carry on business while it isinsolvent. Directors should seek legal advice at thefirst sign of serious financial difficulty. According tothe Principles of Corporate Governance in TheCommonwealth:

“The board must ensure annually that thecorporation will continue as a going concern forits next fiscal year. The intent behind thisprinciple is not that a corporation continues inperpetuity but to have a process in place whichwill prompt directors to act expeditiously when itis believed that the business may no longer be agoing concern.

It is the responsibility of the board, all thingsbeing equal at the time the financial statementsand annual audit have been completed andreviewed, to satisfy itself that the corporation willcontinue as a going concern in its next fiscalyear. Any conclusion arrived at by the board thatthe corporation will continue as a going concernshould result from the evaluation by the board ofobjective criteria. The conclusion should bereported in the financial statements for thebenefit of the shareholders, but also becommunicated as appropriate to thecorporation’s other relevant stakeholders.”

73. In some jurisdictions, directors also owe afiduciary duty to creditors when a company entersthe “vicinity of insolvency.” In such situations thefiduciary duty may shift in favor of creditors. Theboard of directors of a solvent corporation shouldconsider creditors’ interests if a proposed

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transaction could potentially push the corporation tothe brink of insolvency. While the advice of counselshould be sought, the following do’s and don’ts canbe helpful:

(i) act to protect creditor’s interests;

(ii) install an early warning system, includingmonitoring bankruptcy and liquidity tests,and ensure early corrective action;

(iii) require a contingency plan for major riskfactors, an effective internal controlsystem, and the proper maintenance ofrecords;

(iv) take decisions that satisfy the BusinessJudgment Rule–this may involve(a) disclosure of financial difficulties in theannual report; (b) viewing assets as a trustfund to be preserved for creditors and otherconstituents; (c) conserving operating costsand cash flow; and (d) maximizing assets,minimizing liabilities, and preserving wealth-generating capacity;

(v) avoid repurchase or redemption of shares, orpayment of dividends, if such payments will

lead to bankruptcy, or are impermissibleunder loan covenants;

(vi) avoid related party contracts and carefullyscrutinize payments to affiliates and relatedparties; and

(vii) avoid the preferential treatment of one, or agroup, of creditors as against others.

74. Experience has shown that directors offinancially troubled enterprises are particularlyvulnerable and, if they have not taken theappropriate steps, run the risk of being disqualifiedfrom performing the role of a director in the future. Ahandy reference is Crisis Management for Directorsavailable at the web site of the Canadian Institute ofChartered Accountants.

75. Directors should ensure that companiesdischarge their binding obligations to employeepension funds and, in the case of defined benefitschemes, seek compliance with statutory minimumfunding rules.

76. Reforms: Governments should enact laws tomodernize bankruptcy procedures and provide forthe protection of creditor rights.

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A. Hermes Investment Management Ltd1. Hermes endorses the Cadbury Committee’sdefinition of independence: that nonexecutivedirectors “should be independent of managementand free from any business or other relationship thatcould materially interfere with the exercise ofindependent judgment.”

2. Hermes will interpret this to mean that to beconsidered independent a NED must not:

- be or have been an employee of the company

- serve as a director for more than 10 years orbe over 70 years of age

- represent significant shareholders or othersingle interest groups ( e.g., supplier, creditor)

- receive an income from the company otherthan NED fees

- participate in the company’s share option orperformance-related remuneration schemes

- have conflicting or cross-directorships

- have any other significant financial or personaltie to the company or its management whichcould interfere with the director’s loyalty toshareholders.

B. National Association of Pension Funds(NAPF) and the Association of BritishInsurers (ABI)3. The issue of a nonexecutive director’sindependence has been highlighted by theHampel Committee and a company’s viewpointon an individual’s status is likely to be challengedfrom time to time. The ABI and the NAPFsuggest the criteria set out below as theminimum likely acceptable to institutionalinvestors. The assumption is that the individual isindependent unless, in relation to the Company,the director:

- was formerly an executive;

- is, or has been paid by the Company in anycapacity other than as a nonexecutivedirector;

- represents a trading partner or is connected toa company or partnership (or was prior toretirement), which does business with theCompany;

- has been a nonexecutive director for nineyears - i.e., three 3-year terms;

- is closely related to an executive director;

- has been awarded share options,performance-related pay, or is a member ofthe Company’s pension fund;

- represents a controlling or significantshareholder;

- is a new appointee selected other than by aformal process;

- has cross-directorships with any executivedirector; or

- is deemed by the Company, for whateverreason(s), not to be independent.

C. Federal Deposit Insurance Corporation4. “Independent of management” is generally adetermination each institution may make. This termabsolutely excludes a director who

(i) is, or has been within the preceding year, anofficer or employee of the institution or itsaffiliates;

(ii) owns or controls, or has owned or controlledwithin the preceding year, assetsrepresenting 10% or more of any outstandingclass of the institution’s voting securities;and

Appendix 2Definitions of DirectorIndependence

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(iii) beyond this, the institution should considerwhether the director

• has been, prior to the preceding year, anofficer, or employee of the institution or itsaffiliates;

• serves as a consultant, adviser, promoter,underwriter, legal counsel, or trustee of orto the institution or its affiliates;

• is a relative of an officer or other employeeof the institution or its affiliates;

• holds or controls, or has held or controlled,a direct or indirect financial interest in theinstitution or its affiliates; and

• has outstanding extensions of credit fromthe institution or its affiliates.

