Chapter 2

CORPORATE GOVERNANCE CODES

2.1 The driving forces of governance code development

Fraud and corruption

Shareholders can have the perception that the company they have invested in is
being poorly run and that fraud and corruption are occurring. Implementation and
adherence to a code of corporate governance helps remove these fears and builds
market confidence in the company.

Poor governance

A lack of governance in companies can lead to poor performance, simply because

the necessary controls and procedures are not in place to run the company
effectively. Implementing good governance procedures will help to alleviate this
problem.

Enhance company value

A study by McKinsey noted that global investors are willing to pay a premium to
invest in shares where the company has a good system of corporate governance.
Implementation of codes of governance is recommended so directors can show
they are running a company effectively.

Shareholder protection

Implementations of corporate governance principles do not, of themselves,

automatically prevent company collapse or fraudulent activities. However,
implementation does reduce risk (for example, by the running of a risk
management committee) which will help guard against failure. So even if codes
of governance do not add value, they at least help protect shareholders.

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2.2 UK Corporate Governance Code

The UK Corporate Governance Code is a part of UK company law with a set of

principles of good corporate governance aimed at companies listed on the
London Stock Exchange and require that public listed companies disclose how
they have complied with the code, and explain where they have not applied the
code - in what the code refers to as ‘comply’ or ‘explain’. Private companies are
also encouraged to conform; however, there is no requirement for disclosure of
compliance in private company accounts. The Code adopts a principles-based
approach which rigidly defines exact provisions that must be adhered to.

Origins.

The Code is essentially a consolidation and refinement of a number of different

reports and codes concerning opinions on good corporate governance. The first
step on the road to initial iteration of the code was the publication of the Cadbury
Report in 1992. Produced by a committee chaired by Sir Adrian Cadbury, the
Report was a response to major corporate scandals associated with governance
failures in the UK. The committee was formed in 1991 after Polly Peck, a major
UK company, went insolvent after years of falsifying financial reports. Initially
limited to preventing financial fraud, when BCCI and Robert Maxwell scandals
took place, Cadbury’s remit was expanded to corporate governance generally.
Hence the final report covered financial, auditing and corporate governance
matters, and made following three basic recommendations:

 the CEO and Chairman of companies should be separated

 boards should have at least three non-executive directors, two of whom
should have no financial or personal ties to executives
 each board should have an audit committee composed of non-executive
directors

Before long, a further committee chaired by chairman of Marks & Spencer, Sir
Richard Greenbury was set up as a ‘study group’ on executive compensation.
It responded to public anger, and some vague statements by the Prime Minister
John Major that regulation might be necessary, over spiraling executive pay,
particularly in public utilities that had been privatized. In July 1995, the
Greenbury Report was published. This recommended some further changes to
the existing principles in the Cadbury Code.

The Cadbury and the Greenbury principles were then consolidated into a
“Combined Code”.

A further mini-report was produced the following year by the Turnbull

Committee which recommended directors be responsible for internal financial and
auditing controls. A number of other reports were issued through the next decade,

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 particularly including the Higgs review, from Derek Higgs focusing on what
non-executive directors should do, and responding to the problems thrown up by
the collapse of Enron in the US. Paul Myners also completed two major reviews
of the role of institutional investors for the Treasury, whose principles were also
found in the Combined Code. In 2010, a new Stewardship Code was issued by
the Financial Reporting Council, along with a new version of the UK Corporate
Governance Code.

2.2.1 Contents.

Section A: Leadership

Every company should be headed by an effective board which is collectively

responsible for the long-term success of the company.

There should be a clear division of responsibilities at the head of the company,

between the running of the board and the executive responsibility for the running
of the company’s business. No one individual should have unfettered powers of
decision.

The chairman is responsible for leadership of the board and ensuring its
effectiveness on all aspects of its role.

As part of their role as members of a unitary board, non-executive directors

should constructively challenge and help develop proposals on strategy.

Section B: Effectiveness

The board and its committees should have the appropriate balance of skills,
experience, independence and knowledge of the company to enable them to
discharge their respective duties and responsibilities effectively.

There should be a formal, rigorous and transparent procedure for the appointment
of new directors to the board.

All directors should be able to allocate sufficient time to the company to

discharge their responsibilities effectively.

All directors should receive induction on joining the board and should regularly
update and refresh their skills and knowledge.

The board should be supplied in a timely manner with information in a form and
of a quality appropriate to enable it to discharge its duties.

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Section C: Accountability

The board should present a balanced and understandable assessment of the

company’s position and prospects.

