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Companies and Corporate Governance – An Overview

by Ahmed Ibrahim  - 

Everyone dealing with a company, whether as shareholder, stakeholder (suppliers, distributors, agents, and so on.) or director wishes it to be well managed, or at the very least managed for their own benefit.

Of these stakeholders, the only group actually in a position to ensure that the company is managed for their own benefit are the directors. In the meantime, the only group who can control the directors and monitor their performance are the shareholders. So, the relationship between the shareholders and directors is of great importance.

Stock markets and public companies exist to offer the public the opportunity to invest and own shares in companies without involvement in their management. In general, shareholders of public companies acquire their shares on the stock market from other shareholders who want to sell part or whole of their stake in the company in question without having a particular interest in the management of the company. In some companies a wide spread of ownership of shares means that no one shareholder or group of shareholders can exercise effective control over the directors, so if shareholders do not like the performance of a company’s directors, rather than trying to influence the directors, they sell their shares.

In view of these facts, the concept of separation between ownership and management has emerged and that was an underlying rationale behind the introduction of corporate governance rules. In general, corporate governance rules aim to provide “the system by which companies are directed and controlled” . It involves regulatory and market mechanisms, and the roles and relationships between a company’s management, its board, its shareholders and other stakeholders, and the goals for which the corporation is governed . It is to ensure that the Company is managed in an efficient and ethical manner for the benefit of all shareholders over the longer term.

Following the general international business and corporate practices, H.E. Sultan bin Saeed Al-Mansoori, Economy Minister and Board Chairman of the Emirates Securities and Commodities Authority (SCA) has issued decree no. 518 of 2009 on rules and regulations of corporate governance and institutional code of conduct (“Decree”).

Broadly speaking, the Decree sets out:

  1. how board of directors should be composed and its tenor;
  2. types of board members;
  3. the role of the Chairman of the board;
  4. board committees;
  5. remuneration of board members;
  6. internal control; and
  7. external auditors.

The Securities and Commodities Authority (“SCA”) is the authority in charge of supervising, controlling and verifying the compliance of companies with the Decree. The provisions of the Decree are applicable on all companies and institutions whose securities have been listed on a securities market in the UAE and to their board members. By way of exception, the Decree does not apply to companies and institutions that are wholly owned by the Federal Government or a local government.

The Board of Directors of SCA may exempt companies in which the Federal Government or a local government own shares from certain provisions of the Decree; provided, however, that a company's request reflects the provisions from which the company is requesting exemption and the causes of exemption.

Board members and their appointment.

The members of the first board of directors of a company should be elected by the founders, while the members of subsequent boards will be elected for a fixed term by the company's shareholders, the formation of which must take into consideration an appropriate balance between executive, non-executive and independent board members to comply with the Decree.

In this regard, the Decree requires that the composition of the board of directors to be as follows:

  1. at least one-third of members are independent members; and
  2. a majority of members shall be non-executive members who shall have technical skills and experience in order to achieve the best interest of the company.

In all cases, when selecting non-executive members of a company, they should allocate adequate time and exert effort to his/her membership. Board members must not have a conflict of interest with the business of the company in question. The duties of non-executive board members, in particular, include:

  1. participation in board meetings to give an independent opinion in respect of strategic issues, policy, performance, accounting, resources, basic appointments and standards of operation;
  2. giving priority to the interests of the company and its shareholders upon conflict of interest;
  3. participation in the audit committees of the company;
  4. follow-up of the company's performance in order to achieve agreed objectives and purposes and oversee performance reports; and
  5. empowering the board of directors and different committees through utilization of their skills and experience and the diversity of their competences and qualifications through regular attendance, effective participation, attendance of general assembly meetings and developing a balanced understanding of shareholders' views.

In general, each board member shall, when assuming his/her office duties, disclose to the company the nature of positions he/she assumes in companies and public institutions as well as other obligations, their set term and any changes related to it once the same takes place.

Having said that, the Decree defines independent board member as follows:

“a member who neither himself/herself, his/her spouse nor first-degree relative (father, mother, children, spouse, spouse's father, spouse's mother and stepchildren) is a member of the executive management of a company during the last two years or has a relationship that creates financial deals with a company, parent company, sister company or allied company during the last two years if the total amount of these transactions exceeds 5% of the paid-up capital of the Company, an amount of five million dirhams (AED 5,000,000.00) or an equivalent amount in a foreign currency, whichever is less.

