sou · GSB347 · 2005-01-01 00:00:00 — In the Commissions opinion, the regulatory regime is, in gen- eral, satisfactorily designed in many areas that are relevant from the point of view of confidence, even if there is a need to strengthen the regulations in some places. However, the risk of discovery is too low in many instances, for example, in cases of alleged economic crimes and unlawful manipulation of competition. The supervisory system therefore needs to be improved in several areas by such measures as strengthening those public authorities that have important supervisory duties towards the business sector. On the issue of sanctions systems, there are also substantial deficiencies in a number of areas. In many instances, it takes an unreasonably long time before crimes that have been uncovered come to trial. These delays lead to a lack of respect for the regula- tory regime and the norms. At the same time, the deterrent effect of sanctions can, in some cases, be called into question owing to the fact that they are too weak when compared with the substantial economic gains to be made from breaking the law. The implemen- tation of changes in certain systems of sanctions is therefore war- ranted. Openness and transparency. Anyone wanting to enjoy public confidence must show a great deal of openness, and infor- mation needs to be clear, intelligible, correct and relevant to vari- ous target groups interest in the enterprise. In this respect, the requirements for information from companies need to be strength- ened in certain cases. At the same time, the legitimate needs of business to keep information confidential respecting such matters as business secrets and individual integrity must be respected. The mass medias role is to inform, scrutinise and comment. Correct and open information from business makes this role easier and the public debate is more constructive. Clear division of roles and responsibilities. A partial explanation for the relatively large proportion of ambiguities in the division of roles and potential conflicts of interest in Swedish soci- ety is that is a small country with a consensus culture and with closely intertwined networks between persons in positions of leadership. Therefore an important confidence-creating measure is having systems in which the division of roles is clearly defined and both actual and potential conflicts of interest are avoided as much as possible, or – if this is not possible – are exposed and handled in an appropriate way. In addition to these four main strategies, a strong, ethical leader- ship and the social control in the decision-making environment in the business community are very important. If the attitude to those that break the rules is conciliatory or if one is able to profit from certain rules, then events may occur that harm public confidence. Senior managers have a special role to serve as models in their organisations. In addition, it is important that leading representa- tives from the business sector actively participate in the public debate, not least with respect to questions about confidence related to the business sector. Demands made of companies for ethical behaviour and social responsibility, often summarised in the concept Corporate Social Responsibility (CSR), have increased. There are far-reaching vol- untary activities under way in this area by businesses and business organisations in co-operation with non-profit organisations and the Government. In the opinion of the Commission, these make an important contribution to increasing confidence in the business sector. Openness and transparency in these matters is of great impor- tance for confidence in business. Priority Areas for Action The strategies described above sum up the principle approaches used by the Commission to analyse a number of prioritised areas where work to promote public confidence can and should be done. Priority area 1. Improved corporate governance. Several of the events that have shaken confidence are linked to weaknesses in corporate governance caused by the institutionalisation of owner- ship, failure of boards of directors to execute their responsibilities properly and errors in financial reporting, among other things. The Commission will pay special attention to the following issues: Overall issues of corporate governance, which have led to the ini- tiative to draw up a Swedish code of corporate governance in co-operation with a number of organisations and bodies in the business sector; Owners role: the issues of too weak exercise of the owners role as well as risks of abuse of power by strong owners, together with certain special issues related to the exercise of the ownership function in state-owned enterprises are analysed; The functions of the board of directors: the Commission sets out its principal views on a series of issues to be regulated under the corporate governance code referred to previously and makes certain proposals for legislation in addition to the code; Financial reporting and auditing: the Commission presents its view on a number of matters to be regulated under the code; it also proposes certain measures outside this framework. Priority area 2. Increased confidence in the financial sector. Several confidence-damaging phenomena have financial sector links. At the same time, it is especially important for the public to have a high degree of confidence in the financial sector as it has a key role in the way in which the modern market economy functions. The Commission focuses on two areas: System stability: the financial systems ability to withstand de- stabilising forces that may arise during economic crises and cause potentially large economic damages; The consumers perspective: the individual consumer or saver's position in relation to financial sector actors. Priority area 3. A more effective competition policy. A well-func- tioning competition in various sectors is