The board is responsible for determining the nature and extent of the significant
risks it is willing to take in achieving its strategic objectives. The board should
maintain sound risk management and internal control systems.

The board should establish formal and transparent arrangements for considering
how they should apply the corporate reporting and risk management and internal
control principles and for maintaining an appropriate relationship with the
company’s auditor.

Section D: Remuneration

Levels of remuneration should be sufficient to attract, retain and motivate

directors of the quality required to run the company successfully, but a company
should avoid paying more than is necessary for this purpose. A significant
proportion of executive directors’ remuneration should be structured so as to link
rewards to corporate and individual performance.

There should be a formal and transparent procedure for developing policy on

executive remuneration and for fixing the remuneration packages of individual
directors. No director should be involved in deciding his or her own remuneration.

Section E: Relations with Shareholders

There should be a dialogue with shareholders based on the mutual understanding

of objectives. The board as a whole has responsibility for ensuring that a
satisfactory dialogue with shareholders take place.

The board should use the AGM to communicate with investors and to encourage
their participation.

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2.3 OECD guidance

Because of increasing international trade and cross-border links, there is

significant pressure for the development of internationally comparable practices
and standards.

Accounting and financial reporting is one area in which this has occurred.
Increasing international investment and integration of international capital
markets has also led to pressure for standardization of governance guidelines, as
international investors seek reassurance about the way their investments are being
managed and the risks involved.

The Organization for Economic Co-operation and Development (OECD) has

carried out an extensive consultation with member countries, and developed a set
of principles of corporate governance that countries and companies should
work towards achieving. The OECD has stated that its interest in corporate
governance arises from its concern for global investment. Corporate governance
arrangements should be credible and should be understood across national
borders. Having a common set of accepted principles is a step towards achieving
this aim.

The OECD developed its Principles of Corporate Governance in 1998 and issued
a revised version in April 2004. They are non-binding principles, intended to
assist governments in their efforts to evaluate and improve the legal, institutional
and regulatory framework for corporate governance in their countries.

They are also intended to provide guidance to stock exchanges, investors and
companies. The focus is on stock exchange listed companies, but many of the
principles can also apply to private companies and state-owned organizations.

The OECD principles deal mainly with governance problems that result from the
separation of ownership and management of the company. Issues of ethical
concern and environmental issues are also relevant, although not central to the
problems of governance.

2.3.1 The OECD principles

The OECD principles are grouped into five broad areas:

(a) The rights of shareholders

Shareholders should have the right to participate and vote in general

meetings of the company elect and remove members of the board and
obtain relevant and material information on a timely basis. Capital

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 markets for corporate control should function in an efficient and timely
manner.

(b) The equitable treatment of shareholders

All shareholders of the same class of shares should be treated equally,

including minority shareholders and overseas shareholders.

(c) The role of stakeholders

Rights of stakeholders should be protected. All stakeholders should have

access to relevant information on a regularly and timely basis.
Performance-enhancing mechanisms for employee participation should be
permitted to develop. Stakeholders, including employees, should be able
to freely communicate their concerns about illegal or unethical
relationships to the board.

(d) Disclosure and transparency

Timely and accurate disclosure must be made of all material matters

regarding the company, including the financial situation, foreseeable risk
factors, issues regarding employees and other stakeholders and
governance structures and policies. The company’s approach to disclosure
should promote the provision of analysis of advice that is relevant to
decisions by investors.

(e) The responsibilities of the board

The board is responsible for the strategic guidance of the company and for
the effective monitoring of management. Board members should act on a
fully informed basis, in good faith, with due diligence and care and in the
best interests of the company and its shareholders. They should treat all
shareholders fairly. The board should be able to exercise independent
judgment; this includes assigning independent non-executive directors to
appropriate tasks.

2.4 Sarbanes-Oxley

The Sarbanes-Oxley legislation requires directors to report on the effectiveness of

the controls over reporting, limits the services auditors can provide and requires
listed companies to establish an audit committee. It adopts a rules-based
approach to governance.

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The Enron Scandal

The most significant scandal in America in recent years has been the Enron
scandal, when one of the country’s biggest companies filed for bankruptcy. The
scandal also resulted in the disappearance of Arthur Andersen, one of the Big Five
accountancy firms who had audited Enron’s accounts. The main reasons why
Enron collapsed were over-expansion in energy markets, eventually too much
reliance on derivatives’ trading which eventually went wrong, breaches of federal
law, and misleading and dishonest behavior. However enquiries into the scandal
exposed a number of weaknesses in the company’s governance.