D. California Public Employees RetirementSystem (CalPERS)5. “Independent director” means a director who:

(i) has not been employed by the company inan executive capacity within the last 5 years;

(ii) is not affiliated with a company–that is, anadviser or consultant to the company or amember of the company’s seniormanagement;

(iii) is not affiliated with a significant customer orsupplier of the company;

(iv) has no personal services contract(s) with thecompany, or a member of the company’ssenior management;

(v) is not affiliated with a nonprofit entity thatreceives significant contributions from thecompany;

(vi) within the last 5 years, has not had anybusiness relationship with the company(other than service as a director) for whichthe company has been required to makedisclosure under Regulation S-K of theSecurities and Exchange Commission;

(vii) is not employed by a public company inwhich an executive officer of the companyserves a director;

(viii) has not had any of the relationshipsdescribed above with any affiliate of thecompany; and

(ix) is not a member of the immediate family ofany person described above.

E. Council of Institutional Investors6. An independent director is one whose onlynontrivial professional, familial, or financialconnection to the corporation, its chairman,CEO or any other executive officer is his or herdirectorship.

Notes: Independent directors do not invariablyshare a single set of qualities that are notshared by nonindependent directors.Consequently no clear rule can unerringlydescribe and distinguish independent directors.However, members of the Council ofInstitutional Investors believe that thepromulgation of a narrowly drawn definition ofan independent director (coupled with a policyspecifying that at least two thirds of boardmembers should meet this standard) is in thecorporation’s and all shareholders’ ongoingfinancial interest because

(i) independence is critical to a properlyfunctioning board;

(ii) certain clearly definable relationships pose athreat to a director’s unqualifiedindependence in a sufficient number of casesthat they warrant advance identification;

(iii) the effect of a conflict of interest on anindividual director is likely to be almostimpossible to detect, either by shareholdersor other board members; and

(iv) while an across-the-board application of anydefinition to a large number of people willinevitably miscategorize a few of them, thisrisk is sufficiently small that it is faroutweighed by the significant benefits.

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7. Stated most simply, an independent director is aperson whose directorship constitutes his or her onlyconnection to the corporation. The definitionapproved by members of the Council contains thisbasic formulation. It then adds to it a list of therelationships members believe pose the greatestthreat to a director’s independence. The existence ofany such relationship will remove a director from theindependent category.

8. The following notes are supplied to give addedclarity and guidance in interpreting the specifiedrelationships.

9. A director will not generally be consideredindependent if he/she has either of the followingqualifications:

(i) He/she is, or in the past 5 years has been,employed by the corporation or an affiliate inan executive capacity.

Notes: The term “executive capacity” includesthe Chief executive officer (CEO) and operating,financial, legal, and accounting officers of acompany. This includes the president, treasurer,secretary, controller, and any vice-presidentwho is in charge of a principal business unit,division, or function (such as sales,administration, or finance) or performs a majorpolicy-making function for the corporation.

An “affiliate” relationship is established if oneentity either alone or pursuant to anarrangement with one or more other persons,owns or has the power to vote more than 25%of the equity interest in another, unless someother person, either alone or pursuant to anarrangement with one or more other persons,owns or has the power to vote a greaterpercentage of the equity interest. For thesepurposes, equal joint venture partners meet thedefinition of an affiliate, and officers andemployees of equal joint-venture enterprises areconsidered affiliated.

Affiliates include predecessor companies.A “predecessor” of the corporation is acorporation that within the last 10 yearsrepresented more than 80% of the corporation’s

sales or assets when such predecessor becamepart of the corporation. Recent merger partnersare also considered predecessors. A recentmerger partner is a corporation that directly orindirectly became part of the corporation or apredecessor within the last 10 years andrepresented more than 50% of the corporation’sor predecessor’s sales or assets at the timeof the merger.

A subsidiary is an affiliate if it is at least 80%owned by the corporation and accounts for 25%of the corporation’s consolidated sales orassets.

(ii) He/she is, or in the past 5 years has been,an employee or owner of a firm that is one ofthe corporation’s or its affiliate’s paidadvisers or consultants.

Notes: Advisers or consultants include, butare not limited to, law firms, accountants,insurance companies, and banks.

(iii) He/she is, or in the past 5 years has been,employed by a significant customer orsupplier.

Notes: A director shall be deemed to beemployed by a significant customer orsupplier if the director

• is, or in the past 5 years has been,employed by or has had a 5% or greaterownership interest in a supplier orcustomer where the sales to or by thecorporation represent more than 1% ofthe sales of the customer or supplier ormore than 1% of the sales of thecorporation;

• is, or in the past 5 years has been,employed by or has had a 5% or greaterownership interest in one of thecorporation’s debtors or creditors wherethe amount owed exceeds 1% of thecorporation’s or the third party’s assets;

Ownership means beneficial or record ownership,not custodial ownership.

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(iv) He/she has, or in the past 5 years has had, apersonal services contract with thecorporation, its chairman, CEO, or otherexecutive officer or any affiliate of thecorporation.

Notes: Council members believe that evensmall personal services contracts, no matterhow formulated, can threaten a director’scomplete independence. This includes anyarrangement under which the directorborrows or lends money to the corporationat rates better (for the director) than thoseavailable to normal customers–even if noother services from the director are specifiedin connection with this relationship.