very much in the interest of consumers. At the same time, several of the events that have shaken public confidence are connected to shortcomings, especially in the oversight and sanctions systems in this area. Priority area 4. Stronger provisions against economic crimes. The risk of discovery is low and the sanctions system is weak, but at the same time, this area is highly relevant from the standpoint of public confidence. This warrants measures that will make combating economic crimes more effective. Improved Corporate Governance – a Swedish Code of Well-run companies are a prerequisite for the market economy system to be able to create prosperity and growth. Good corporate governance is therefore important not only for a companys own- ers and the capital markets, but also for society as a whole. It is accordingly of great general interest that corporate governance be improved in public companies, particularly in those listed on the stock exchange. In Supplement 8, there is an analysis of corporate governance in state-owned companies. Swedish Code of Corporate Governance The Commission has, together with a number of organisations and bodies in the business sector, established a working group, the , to draw up a proposal for a corporate governance code that summarises and develops best Swedish practice in the area. The proposed code specifies rules for the organisation and working methods of a company's governance bodies and the inter- action between these two functions for the companys reporting to owners and the capital market in general. However, there is no dis- cussion of the auditing function per se, stock market rules and the in which the stock market works, or the companys rela- tions with , employees or the general public. Compared with what is required by law, the rules in the code are more ambitious. A company that follows the code can deviate from individual rules but then this deviation must be warranted under the principle comply or explain. Companies covered by the code are to attach a special corporate governance report to the annual report. For companies listed on the stock market, the market will decide if the reason reported for any deviations is acceptable or not. This model has been successfully used in a number of foreign corporate governance codes in recent years. The code is written primarily for stock market companies, but it is probably also relevant for unlisted public companies and other companies with a broad owner- and/or public interest. Co-opera- tives, state- and municipally-owned companies, and many medium- sized and larger privately owned companies could probably use the code for the most part. After interested parties have analysed and commented on the code and the final version has been decided, a body tentatively named should own and administer the code. should come under civil law, with organisations and bodies in the business community forming a clear majority, but it should also have some state partici- pation. Its activities should be financed by commitments that are binding in the long term from business leaders, possibly supple- mented by fees from the companies covered by the code. proposals are reported in a separate volume entitled Swedish Code of Corporate Governance (Svensk kod för bolagsstyrning) (SOU 2004:46). A Stronger Role for Owners in Companies with Broad Ownership or a Public Interest An effective utilisation of the resources of the business community and companies assumes that capital is provided to the sectors and companies having the best of meeting the needs of the market and that the capital in each firm is used in the best possible way. Here the share market and shareholders play a decisive role. Contemporary developments in corporate governance basically address how the role of the owner is to be exercised and how owners responsibility is to influence corporate governance. Increased Owner Involvement in Corporate Governance The ownership of stock market companies has been largely insti- tutionalised and internationalised. Pension funds, insurance com- panies, investment funds and other portfolio management institu- tions dominate the owner representation in the large stock market companies. Similar changes have taken place in other developed countries, but this course has become accentuated in . After the abolition of foreign exchange regulations in and the repeal of the law on foreign acquisition of shares in Swedish com- panies in the late 1980s, the percentage of foreign-owned Swedish shares listed on the stock exchange rose from less than 10 per cent to over 30 per cent. Fewer restrictions on ownership. Institutional owners, both Swedish and foreign, now represent the largest percentage of the stock exchange value. They are primarily portfolio managers with the main task of guaranteeing savers a good rate of return, not of exercising influence in the company. However, in the opinion of the Commission, it is desirable to make it easier for those institu- tions that have the will and the capacity to take a more responsibility as owners to do so. One step in this direction is to reduce the remaining restrictions on certain institutional owners, principally the ownership in individual companies. Since the equivalent restrictions for the life insurance companies were scrapped a few years ago, it is the opin- ion of the Commission that there is also cause for reviewing these restrictions on the . The Commission therefore pro- poses that the restrictions on the First - Fourth and shareholding and the voting rights for the shares held be re-examined with a view to abolishing these restric- tions. Furthermore institutional owners should, in line with the 's corporate governance principles, make public their own- ership policy and the way in which voting rights for shareholders are exercised. The wealth tax should be abolished as it plays a negative role for individual direct