A lack of the transparency in the accounts

This particularly related to certain investment vehicles that were kept off balance
sheet. Various other methods of inflating revenues, offloading debt, massaging
quarterly figures and avoiding taxes were employed.

Ineffective corporate governance arrangements

The company’s management team was criticised by being arrogant and over
ambitious. The Economist suggested that Enron’s Chief Executive Officer,
Kenneth Lay, was like a cult leader with his staff and employees fawning over his
every word and following him slavishly. The non-executive directors were weak,
and there were conflicts of interest. The chair of the audit committee was Wendy
Gramm; her husband, Senator Phil Gramm, received substantial political
donations from Enron.

Inadequate scrutiny by the external auditors

Arthur Andersen failed to spot or failed to question dubious accounting

treatments. Since Andersen’s consultancy arm did a lot of work for Enron, there
were allegations of conflicts of interest.

Information asymmetry

That is the agency problem of the directors/managers knowing more than the
investors. The investors included Enron’s employees. Many had their personal
wealth tied up in Enron shares, which ended up being worthless. They were
actively discouraged from selling them. Many of Enron’s directors, however,
sold the shares when they began to fall, potentially profiting from them. It is

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alleged that the Chief Financial Officer, Andrew Fastow, concealed the gains he
made from his involvement with affiliated companies.

Executive compensation methods

These were meant to align the interests of shareholders and directors, but seemed
to encourage the overstatement from short-term profits. Particularly in the USA,
where the tenure of Chief Executive Officers is fairy short, the temptation is
strong to inflate profits in the hope that share options will have been cashed in by
the time the problems are discovered.

The Sarbanes-Oxley Act 2002

In the US the response to the breakdown of stock market trust caused by

perceived inadequacies in corporate government arrangements and the Enron
scandal was the Sarbanes-Oxley Act 2002. The Act applies to all companies that
are required to file periodic reports with the Securities and Exchange Commission
(SEC). The Act was the most far-reaching US legislation dealing with securities
in many years and has major implications for public companies. Rule-making
authority was delegated to the SEC on many provisions.

Sarbanes-Oxley shifts responsibility for financial probity and accuracy to the

board’s audit committee, which typically comprises three independent directors,
one whom has to meet certain financial literacy requirements.
Along with rules from the Securities and Exchange Commission, Sarbanes-Oxley
requires companies to increase their financial statement disclosures, to have an
internal code of ethics and to impose restrictions on share trading by, and loans
to, corporate officers.

Detailed provisions of The Sarbanes-Oxley Act

Public Oversight Board

The Act set up a new regulator, the Public Company Accounting Oversight Board
(PCAOB), to oversee the audit of public companies that are subject to the
securities laws.

The Board has powers to set auditing, quality control, independence and
ethical standards for registered public accounting firms to use in the preparation
and issue of audit reports on the financial statements of listed companies. In

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particular the board is required to set standards to registered public accounting
firms’ report on listed company statements on their internal control over financial
reporting. The board also has inspection and disciplinary powers over firms.

Auditing standards

Audit firms should retain working papers for at least seven years; have quality
control standards in place such as second partner review. As part of the audit
they should review internal control systems to ensure that they reflect the
transactions of the client and provide reasonable assurance that the transactions
are recorded in a manner that will permit preparation of the financial
statements in accordance with generally accepted accounting principles. They
should also review records to check whether receipts and payments are being
made only in accordance with management’s authorization.

Non-audit services

Auditors are expressly prohibited from carrying out a number of services

including internal audit, bookkeeping, systems design and implementation,
appraisal or valuation services, management functions and human resources,
investment management, legal and expert services. Provision of other non-audit
services is only allowed with the prior approval of the audit committee.

Quality control procedures

There should be rotation of lead or reviewing audit partners every five years and
other procedures such as independence requirements, consultation, supervision,
professional development, internal quality review and engagement acceptance and
continuation.

Auditors and audit committee

Auditors should discuss critical accounting policies, possible alternative

treatments, the management letter and unadjusted differences with the audit
committee.

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Audit committee

Audit committees should be established by all listed companies.

All members of audit committee should be independent and should therefore not
accept any consulting or advisory fee from the company or be affiliated to it. At
least one member should be a financial expert. Audit committees should be
responsible for the appointment, compensation and oversight of auditors.
Audit committee should establish mechanism for dealing with complaints about
accounting, internal controls and audit.