(v) He/she is, or in the past 5 years has been,an employee, officer, or director of afoundation, university, or other nonprofitorganization that receives significant grantsor endowments from the corporation or oneof its affiliates.

Notes: This relationship includes that of anydirector who is, or in the past 5 years hasbeen, an employee, officer, or director of anonprofit organization to which thecorporation or its affiliate gives more than$100,000 or 1% of total annual donationsreceived (whichever is less), or who is, or inthe past 5 years has been, a directbeneficiary of any donations to such anorganization.

(vi) He/she is, or in the past 5 years has been, arelative of an executive of the corporation orone of its affiliates.

Notes: Relatives include spouses, parents,children, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, brothers-and sisters-in-law, aunts, uncles, nieces,nephews, and first cousins. Executivesinclude those serving in an “executivecapacity.”

(vii) He/she is, or in the past 5 years has been,part of an interlocking directoratein which the CEO or other executive officer

of the corporation serves on the board ofanother corporation that employs thedirector.

F. New York Stock Exchange’s Definition

10. The following note has been extracted fromthe web site of Mcguire Woods LLP at http://www.mcguirewoods.com/news-resources/publications/corporate_services/article667.asp.

On 12 March 2003, NYSE separately filed thedirector independence portion of its corporategovernance proposals, which was in somerespects modified from the August 2002 submission.Some of the changes were driven by the Sarbanes-Oxley Act of 2002, which became law just daysbefore NYSE’s Board of Directors acted on theCommittee’s recommendations in August, and theSecurities and Exchange Commission’s (SEC) rulesimplementing certain provisions of that Act.

11. As originally and currently proposed, NYSEdirector independence rules would

(i) require that a majority of the directors ofNYSE-listed companies be “independent”;

(ii) require that the board of directorsaffirmatively determine that a director has nomaterial relationship with the listed companyfor the director to be considered independentand that such determination be publiclydisclosed; and

(iii) prohibit directors associated with current andformer auditors and directors in interlockingcompensation committee relationships frombeing considered independent.

In its recent filing, NYSE clarified itsdefinition of “director independence” in thefollowing key respects.

i. Former Employees and IndependentContractors

12. In its August 2002 filing with SEC, NYSEproposed that no director who is a former employeeof the company can be independent until 5 years

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after the employment relationship has ended.In its current proposal, NYSE intends to eliminatethe per se bar to independence for all recent formeremployees in favor of a rebuttable presumption thatany person who receives (or whose immediatefamily member receives) more than $100,000 peryear in direct compensation from the company hasa material relationship with the company and isnot independent until 5 years after he or she ceasesto receive more than $100,000 per year.The presumption applies to both employees andindependent contractors who receive directcompensation from the listed company.

13. In its commentary on the proposal, NYSE statesthat the presumption of nonindependence may berebutted by a unanimous determination by theexisting independent directors that, based upon therelevant facts and circumstances, the payments donot constitute a material relationship. The listedcompany will also be required to disclose thespecifics of such determinations.

14. For purposes of the rule, direct compensationdoes not include director’s fees or pension ordeferred compensation paid in respect of priorservice to the company. Also, if the compensationrecipient dies or becomes incapacitated, thepresumption will cease immediately.

ii. Significant Suppliers and Customers

15. The NYSE intends to prohibit persons frombeing considered to be independent if they areexecutive officers or employees of, or if theirimmediate family member is employed in anexecutive capacity by, suppliers or customers thatconduct business with the listed company at a levelof $1,000,000 or 2% of the gross revenue of thelisted company, whichever is greater. Suchprohibition would remain in effect until 5 years after

the customer or supplier falls below thesethresholds.

16. The rule would permit the board to use itsdiscretion to find a lack of a material relationshipwith regard to persons associated with suppliersor customers who transact less than thesethreshold amounts of business with the listedcompany.

17. The rule would also permit persons affiliated withconsultants and advisors to the listed company(other than auditors) to be considered independentdirectors, subject to a finding of a lack of materialrelationship, as long as the compensation their firmsreceive as “suppliers” to the listed company doesnot exceed these threshold amounts.

18. During the 5-year period following enactment ofthe director independence standards, the 5 year“cooling off” period for determining presumptionsand prohibitions will instead be measured as anyshorter period following the enactment of thestandards. Thus, for example, if measured a monthafter enactment, a person who has not been anemployee of the listed company during the month,but who did receive over $100,000 in directcompensation from the company 3 years before, willnot be subject to the presumption of a materialrelationship even though the compensation wasreceived within the last 5 years.

19. The SEC has not yet published for commentNYSE’s latest corporate governance proposal, andtherefore no deadline for comments has beenestablished. However, once these corporategovernance standards have been adopted, NYSE-listed companies will have 18 months, or, in thecase of companies with classified boards, a total of30 months after adoption to comply with the newindependence standards.

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I. Introduction1. Hermes places great emphasis on exercisingstewardship at all the companies in which it investson behalf of clients. The aim is to ensure thatcompanies are run by managers and directors in thebest long-term interests of shareholders. Hermesapproach to stewardship is based on a fundamentalbelief that companies with concerned and involvedshareholders are more likely to achieve superiorlong-term returns than those without.

