ROLE OF SECP(Securities And Exchange Commission Of Pakistan) IN CORPORATE GOVERNANCE

Role of SECP  in Corporate Governance

Introduction

Corporate Governance

“Formal system of accountability and control for a legal, ethical and socially responsible decisions and use of resources in business organization”

Top to Down Process

Corporate Governance Functions Þ Millstein et al.

Consistent Improvement of existing laws

Issue of Code of Corporate Governance

In March 2002

United Nation Development Programs & Economic Affair Division

Under the Section of 34(4), SECP issued  directions to KSE, ISE & LSE

Code Vs Corporate Law

Corporate Laws Review Commission (CLRC)

Significance of Corporate Governance arises with the increasing number of Corporate Scandals

Contents

Historical Prospective

Tool of corporate management

Strengthens social, cultural and religious values of a country

Corporate environment

Corporate governance issues

Corporate law in Pakistan

Historical Prospective

Contents

History Of Corporate Governance In Pakistan

sole proprietorship

conflict of interest

Corporate entities regulated by SEC

Corporate Law Authority

Corporate Governance framework

Islamic Ethics

Initiatives taken by SECP

Issuance of Code

Further explanations & interpretations

Formation of PICG

Notification on CSR

Corporate Governance in Banks

History Of Corporate Governance In Pakistan

Contents

Creation of SECP

set up in pursuance of the SECP Act, 1997

SECP became operational in January 1999

initially concerned with the regulation of corporate sector and capital market

Vision

Mission

Strategy

Creation of Securities and Exchange Commission of Pakistan

Contents

Major Institutions

SECP

SBP

PICG

ICAP

KSE, LSE, ISE

IFC’s Corporate Governance Project in Pakistan

LUMS

IBA, Karachi

ACCA, Pakistan

Institutions Contributing for implementing Corporate Governance in Pakistan

Contents

Constitution of Corporate Law Authority

Notified by: Federal Government

Number of Members: Not more than 3

Federal Government appoints Chairman

Powers and functions of the Authority

Specify limitations & conditions

Purpose of Proceeding/enquiry

Produce, specify & examine books, accounts etc.

CLA vs. SECP

Role, Function and Legal Framework of Corporate Law Authority Of Pakistan

Contents

SECP regulates the corporate sector

Under SEC Act, 1997

Companies Ordinance, 1984

Objectives of the CLRC

To access the companies ordinance objectives

To develop and maintain the efficient, deregulated and cost effective corporate sector

To prepare and revise the conceptual framework

Redraft the companies ordinance law

Review the structure and contents

To balance the international practices and indigenous conditions

Execution of the work

A conceptual paper

A draft bill

A statement of the objects and reasons of amendments

A report

Companies Ordinance 1984 and Its Implementation

Contents

SECP issued Code of Corporate Governance

Best performance & ensure company’s conformance in the long run

Benefits of SECP that relates to corporate governance in Pakistan

- Competitive market                        - Corporate sector growth

- Corporate sector growth               - Attract capital & investors

            -  Enhance the productivity & expansion of the business

Company Law division, specialized company division including Modaraba creation

Basis of Islamic economic principles

  

Role, Function and Legal Framework of SECP

Contents

SECP Divisional Structure

SECP functional profile

Advisory wing

To provide legal advice to the operational divisions and other departments of SECP

Litigation

To Manage the operational divisions and other departments of SECP

Legislation

Amendment and vetting from the Federal Government and for the SECP

Role, Function and Legal Framework of SECP (cont.)

Conclusion

SECP successfully implemented the effective code of corporate governance

It ensured the conformance to the applicable laws, rules and practices

Better outcome and streamline operations within the corporate enterprise

Recommendations

Effective and better implementation of the identified methods and principles of corporate governance

Consistent examination of the companies ordinance

Redrafting the law

Only professional accountants should be the Chief Finance Officer

The auditors must be appointed by the SECP

DIVIDEND POLICY AND RETAINED EARNINGS

Dividend Policy and Retained Earnings

v  Optimal Dividend Policy

v  Conflicting Theories

v  Other Dividend Policy Issues

v  Residual Dividend Theory

v  Stable Growth in Dividend Policy

v  Some Additional Considerations

v  Stock Dividends and Stock Splits

v  Stock Repurchases

v  Optimal Dividend Policy

  The optimal dividend policy should maximize the price of the firm’s stock holding the number of shares outstanding constant.

 

v  A decision to increase dividends will raise D₁ putting upward pressure on P₀. Increasing dividends, however, means reinvesting fewer dollars, lowering g, and putting downward pressure on P₀.

  Problem: What is the correct balance between dividends and retained earnings?

 Conflicting Theories

 Dividend Policy is Irrelevant:

v  (Dividend Irrelevance Theory)

  Assuming:

 No transactions costs to buy and sell securities

No flotation costs on new issues

 No taxes

 Perfect information

  Dividend policy does not affect k_e

Dividend policy is irrelevant. If dividends are too high, investors may use some of the funds to buy more of the firm’s stock. If dividends are too low, investors may sell off some of the stock to generate additional funds.

 High Dividends Increase Stock Value:

v  (Bird-in-the-Hand Theory)

Dividends are less risky. Therefore, high dividend payout ratios will lower k_e (reducing the cost of capital), and increase stock price.