Corporate responsibility

The chief executive officer and chief finance officer should certify the
appropriateness of the financial statements and that those financial statements
fairly present the operations and financial condition of the issuer. If the
company has to prepare a restatement of accounts due to material non-compliance
with standards, the chief finance officer and chief executive officer should
forfeit their bonuses.

Off balance sheet transactions

There should be appropriate disclosure of material off-balance sheet

transactions and other relationships (transactions that are not included in the
accounts but the impact upon financial conditions, results, and liquidity or capital
resources).

Internal control reporting

Annual reports should contain internal control reports that state the
responsibility of management for establishing and maintaining an adequate
internal control structure and procedures for financial reporting. Annual
reports should also contain an assessment of the effectiveness of the internal
control structure and procedures for financial reporting. Auditors should
report on this assessment.

Companies should also report whether they have adopted a code of conduct for
senior financial officers and the content of that code.

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 Whistleblowing provisions

Employees of listed companies and auditors will be granted whistleblower

protection against their employers if they disclose private employer information
to parties involved in a fraud claim.

2.5 Malaysian Code of Corporate Governance.

 The Malaysian Code on Corporate Governance (MCCG) introduced in 2000, has
been a significant tool for corporate governance reform, and has influenced
corporate governance practices of companies positively.

 The MCCG reflects global principles and internationally recognized practices of

corporate governance which are above and beyond the minimum required by
statute regulations or those prescribed by Bursa Malaysia.

 The MCCG permits a more constructive and flexible response to raise standards
of corporate governance. It recognizes that there are aspects of corporate
governance where statutory regulation is necessary and others where self-
regulation complemented by market regulation is more appropriate.

 The MCCG was reviewed in 2007 and 2012 to ensure that it remains relevant and
is aligned with globally recognized best practices and standards.

 In 2017, the MCCG, which supersedes its earlier edition, takes on a new approach
to promote greater internalization of corporate governance culture.

2.5.1 Key features of the new approach.

Identify
exemplary
The The shift from Greater focus Guidance to practices
Comprehend, comply or and clarity on assist which support
Apply and explain to the Intended companies in companies in
Report apply or Outcomes for applying the moving
approach - explain an each practice Practices towards
CARE alternative greater
excellence –
Step Ups

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 As listed companies are not a homogeneous group, it is necessary to provide
flexibility and proportionality in the application of certain best practices.
Certain practices are applicable only to Large Companies.

Large Companies are:

 Companies on the FTSE Bursa Malaysia Top 100 Index; or

 Companies with market capitalization of RM2 billion and above,

at the start of the companies’ financial year.

Once a company is under the category of Large Companies, it will remain as one
for the entire financial year regardless of the change in its status during the
financial year.

These companies should continue applying the practices even if they fall out of
the FTSE Bursa Malaysia Top 100 Index or their market capitalization decreases
below the prescribed threshold. Other listed companies may consider adopting the
practices identified for Large Companies if they aspire to achieve greater
excellence in corporate governance.

While the MCCG is targeted at listed companies, non-listed entities including

state-owned enterprises, small and medium enterprises (SMEs) and licensed
intermediaries are encouraged to embrace this code on corporate governance.
These non-listed entities should consider applying their practices in the MCCG to
enhance their accountability, transparency and sustainability.

2.5.2 Comprehend, Apply and Report (CARE).

Comprehend, Apply and Report or CARE encourages companies to clearly

identify the thought processes involved in practicing good corporate governance
including providing fair and meaningful explanation of how the company has
applied the practices.

COMPREHEND.

Good corporate governance practices instill in companies the required vision,

processes and structures that ensure long-term sustainability. It is also critical to
support good corporate citizenship, which is a commitment to ethical behavior in
business strategy, operations and culture. In today’s globalized and interconnected
world, investors, creditors and other stakeholders are increasingly recognizing

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that economic, environmental and social responsibilities are integral to the
company’s performance and long-term sustainability.

Boards should therefore understand and incorporate these new dimensions into
their core decision-making processes to ensure that companies operate
successfully and sustain growth.

APPLY.

“Apply or explain an alternative.”

The MCCG adopts a novel approach of “apply or explain an alternative.”

Under this approach, listed issuers must explain how they have applied the
practices identified and where there is a departure; there must be clear and
meaningful disclosure on why the practice was not applied and how the
alternative practice achieves the Intended Outcome. The Intended Outcome
is meant to provide listed issuers with the line of sight and intention of the
practices.