2. Good stewardship creates value. These corporategovernance guidelines explain in detail how Hermeswill exercise its clients ownership rights in practice.The guidelines are intended as a basis for dialoguebetween companies and shareholders. Hermes willapply the guidelines with thought, giving dueconsideration to the specific circumstances ofindividual companies, and adopting a pragmaticapproach where appropriate.

Hermes Investment Management Limited3. Hermes is one of the United Kingdom (UK)’slargest fund managers with 36 billion pounds undermanagement as of 30 September 2002. HermesInvestment Management is one of the largestpension fund managers in the city of London. It isowned by, and is the principal fund manager for, theBT Pension Scheme, the UK’s largest pension fund.Hermes also manages portfolios for the Post OfficePension Plan and other major corporate and publicpension schemes.

4. It takes its corporate governance responsibilitiesseriously. It has published its approach togovernance in three documents, i.e., The Statementon UK Corporate Governance and Voting Policy,International Corporate Governance Principles, andthe Hermes Principles. It has also established threefunds focused on governance issues in which it hascoinvested together with other governanceconscious investors. It performs a stewardship roleand takes active part in voting on resolutionsproposed by its investee companies as well aspublishes its approach at various fora in the world’scapital markets. The full text of Hermes’s corporate

governance policies and principles is posted on itsweb site at http://www.hermes.co.uk.

5. The governance approach of investors such asHermes is twofold. First, if enterprises in developingcountries wish to attract capital from suchinstitutions, it will be to their advantage if theyconform to the governance principles such as thosethat Hermes espouses. Second, domesticinstitutional investors in developing countries canconsider adopting similar governance principlestailored to the specific conditions of their countries.

6. By way of illustration, some extracts fromHermes’s statement on UK Corporate Governanceand Voting Policy 2001 are given below.

II. Statement of General Principle7. Directors of public companies are responsible forrunning companies in the long-term interests ofshareholders. Shareholders and their agents haveresponsibilities as owners to exercise stewardship ofcompanies. Corporate governance should provide aframework where both parties can fulfill theseresponsibilities.

8. A company run in the long-term interests of itsshareholders will need to manage effectivelyrelationships with its employees, suppliers, andcustomers; to behave ethically; and to have regardfor the environment and society as a whole.Hermes’s approach to social, environmental, andethical matters is explained in Appendix 4 of itscorporate governance document.

9. Nonexecutive directors (NEDs) should workcooperatively with their executive colleagues anddemonstrate objectivity and robust independence ofjudgment in their decision making.

10. Hermes supports a standard approach tocorporate governance. Hermes welcomes thepublication of the Combined Code on CorporateGovernance and will normally apply itsrecommendations. Consideration will also be givento the fuller discussions in the Cadbury, Greenbury

Appendix 3Case Study: Hermes InvestmentManagement Ltd.

33

and Hampel reports that underlie the CombinedCode. Where relevant, reference will be made to thepolicies of the National Association of PensionFunds and other related bodies. There are someissues that Hermes believes, primarily because of itsinvestment policies, require greater emphasis or analternative approach. In addition, the Hampel reportleft open some matters of detail for shareholders toresolve with company boards. This supplementarystatement is intended to assist directors’understanding of Hermes’ views on these issues.

III. The BoardA. Composition11. The precise number of executive directors (EDs)and NEDs for any company is for its board todetermine with the approval of its shareholders. It isthe overall balance of the board that is important.Not all NEDs need to be independent but thereshould be a strong core of NEDs that are bothindependent and seen to be independent.

B. Role of NEDs12. The key role of NEDs is to ensure that the chiefexecutive and the board as a whole concentrate onmaximizing long-term shareholder value.

13. There are three aspects of this for which NEDsshould expect to be held accountable. These are thestrategic function, expertise and the governancefunction.

C. Independence of NEDs14. The board should have a core of at least threevigorously independent directors on whomshareholders can rely for the independence of theirjudgment and who can act as agents for changeshould the need arise. Hermes endorses theCadbury Committee’s definition of independence:that NEDs should be independent of managementand free from any business or other relationship thatcould materially interfere with the exercise of theirindependent judgment.

15. Hermes accepts that not all NEDs need to beindependent in accordance with this definition andthat there can be a role for other NEDs provided amajority of NEDs satisfy the above test ofindependence. We believe that the final decision onwhether NEDs are independent lies with theshareholders who elect them. There should be full

disclosure in the annual report of any factors to betaken into account in judging an individual’sindependence in accordance with the abovecriteria.

16. It is good practice for all boards to conduct anannual review of the performance of NEDs and thechairman and to consider the effectiveness of theboard as a whole. The role of the NED is becomingincreasingly complex and Hermes recommends thatcompanies encourage NEDs to participate in therange of seminars and workshops offered byorganizations such as Cranfield School ofManagement, Henley Management College, Instituteof Directors and Spencer Stuart.

17. Hermes contributes to several of thesedevelopment fora, which encourage a participatoryapproach and include case studies illustratingdifficult situations.

IV. Voting18. Hermes believes that a separate resolutionseeking approval of the annual report and accountsshould be tabled at all annual general meetings(AGMs).

19. Hermes welcomes the introduction of electronicproxy voting and encourages companies to adoptthis as soon as practicable.