 In particular, a board member does not meet the independence condition in the following cases:

  • he/she is an employee of any party related to the company during the last two years;
  • he/she is directly related to a company that performs consultation business or provides consultations to the company or any parties related thereto;
  • he/she enters into personal service contracts with the company, any party related to the company or the employees of the executive management of the company;
  • he/she is directly related to a non-profit organization that receives a considerable financing from the company or a party related thereto;
  • he/she is during the last two years related to or an employee of any external or former auditor of the company or any party related to the company;
  • if his/her or his/her minor children’s share or the share of both in the capital of the company amounts ten percent (10%) or more”.

The Decree also defines non-executive board member as follows:

“a member who is not dedicated on a full time basis to the management of a Company or does not receive a monthly or annual salary from a company. The remuneration received as a board member may not constitute a salary”

While the executive board member is defined as “a member who is dedicated on a full-time basis to the management of a company or who receives a monthly or annual salary from a company.

Chairman and Chief Executive Officer

In principle, the roles of the Chairman and the Chief Executive Officer should not be carried out by the same individual. In particular, the Chairman’s duties are:

  1. ensuring the efficient and timely performance and discussion of all main issues by the board;
  2. Responsible for the agenda of every meeting of the board taking into consideration any matter proposed by his fellow directors. This responsibility can be delegated by the Chairman to another director or the secretary of the board;
  3. encouraging all directors to fully and efficiently participate in handling the affairs of the board and ensuring that the board is working in the best interests of the Company;
  4. taking appropriate measures to ensure efficient communication with the Company’s shareholders;
  5. allowing efficient participation of non-executive directors and promoting constructive relations between executive and non-executive directors.

Board Committees

There are two essential standing committees that the board of directors must form, namely:

  1. The audit committee, which  monitors the company’s financial statements, to renew and recommend changes to the financial and control systems and to maintain an appropriate relationship with the company's external auditors; and
  2. The nomination and remuneration committee to set the policy for the remuneration of the executive management, determine targets for performance-related pay and determine the total individual remuneration package of each executive director, including salary, bonuses, pensions and incentive schemes.  

Committees must comprise at least three (3) non-executive board members, of whom at least two (2) members are independent members and to be chaired by either independent members. The chairman of the board of directors may not be a member of any such committees. The board of directors shall select non-executive board members for the committees charged with the duties that may result in conflict of interests, such as verification of the integrity of financial and non-financial reports, review of deals concluded with interested parties, selection of non-executive board members and fixation of remuneration.

Other European and Middle Eastern jurisdictions, such as England and Egypt, require a third committee affiliated to the board in charge of monitoring business risks, namely the Risk Committee.

Remuneration of Board members

Under Article (118) of the Law of Commercial Companies No. (8) of 1984, the remunerations of board members may be a percentage of net profit. The Company may also pay ancillary expenses or fees or a monthly salary in the amount fixed by the board of directors to any member if such a member works in any committee, exerts special efforts or undertakes additional duties for the company beyond his/her normal duties as a member of the board of directors of the company. In all cases, the remunerations of board members may not exceed ten percent (10%) of net profits, having deducted depreciation, reserve and distribution of a dividend of at least five percent (5%) of capital to shareholders.

Internal Audit

A company has to apply a precise internal control system that aims at developing an assessment of the company's risk management means and measures, sound application of governance rules, verification of compliance by the company and its employees with applicable laws.

External Auditor(s)

The board of directors shall nominate an external auditor at the recommendations of the Audit Committee. Appointment is to be made and remunerations are to be fixed by a resolution of the general assembly of the Company. The external auditor shall be independent from the Company and its board of directors and may not be a partner, agent or a relative, even of the fourth degree, of any founder or board member of the company.

Following the same principle set out by the US Sarbanes Oxley Act, was formulated in the wakes of the “Enron” scandal, the Decree provides that external auditors may not, while assuming the auditing of the company's accounts, perform any technical, administrative or consultation services or works in connection with its assumed duties that may affect its decisions and independence or any services.

These mandatory rules of corporate governance are applicable on public companies only, private joint stock and limited liability companies may also select the best of these rules as a code of best practice. It would assist these companies to manage their business properly and formulate solid grounds for future expansion with possibilities of going public or attracting strategic investors. Any outside investor will find a company governed well and ethically an attractive proposition, particularly if it has a track record extends back over time.

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