Where applicable, a listed company should advocate the adoption of the best
practices in the MCCG by its subsidiaries, in order to promote a holistic adoption
of corporate governance practices and culture within the group (a listed company
and its subsidiaries)

In order for the “apply or explain an alternative” approach to work and be

sustainable, listed issuers need to demonstrate genuine commitment to good
governance and give proper consideration to the explanations. Stakeholders on the
other hand, should engage listed issuers and scrutinize the disclosures made by
them so as to ascertain if the explanations provide meaningful representation of
the listed issuers’ corporate governance practices. Communication by listed
issuers on plans to adapt and improve corporate governance practices can serve to
assure stakeholders that the business is being run for the long-term and in the
interests of the stakeholders. Simply put, when there is a mutually reinforcing
effort between listed issuers and stakeholders, particularly shareholders, the
“apply or explain an alternative” model can be an effective tool in driving
continuous improvement on corporate governance practices and disclosures.

REPORT.

Companies must provide meaningful explanation on how it has applied each

Practice. Where there is a departure from a Practice, the company must-

 Provide an explanation for the departure; and

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  Disclose the alternative practice it has adopted and how the alternative
practice achieves the Intended Outcome.

In addition to the above, where Large Companies depart from a Practice, they are
also required to disclose-

 Actions which they have taken or intend to take; and

 The timeframe required

for them to achieve application of the prescribed Practice. A short timeframe will
signify the commitment and seriousness of the board in adopting good corporate
governance practices. A timeframe of 3 years or less would be considered as
reasonable. Non – large companies with departures are also encouraged to adopt
the practices within 3 years or less.

2.5.3 Structure.

The structure of the MCCG is as follows:

Principles.

The MCCG is based on three key principles of good corporate governance, which
are-

Principle A

Board Leadership and Effectiveness

 Board Responsibilities
 Board Composition
 Remuneration

Principle B

Effective Audit and Risk Management

 Audit Committee
 Risk Management and Internal Control Framework

Principle C

Integrity in Corporate Reporting and Meaningful Relationship with

Stakeholders

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  Communication with Stakeholders
 Conduct of General Meetings

Intended Outcome

The Intended Outcome provides companies with the line of sight on what they
will achieve through practices.

Practices

Practices are actions, procedures, or processes which companies are expected to

adopt to achieve the Intended Outcome.

The Practices in the MCCG were crafted taking into consideration the existing
requirement in the law, Bursa Malaysia Listing Requirements, different sizes and
complexities of Malaysian companies and global developments in corporate
governance best practices.

2.6 Disclosure requirements on MCCG

Recognizing the need to equip stakeholders with adequate information on how the
affairs of the company are directed and managed with a view of promoting
business prosperity and corporate accountability, Paragraph 15.25 of Bursa
Securities Listing Requirements requires listed issuers to disclose their
application to the MCCG.

Paragraph 15.25 of Bursa Securities Listing Requirements.

1) A listed issuer must ensure that its board of directors provides an overview of the
application of the Principles set out in MCCG, in its annual report. Note: This is
referred to as the “CG Overview Statement.”

2) In addition, the listed issuer must disclose the application of each Practice set out in the
MCCG during the financial year, to the Exchange in a prescribed format and announce
the same together with the announcement of the annual report. The listed issuer must
state in its annual report, the designated website link or address where such disclosure
may be downloaded. Note: This is referred to as the “CG Report.”

2.6.1 CG Overview Statement

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 The CG Overview Statement serves to provide stakeholders with an
understanding of a listed issuer’s commitment to corporate governance and how
the listed issuer’s corporate governance practices support its ability to create long-
term value for stakeholders.

In producing the CG Overview Statement, a listed issuer must disclose a

summary of it’s corporate governance practices during the financial year
with reference to the 3 Principles. Listed issuers should outline their approach
to corporate governance and the key features of their corporate governance
framework. There should be a statement on the extent to which the listed issuer
has applied the Practices encapsulated in the Principles of MCGG during the
financial year and the linkages to the information presented in the CG Report.
The listed issuer should also discuss how the practices support its overall
corporate governance objectives.

2.6.2 CG Report

As stated in Paragraph 15.25(2) of Bursa Securities Listing Requirements, a

listed issuer is required to disclose the application of each Practice set out in the
MCCG during the financial year to Bursa Malaysia Securities Berhad (“the
Exchange”) in a prescribed format (“CG Report”) and announce the same
together with the announcement of the annual report. The listed issuer must state
in its annual report, the designated website link or address where the CG Report
may be downloaded.