20. Takeovers are an important part of an efficientand competitive corporate environment but do notalways add to shareholder value, particularly for thebidding company. Hermes’s predisposition in ahostile bid is to support existing management, butthis support is conditional. It does not apply whereconfidence has been lost in management, or forexample, where synergistic or strategic benefitsclearly justify a bid premium. Unreasonable orunjustifiably expensive defense tactics will not besupported.

21. Hermes acknowledges, on behalf of its clients,that shareholders have responsibilities as owners toparticipate in the stewardship of companies andthat, in companies outside their home market, theprimary way of achieving this is through proxyvoting. Accordingly, Hermes will endeavor to lodgeproxies at company general meetings, subject to

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excessive costs or administrative difficulties.Companies, for their part, can promote goodpractice and system development in their ownmarket, thus minimizing the obstacles toshareholder voting. Hermes recommends followingthe International Corporate Governance Network’sGlobal Share Voting Principles to achieve this end.

22. Management of companies run in the long-terminterests of shareholders can be confident ofHermes’ continuing support. Hermes is committedto applying its corporate governance and votingpolicies with thought, giving due consideration tothe specific circumstances of individual companies,and will adopt a pragmatic approach whereappropriate. Hermes will reconsider, at the requestof a company, any company-specificcircumstances that may make it inappropriate toapply Hermes’ standard policies.

23. Hermes will contact companies to explain itsreasons for voting against or abstaining onresolutions. Hermes prefers these discussions to bekept private. Hermes welcomes correspondencefrom companies in which its clients invest and whereappropriate wishes to encourage discussions withcompany directors and executives.

24. Corporation’s ordinary shares should featureone vote for each share. Corporation should act toensure the owner’s rights to vote. Fiduciaryinvestors have a responsibility to vote. Regulatorsand law should facilitate voting rights and timelydisclosure of the levels of voting.

V. Hermes’ Business PrinciplesHermes’ overriding requirement is that companies berun in the long-term interest of shareholders.Companies adhering to this principle will not onlybenefit their shareholders, but also the wider economyin which the company and the shareholdersparticipate. We believe a company run in the long-terminterest of shareholders will need to manage effectivelyrelationships with its employees, suppliers andcustomers, to behave ethically, and have regard forthe environment and society as a whole.

CommunicationPrinciple 1 Companies should seek an honest,open, and ongoing dialogue with shareholders. They

should clearly communicate the plans they arepursuing and the likely financial and widerconsequences of those plans. Ideally, goals, plansand progress should be discussed in the annualreport and accounts.

FinancialPrinciple 2 Companies should have appropriatemeasures and systems in place to ensure that theyknow which activities and competencies contributemost to maximizing shareholder value.

Shareholder valuePrinciple 3 Companies should ensure allinvestment plans have been honestly and criticallytested in terms of their ability to deliver long-termshareholder value.

Principle 4 Companies should allocate capital forinvestment by seeking fully and creatively to exploitopportunities for growth within their core businessesrather than seeking unrelated diversification. This isparticularly true when considering acquisitive growth.

Principle 5 Companies should have performanceevaluation and incentive systems designed cost-effectively to incentivize managers to deliver long-term shareholder value.

Principle 6 Companies should have an efficientcapital structure which will minimize the long-termcost of capital.

StrategicPrinciple 7 Companies should have and continueto develop coherent strategies for each businessunit. These should ideally be expressed in terms ofmarket prospects and of competitive advantage thebusiness has in exploiting these prospects. Thecompany should understand the factors which drivemarket growth, and the particular strengths whichunderpin its competitive position.

Principle 8 Companies should be explain why theare the “ best parent” of the businesses they run.Where they are not best parent they should bedeveloping plans to resolve the issue.

Social, ethical, and environmentalPrinciple 9 Companies should manage effectively

Appendix 3 continued

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relationships with their employees, suppliers, andcustomers and with others who have a legitimateinterest in the company’s activities. Companiesshould behave ethically and have regard for theenvironment and society as a whole.

Principle 10 Companies should support voluntaryand statutory measures which minimize theexternalization of costs to the detriment of societyat large.

VI. Shareholder or Shareowner?Hermes believes that companies with active andinformed investors achieve superior returns over thelong-term and, accordingly has been a leader inpromoting better stewardship at investee companiesfor over a decade. Passive fund managementshould include active ownership and our index-tracking funds benefit from an active approach toownership. The 40 person team involved ingovernance and engagement are not reserved just

for our focus funds. Following the Myners Report, allinstitutional investors are being required to take anactive role in monitoring performance. To that endthe Institutional Shareholders Committee (ISC) haspublished guidelines for trustees and their agents.Hermes welcomes the guidelines as a benchmarkfor the fund management industry and anendorsement of our stewardship activities.

With our fully integrated approach to corporategovernance and investment management, includingour ownership of the only institutional shareholderengagement (Focus) fund, we believe that we areuniquely positioned to meet the letter and spirit ofthe guidelines (see table). Additionally, our expertisein the field of engagement is available to investorswith portfolios managed by third party managersfor mutual clients. We welcome the opportunityto carry out governance and interventionactivities on behalf of our existing and futureclients.

Appendix 3 continued

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Hermes’ Approach

Published and sent to all UK investee companies:- Corporate Governance and Proxy Voting

Statement- Hermes Principles on strategy and performance

See chart overleaf.Votes clients’ shares at all UK general meetings.Graduated approach: proxy voting decisions basedon annual report disclosures, discussions withcompany and independent analysis. Database ofcontract and vote.Companies included in “core engagementprogram” or “focus funds” if further interventionmerited.