ownership of shares listed on the stock exchange. In addition, it affects a companys choice of type of listing on the stock exchange. Abolishing this tax would not create new asym- metries or other undesirable economic side effects. capital flight induced by the wealth tax would stop and perhaps even turn into some repatriation of financial assets. Protection for Minority Shareholders Shareholders' meetings should have an independent chair and be conducted in a that promotes participation on the part of owners. The revision of the provisions on the organisation of public limited companies in the Act (Aktiebolagslagen) on January 1, 1999 largely satisfies these needs. The corporate governance code takes additional steps for promot- ing shareholders means of exerting influence via the shareholders' meeting. Owners abuse of power. There is no general criticism of the regulations in the Act for the protection of minority shareholders but the Government authorities should, in the appropriate context, consider current limitations on minority rights. and managements responsibility for damages. Because there have been few legal procedures, the courts have not played the same role in the evolution of the law in this area that courts in other countries have. The responsibility of the board of directors would be made clearer and the position of minority shareholders would be strengthened if revised rules on the appor- tionment of the costs of judicial examination of these questions contributed to more cases being tested in the courts. The issue of differentiated voting rights is highly relevant from the corporate governance perspective. There are reasons both for and against the current regulations. However, it is the opinion of the Commission that this subject is not primarily a matter of confi- dence in the business sector. The Commission has therefore refrained from presenting any proposals in this area. Public take-over bids. An efficient market for controlling inter- ests in listed companies reduces the risk that the management in a company in which the ownership and management are divided will act in a that is contrary to shareholders' interests. Carefully considered regulations on public take-over bids are therefore important elements in the protection of minority shareholders. At the end of 2003, a political agreement on an EU directive in the area was reached; therefore, the Commission has not analysed these issues in more detail. Owner Involvement in the Governance of State-Owned The central government is the largest business owner on the . In Supplement 8, it is argued that the mandate from the owner in the governance of state-owned compa- nies is typically ill-defined and that there are generally insufficient resources to exercise the ownership role. The Commission sup- ports this assessment. However, on the issue of nominating mem- bers of the board of directors, the central government has been in the forefront, with newly formulated rules for a structured evalua- tion of the board and a systematic set of procedures for the selec- tion process that include requiring a nomination committee. Ill-defined mandate from the owner. Effective corporate govern- ance is not promoted by trying to maintain the fiction of a fully competitive and purely commercial activity with a clearly stated goal for return on capital if the company in actuality has a partial monopoly position and/or an additional mandate in the public interest. It is therefore proposed that for enterprises owned by the state, a realistic and thorough description of each companys mandate from the owner and efficient models for steering the activities of the companies towards these more multidimensional goals be drawn up. Exercise of the ownership role. The Commission proposes re- organising and augmenting the states resources for corporate gov- ernance. The management of all of the companies or partially owned by the state should be concentrated in the , Employment and Communications (Näringsdepar- tementet); There should be a minimum 50 per cent increase in the resources to administer the companies; the additional estimated cost comes to about million; The tasks of company administrators should be changed so that less time is devoted to participating in company boards and more time on drafting the role of the owners, following up compliance with targets and directing the nomination process; A pool of external specialists should be established to reinforce the competence of the ministrys own staff. Improving the Performance of Company Boards The competence and professionalism of in many instances have been inadequate in managing extreme rises and falls in share values. The that boards and individual board members devote to their task has been deficient in certain cases. Individual board members civil and integrity some- times appear to have wavered. in the way that many boards have functioned have seriously shaken public confidence. It is the opinion of the Commission that most of the measures needed to improve the work of the company boards are included in the proposal for a Swedish Code of Corporate Governance. In addition, the Commission proposes amendments to the legislation in some instances. Performance under the Code The size of the board of directors should be decided by finding a balance between the need for knowledge, experience and perspec- tive and the importance of simple, effective forms of work and personal responsibility. There are arguments for specifying an upper limit on the number of directors chosen at the companys shareholders meeting. Composition of the board of directors. Boards should be diversely composed of persons with different competences, experience and personal background, who together form a strong whole. An even gender distribution should be sought. Independence of the board of directors. Of the members of the board of directors chosen at the companys