Essentially, the CG Report provides a platform for listed issuers to better profile
their strengths and corporate governance practices in a meaningful manner to
stakeholders. The detailed disclosures encapsulated in the CG Report allow
stakeholders to seamlessly assess the “corporate governance health” of listed
issuers besides aiding regulators in monitoring the corporate governance practices
of listed issuers to gain insights.

2.7 Approaches to corporate governance

2.7.1 Principal-based approach

A principal-based approach requires the company to adhere to the spirit rather

than the letter of the code.

The company must either comply with the code or explain why it has not through
reports to the appropriate body and its shareholders. However, in many

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principles-based jurisdictions, the code had to be followed in order to obtain a
listing on the relevant stock exchange. This means that the code is not quite
‘voluntary’.

Of the major corporate governance reports, the Hampel report (1998) in the UK
came out the strongest in favour of a principles-based approach. The committee
preferred relaxing the regulatory burden on companies and was against treating
the corporate governance codes as sets of rules, judging companies by whether
they have complied (‘box-ticking’). The reports states that there maybe
guidelines which will normally be appropriate but the differing circumstances of
companies meant that sometimes there are valid reasons for exceptions.

“Good corporate governance is not just a matter of prescribing particular

corporate structures and complying with a number of hard and fact rules. There is
a need for broad principles. All companies should then apply these flexibily and
with common sense to the varying circumstances of individual companies

Advantages of a principles-based approach

(a) It avoids the need for inflexible legislation that companies have to comply
with even though the legislation is not appropriate.

(b) It is less burdensome in terms of time and expenditure.

(c) It allows companies to develop their own approach to corporate governance

that is appropriate for their circumstances within the limits laid down by stock
exchanges.

(d) Enforcement on a comply or explain basis means that businesses can explain
why they have departed from the specific provisions if they feel it is
appropriate and create their own alternative method.

(e) A principles-based approach accompanied by disclosure requirements puts the

emphasis on investors making up their own minds about what businesses are
doing (and whether they agree departures from the codes are appropriate).

Criticisms of principles-based approach

(a) The principles set out in the Hampel report have been criticized as so broad
that they are of very little use as a guide to best corporate governance
practice.

(b) There maybe confusion over what is compulsory and what isn’t. Although
codes may state that they are not prescriptive, their adaptation by the local

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 stock exchange means that specific recommendations in the codes effectively
become rules, which companies have to obey in order to retain their listing.

(c) Some companies may perceive a principles-based approach as non-binding

and fail to comply without giving an adequate or perhaps any explanation.
Not only does this demonstrate a failure to understand the purpose of
principles-based codes but it also casts aspirations on the integrity of the
companies’ decision-makers.

2.7.2 Rules-based approach

A rules-based approach to corporate governance instils the code into law with
appropriate penalties for transgression. The code therefore has to be followed-and
if it is not followed then the directors are normally liable to a fine, imprisonment
or both. The US model is enshrined into law by virtue of SOX. It is therefore, a
rules-based approach.

Advantages of rules-based approach

(a) There is clarity in terms of what the company and directors must do to
comply with the corporate governance regulations.

(b) Standardization for all companies- there is no choice as to complying or

explaining and this creates a standardized and possibly fairer approach for
all businesses.

(c) There are criminal sanctions for non-compliance which means that there is
a greater like hood that the regulations will be followed. In a principles-
based approach, although there may be the threat of de-listing, there is no
penalty on the directors meaning that there can be less incentive to
actually follow the code.

Criticism of rules-based approach

(a) The fact that the regulations are statutory tends to lead to methods of
avoiding the “letter of the law” – that is loopholes will be found and
exploited.

(b) The rules are simply there; agreement with the rules is not required, only
compliance. In principles-based systems, there is the underlying belief

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 that the principles are accepted. In other words compliance is more likely
simply because companies and directors want to follow them to show
good corporate governance.

(c) Companies and directors must follow the rules that have been set. There is
no incentive to improve on the basic minimum standard, for example, in
terms of providing additional disclosure.

A principles-based system allows interpretation of the minimum standards

and in effect encourages additional disclosure where necessary as this
complies with the “spirit” of the regulations.

2.7.3 HYBRID APPROACH

Adopted in Malaysia. Combines mandatory laws and regulations with

standards and voluntary principles based on codes of best practices.

Allows companies to develop their own approach to corporate governance

based on their business needs, capability and own circumstances but
within the guidelines provided.

To provide an alternative if there are any deviation from the provisions of

the code to shareholders or relevant regulators in the annual report.

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