Company-specific. Companies included in “coreengagement program” on basis of formal proposalapproved by Corporate Governance Committeewhich oversees engagement process. Similar butmore detailed approach for “focus funds”.

Regularly meets with executive and nonexecutivedirectors on both company-specific and generalgovernance and performance issues. Works withother investors as appropriate. Prefers not to takepublic route unless all other alternatives exhaustedbut when necessary will use press and generalmeetings to drive change.

Has staff of 40 focused on governance andstewardship activities. Broad range ofbackgrounds/expertise including corporate (picboard-level), investment, legal, financial, strategicmanagement consultancy and forensicaccountancy.

Myners/ISC RequirementsStatement of activism policyOwners should be clear about what they expectfrom companies:– it should be clear, consistent and comprehensive– it should be well-communicated

Monitor performance of and have dialogue withinvestee companiesOwners should have a systematic process which:– reviews company performance– undertake core ownership duties (voting and

engagement/dialogue)\– identifies situations where further intervention is

merited

Intervene where necessaryOwners should be able to explain reason for,objective of, and measures of success ofintervention

Escalate intervention on a case-by-case basis– Meetings with management, board, advisers– Intervene jointly with other investors– Public statements in advance of AGM– Call EGM/put shareholder resolutions at AGM

Evaluate impact of activism and report toclients– Auditable process– Agree format of reports to clients

Hermes’ Approach

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Hermes’ Corporate GovernanceFunction

Receipt of Proxy Material

Further research:• In-house governance database• Governance research services• Proprietary news and information services• Companies’ house public records• City and governance contacts

Problems

Engagement and Intervention

Speak to company

Speak to company’s brokers

Write to company

Meet with company executives and nonexecutives

Formulate a plan for change

Consult other shareholders

Vote against or abstain on management resolution

Attend AGM/EGM

Put shareholder resolutions on proxy card*

Call EGM*

Problems solved

Vote in favor of management resolutions at AGM/EGM

Corporate Governance Analysis of AnnualReport and Accounts covering:• Total shareholder return performance• Board structure

– Number of non-executive directors– Independence of non-executive directors– Chairman/ chief executive roles split– Nominated senior non-executive director– Committee structures

• Remuneration– Total package– Incentive pay

• Directors’ contracts– Risk management– Reporting systems

• Social, ethical, and environmental matters• Shareholder base

No Problems

Vote in favor of management

Course of action taken differs case-by-case

* In extreme cases

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1 Value of Corporate Governance, InvestorActivism and Economic Value Added

(i) The Value of Corporate Governance, ColinMelvin, April 2003 (available atwww.hermes.co.uk).

(ii) Corporate Governance Develops in EmergingMarkets, Campos, Newell & Wilson, McKinseyon Finance, Winter, 2002 atwww.mckinsey.com

(iii) The concept of Economic Value Addedhas been popularized by the consultingfirm Stern Stewart & Co. An explanationof the concept can be found atwww.sternstewart.com.

(iv) 7 Common Traits of EVA Companies, TadLeahy at www.business financemag.com.

2 Human Capital and Shareholder Value

(i) Human Capital Index: Measuring yourOrganization’s Greatest Asset athttp://www.watsonwyatt.com/search/publications.asp?Component=Strategy&ArticleID=7379.

(ii) Human Capital Index®: Human Capital As aLead Indicator of Shareholder Value athttp://www.watsonwyatt.com/research/resrender.asp?id=W-488&page=1.

3 Model Terms of Reference of Nominationand Renumeration Committees

(i) Guidance Note, Nomination Committee –Terms of Reference, at the web site ofThe Institute of Chartered Secretaries andAdministrators (ICSA) at www.icsa.org.uk.

(ii) A set of written terms of reference isavailable at www.bhpbilliton.com/bbContentRepository/AboutUs/Governance/NomsCommittee.pdf.

(iii) Guidance Note, Remuneration Committee –Terms of Reference, at ICSA’s website.

4 Audit Committee Effectiveness

(i) Jim Kaplan’s Auditnet at www.Auditnet.org/corpgov.htm. In particular see Audit CommitteeEffectiveness-Self Assessment by BradDavidson and Clarence Eberse.

(ii) Best practices and sample audit committeecharters are included in the report of the BlueRibbon Committee on Improving theEffectiveness of Corporate Audit Committees atwww.nyse.com/content/publications/NT000113C6.html.

(iii) Various materials at the KPMG AuditCommittee Institute web site at http://www.kpmg.com/aci/additional.htm.

(iv) The Financial Aspects of CorporateGovernance, The Cadbury Report,1 December 1992.

(v) Audit Committees, Good Practices forMeeting Market Expectations,PricewaterhouseCoopers

(vi) Related Party Transactions, CorporateGovernance series, Ernst & Young atwww.ey.com.au.

(vii) Accounting and Auditing for RelatedParties and Related Party Transactions athttp://www.aicpa.org/news/relptv1.htm andhttp://fp.aicpa.org/public/download/news/relpty_toolkit.pdf.

(viii) Financial Statements Due DiligenceQuestionnaire, Corporate GovernanceSeries, Ernst & Young atwww.ey.com.au.

(ix) Red Flags in Board Reports, A Guide forDirectors, Comptroller of the CurrencyAdministrator of National Banks (this guide isrelevant to bank reports).