shareholders meeting, the majority should be independent of the company and at least two should also be independent of major owners. Other than employees representatives, only the managing director – if he or she is part of the board – should be employed in the company. Recruiting board members. Methods and systems for recruiting board members should be developed substantially by way of a special nomination committee chosen by the owners. new board member should receive an adequate introductory briefing on the company and all members of the board should develop their knowledge of the company and its activities on an ongoing basis. Definition of owners mandate. A boards most fundamental duty is to acquaint itself with owners intentions and interests in the company and consolidate them into an integrated owners mandate as the basis for governing the company. The role of the boards chair. In recent years, the position of the chair of the board has become stronger, with explicit responsibility for leading the boards work and seeing that the board discharges its duties according to the law. The chair of the board should therefore be chosen at the shareholders meeting. The boards decision-making culture. It is primarily the responsi- bility of the chair of the board to see that the effort to come to a consensus on decisions made by the board is not taken to the point where it is difficult for individual members to pursue dissenting opinions of high integrity on individual issues. The board's basis for a decision. Under the Companies Act, a board is not allowed to come to a decision unless it has a satisfac- tory basis. This is one of the few provisions of the Act punishable by law. Remuneration of board and management. The following require- ments should be made of such systems: they are competitive for recruitment purposes; they reward behaviour that is in accordance with the companys goals; there is a clear connection between remuneration and perform- ance; there is a well-defined ceiling on variable remuneration; pensions are premium based and the premiums paid are based on the fixed salary only. The board of directors should follow a clear and structured process in dealing with remuneration matters. The code therefore includes a requirement for a special remuneration committee to prepare these matters. The boards responsibility for the companys conduct towards the public. The board is responsible for the companys behaviour towards its employees, and the general public, and in particular, for seeing that the company follows existing laws and regulations and other regulatory systems that the company is obliged to follow. To exercise its responsibility in such matters, the board must establish appropriate policies and guidelines governing the companys conduct, ensure that their content is made clear to the company officials and staff members concerned and intervene forcefully at any sign that established rules and norms have been breached. Evaluation of the board. The same requirements for systematic management by objectives and a structured evaluation process should be set for the board as are set for the companys organisa- tion in general. It is the responsibility of the chair to see that the board formulates clear objectives for its work and evaluates its performance in a systematic way. Decision on remuneration to senior executives. It is the opinion of the Commission that owners should take greater responsibility for remuneration to senior executives. It therefore proposes the intro- duction of regulations into the Companies Act that would require the following decisions to be taken at shareholders' meetings in public limited companies: the principles governing remuneration for managing directors and other company executives; the size of directors fees and their allocation to the chair, other board members and remuneration for committee work; all forms of share and share price incentive programmes for company executives or for the board. Information on remuneration to senior officials. Openness is a restraint on excessive levels of remuneration or remuneration that is inappropriately designed, particularly when the reporting is done at the individual level. The Commission therefore proposes the introduction of regulations in the Annual Accounts Act (Års- redovisningslagen) and the Companies Act to the effect that public companies are to: present in the annual report information on the terms of employment for senior officials on a person-by-person basis; this information is to be equivalent to that contained in the rules of the and Committee () on the subject, with the addition that the circle covered by these decisions is to be widened to include all members of boards of directors; this matter is to be made the subject of a separate report at the shareholders meeting. Election to the chair of the board at the shareholders meeting. A regulation requiring the chair of the board of directors in public companies to be elected at shareholders meetings should be added to the Companies Act. The board of directors should have the right to appoint a chair only if the chair resigns in the course of the mandate, in which case, the appointment should cover the time remaining until a new shareholders meeting, at which time the election of a new chair should be conducted. A legislated role for the nomination committee. In connection with the coming revision of the Companies Act, consideration should be given to legislating the tasks and responsibilities of the nomina- tion committee. Limitation on substitutes for employee directors to be present at board meetings. The law on board representation for employees in private companies should be changed to limit the right of substi- tutes for employee directors to be present at board meetings to only those occasions when they are substituting for an absent director. Reliable Financial Reporting and Auditing