(x) Financial Shenanigans, 2nd Edition, 1999: Howto Detect Accounting Gimmicks and Fraud inFinancial Reports, Howard Schilit.

References

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(xi) The Financial Numbers Game, 2002:Detecting Creative Accounting Practices,Charles W. Mulford and Eugene E. Comiskey.

(xii) Sarabanes-Oxley Act of 2002: see summariesat http://www.aicpa.org/info/Sarbanes_oxley_summary.htm and http://www.cov.com/publications/297.pdf and http://www.mayerbrown.com/legal/SecU093002.pdf.

(xiii) SEC Proposes Auditor Independence andWork Paper Retention Rules Required UnderSarbanes_Oxley Act at www.sec.gov/news/press/2002-165.htm.

(xiv) Audit Committee : Terms of Reference atwww.icsa.org.uk. and Audit CommitteeGuide, Arthur H. Bill at http://www.bowne.com/bsc/pubs_audit.asp

(xv) Management’s Discussion and Analysis ofFinancial Condition and Results of Operations:see “the MD&A Rules” at www.sec.gov.

(xvi) See the website of Blunn & Company forimproving online annual reports atwww.blunn.com.

(xvii) Audit Committee Financial Expert definition:see 15 January 2003 press release at U.S.SEC website.

(xviii) How to Work with and Protect the Board andAudit Committee, Margaret M. Zagel,Altheimer & Gray, 26 February 2003 atwww.complianceweek.com.

(xix) For some tips for minimizing compliance costssee: Corporate Governance on a Budget, AmarBudarapu, Compliance Week, 1 July, 2003.

(xx) Employee Hotlines: A Valuable ComplianceTool for the Board, Tony Malone & RalphChilds, Directors Monthly, March 2003.

5 Internal Controls

(i) The Turnbull Report: the full text is available athttp://www.cabinet-office.gov.uk/risk/Corporate_Governance_folder/turnbul.pdf.

(ii) Effective Governance, UK Institute ofChartered Accountants at http://www.blindtiger.co.uk/IIA/uploads/2c9103-ea9f7e9fbe—7ebc/EffGovKC.doc.

(iii) The COSO Report: Internal Control—IntegratedFramework, prepared by the TreadwayCommission, i.e., National Commission onFraudulent Financial Reporting. See http://bear.cba.ufl.edu/hackenbrack/acg5637/PDF/NCFFR.pdf.

(iv) Internal Control: A Practical Guide, KPMG atwww.kpmg.co.uk/kpmg/uk/imageInternalcontrol.pdf.

(v) Internal Audit in Banks and the Supervisor’sRelationship with Auditors, Basle Committee onBanking Supervision, at http://www.bis.org/publ/bcbs84.htm.

(vi) Framework for Internal Control Systemsin Banking Organizations, Basle Committeeon Banking Supervision at http://www.bis.org/publ/bcbs40.pdf.

(vii) Management Reports on Internal Controls,David M. Willis and Susan S. Lightle athttp://www.aicpa.org/pubs/jofa/oct2000/willis.htm

(viii) Internal Controls and the Sarbanes-Oxley Act,Mathew Leitch at www.auditnet.org.

6 Code of Business Conduct andImplementation

(i) The Commonwealth Association of CorporateGovernance has reproduced a template fordesigning a corporate code at http://www.combinet.net/Governance/FinalCer/codeof.htm.

(ii) Corporate Codes of Conduct, Bureaufor Workers’ Activities, InternationalLabour Organisation at http://www.itcilo.it/english/actrav/telearn/global/ilo/code/main.htm.

40

(iii) A Bank Director’s Guide to Codes of Conduct,American Association of Bank Directors.

(iv) A Bank Director’s Guide To InternalInvestigations, American Association of BankDirectors.

(v) Another helpful web site is that of the Instituteof Business Ethics. It contains model codes aswell as numerous tips and suggestions toensure that codes are in fact adhered to.See http://www.ibe.org.uk/code.htm.

(vi) ICSA Guidance Note, Directors’ ShareDealings at www.icsa.org.uk.

(vii) Cinergy Corp. Insider Trading Policy atwww.cinergy.com.

(viii) Examples of whistleblower materials are theUK’s Public Interest Disclosure Act and theUS’s False Claims Act. See http://www.whistleblower.org/ and the website ofPublic Concern at Work at http://www.pcaw.co.uk/. Whistleblowing laws shouldbe credible and not cosmetic.

7 Environment

(i) Sustainability, Eco-efficiency, Life-CycleManagement & Business Strategy, KevinBrady, Patrice Hanson, James Fava atwww.firewinds.com.

(ii) Value, Growth, and Success–How Sustainableis your Business: A Briefing Note for Directorsat http://www.defra.gov.uk/environment/acbe/pubs/pdf/directors.pdf.

(iii) Primer on Choosing and Using EnvironmentalConsultants, Bruce Klafter at www.orrick.com/news/environ/primer.htm.

(iv) Various publications at ADB’s websitewww.adb.org.

8 Directors’ Duties

(i) Flunking the Duty of Care, The Four MostCommon Mistakes Made by Directors,

Michael F. Sullivan, Bricker and Eckler LLP athttp://www.bricker.com/newsevents/articles/157.asp.

(ii) Corporate Governance and Chairmanship,A Personal View, Adrian Cadbury, OxfordUniversity Press, 2002

(iii) Guidance for Chairmen, and Guidance forNon-Executive Directors, Derek Higgs review,20 January, 2003 at www.dti.gov.uk.

(iv) Board Meeting in Session, Evaluating theBoard of Directors, Korn/Ferry International.

(v) The Insolvency Service: A Guide for Directors,available at http://www.insolvency.gov.uk/information/guidanceleaflets/directors/gindex.htm.

(vi) What Makes Great Boards Great, Jeffrey A.Sonnenfeld, Harvard Business Review, Sept.2002.

(vii) Directors’ Duties, Corporate GovernanceSeries, Ernst & Young at www.ey.com.au.

(viii) Personal Liabilities of a Company Director athttp://www.elbornes.com/articles/persliab.htm.

(ix) The Board Agenda, Good Practices for MeetingMarket Expectations, PricewaterhouseCoopers.

(x) Board Meeting In Session, Twenty “BestPractices to Improve Board Performance,” KornFerry International.

(xi) Best Practices in Board Reporting, Ernst &Young at www.ey.com.au and Does your BoardHave an Effective Management System of ItsOwn – Carolyn Brancato, The ConferenceBoard.

(xii) Reporting Progress, Good Practices forMeeting Market Expectations,PricewaterhouseCoopers.

(xiii) The Role of a National Bank Director: TheDirector’s Book, Comptroller of the CurrencyAdministrator of National Banks.

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(xiv) A Bank Director’s Practical Guide toAvoiding Enforcement Actions, AmericanAssociation of Bank Directors.

(xv) The Regulatory Exclusion in Directors andOfficers Liability Insurance Policies andObtaining Regulatory Coverage in thePresent Market, John C. Hockenbury andGregory J. Manderlink, AmericanAssociation of Bank Directors.

(xvi) Frequently Asked Questions About Directorsand Officer’s Liability Insurance, January2000, www.haledorr.com.

(xvii) ICSA Compliance Note: Matters Reservedfor The Board, at www.icsa.org.uk.

(xviii) Independent Director Definition, Council ofInstitutional Investors at http://www.cii.org/independent_director.asp.

(xix) Various guides for directors in the ‘20Questions’ series available at the web site ofthe Canadian Institute of CharteredAccountants, including 20 QuestionsDirectors Should Ask About Management’sDiscussion and Analysis.

(xx) Director’s Liability (for unremmitted taxes),David J. Rotfleisch, at www.taxpage.com/Articles/taxart5.htm.

(xxi) Staying Out of Trouble: Officer and DirectorLiability in Connection with RegistrationStatements; How to Draft Documents toLimit Liability, Jack R. T. Jordan, November1999 edition, Andrews Corporate RiskSpectrum.

(xxii) ICSA Guidance Note, Matters Reserved forthe Board.

(xxiii) The Responsibilities of Company Directors,2nd Edition, Andrew Sparrow, FinancialTimes, Prentice Hall.

(xxiv) Fund Directors Guidebook, American BarAssociation.

(xxv) Rights and Duties of Directors, 5th edition,Martha Bruce, FCIS, Tolley Lexis NexisTM

(xxvi) The ICSA Director’s Guide, Martha Bruce.

9 Turnaround Situations

(i) The web site of the Turnaround ManagementAssociation at http://www.turnaround.org

(ii) Corporate Turnaround, ManagingCompanies in Distress, Stuart Slatter &David Lovett, Penguin, 1999.

(iii) Corporate Governance Screen used byCalPERS at http://www.calpers-governance.org/alert/selection/screening-process.asp.

(iv) Company Director’s Disqualification Act 1986and Failed Companies.

(v) Officer and Director Liability in FinanciallyTroubled Corporations, Jamey S. Seelyavailable at the web site of Thompson &Knight at http://www.tklaw.com.

10 Shareholder Rights

(i) OECD Principle of Corporate Governance &Corporate Governance Practices and theRights of Shareholders, Parliament of theCommonwealth of Australia, 1991 atwww.aph.gov.au.

(ii) Understanding Securities Class ActionLitigation at www.securitiessleuth.com/corporatefraud/understanding.html. andClass Action Dilemmas, Hensler et al, RandInstitute of Civil Justice at http://www.rand.org/publication/MR/MR969.1/MR969.1pdf

(iii) See claim recovery by institutional investorsin Bernstein, Litowitz, Bergman &Grossmann LLP at http://www.blbglaw.com/settlements/main.cfm.

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Acknowledgment

The following contributed to the preparation of thispaper: Peter Butler and Colin Melvin of HermesInvestment Management Ltd and Robert Bestani,Alfredo E. Pascual and Arvind Mathur of the AsianDevelopment Bank. A number of other staff fromvarious departments of the Asian DevelopmentBank also commented on an earlier draft.

Corporate Governance Principles for Business Enterprises

HERMES PENSIONS MANAGEMENT LIMITED

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Copyright 2003 Asian Development BankISBN 971-561-500-7Publication Stock No. 050403

The contents of this paper do not necessarily reflectthe views of the Asian Development Bank or HermesPensions Management Ltd.

The photograph of the Singapore skyline on the coverand back page has been reproduced courtesy of theSingapore Tourism Board. The photographs of the stockexchange and the laboratory are from the AsianDevelopment Bank.

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