Low Dividends Increase Stock Value:

v  (Tax Preference Theory)

  Dividends received are taxable in the current period. Taxes on capital gains, however, are deferred into the future when the stock is actually sold. In addition, the maximum tax rate on capital gains is usually lower than the tax rate on ordinary income. Therefore, low dividend payout ratios will lower k_e (reducing the cost of capital), raise g, and increase stock price.

v  Conflicting Theories (Continued)

 Empirical Evidence:

No conclusive proof, one way or another.

  Difficult to hold the rest of the world constant while we study dividend policy.

 Cannot measure the cost of equity (k_e) with a high degree of accuracy.

v  Other Dividend Policy Issues

Clientele Effect: Investors needing current income will be drawn to firms with high payout ratios. Investors preferring to avoid taxes will be drawn to firms with lower payout ratios. (i.e., firms draw a given clientele, given their stated dividend policy). Therefore, firms should avoid making drastic changes in their dividend policy.

Information Content: Changes in dividend policy may be signals concerning the firm’s financial condition. A dividend increase may signal good future earnings. A dividend decrease may signal poor future earnings.

v  Residual Dividend Theory

  Retain and reinvest earnings as long as returns on the investments exceed the returns stockholders could obtain on other investments of comparable risk. This concept is illustrated graphically below. A corporation should retain all necessary earnings to invest up to the level indicated by the intersection of the MCC (marginal cost of capital) and IOS (investment opportunity schedule) functions. Residual earnings are distributed to shareholders.

  Stable Growth in Dividend Policy

  Most corporations attempt to maintain a stable growth in dividend policy:

Many financial institutions invest only in companies with regular dividend payments.

 Perhaps leads to higher stock prices:

o   (Lower risk - lower k_e - higher P₀)

o   As a result, dividends tend to be a function of the “sustainable growth” in earnings.

Stable Growth in Dividend Policy (Cont)

v  Some Additional Considerations

Legal Restrictions: Dividends cannot be paid out of the permanent capital accounts.

 Liquidity: Retained earnings and cash are not identical.

  Access to other sources of financing.

 Stability of earnings.

 Restrictions in debt contracts.

v  Some Additional Considerations (Continued)

  Ownership Control: Smaller firms may be averse to issuing new stock due to dilution of corporate control. Therefore, retain earnings and pay few dividends.

 Inflation: Since replacement costs of assets are higher in inflationary periods, more retention of earnings may be required.

  Dividend Reinvestment Plans: Investors can automatically reinvest dividends often at a discount with no transaction costs. Frequently a good investment tool. Companies may use these plans to raise additional equity capital.

v  Stock Dividends

 Accounting for stock dividends:

o   Retained Earnings    xxxx

§  Common Stock     xxxx

§  Paid-in-Capital      xxxx

  The market value of the stock dividend is taken out of retained earnings and placed into the permanent capital accounts.

§  Stock Splits

No changes in the capital accounts.
Par value decreased.

 Number of shares outstanding increased.

The Impact on Stockholders’ Wealth
of Stock Dividends and Stock Splits

 Everything else remaining the same, stock dividends and stock splits do not increase stockholder wealth. Perhaps, however, they are beneficial in the long-run due to the “optimal price range” concept.

Price may rise, however,  if other variables also change (e.g., cash dividends increase, higher expected future earnings)

Stock Repurchases
(A Corporation Acquires its Own Stock)

Alternative to cash dividends: Shares outstanding are reduced, EPS increases, and if the P/E does not change, the stock price increases. (i.e., capital gains are substituted for cash dividends). Stock repurchases may be a sound strategy for firms with “temporary” excess cash.

Share price too low: Outstanding shares may be repurchased to drive the stock price up to a “more appropriate” level.
  Change the capital structure quickly: Issue debt and use the proceeds to buy back outstanding stock.

TAXATION OF U.S. MULTINATIONAL CORPORATIONS

Taxation of U.S. Multinational Corporations

Overview

Federal corporate tax rate is 35%

•         Tax rate is same for purely domestic firms and for U.S. multinational corporations (MNCs) who make profits abroad

•         MNCs pay an additional state corporate tax rate ranging from 4 to 6%

Current U.S. corporate tax system takes a worldwide approach

•         All foreign subsidiaries are subject to US taxation under the “worldwide income” concept

Therefore, U.S. MNCs:

•   Re-invest large portions of their income abroad in low-tax countries

•   Repatriate only a limited percentage of total income made in host countries

•   Also obtain U.S. tax credits for the foreign taxes paid on the total income made abroad

•         Because of the shift to reporting income abroad, the U.S. corporate tax base remains narrow and corporate tax revenues as share of GDP low

•         Total share of U.S. corporate tax revenues as percentage of all tax receipts was 30% in 1950 and 6.6% in 2009

•         U.S. corporate tax rate has not changed much since 1986

•         Among OECD members, U.S. tax rate is considerably higher than average rate; 1^st

 highest

•         However, other OECD members raise more tax revenues

Legislation

Tax credits

•         Firms are able to claim a tax credit for monies paid to governments abroad on income they earned in the foreign country (but only up to their U.S. tax liability on that income)

The U.S. attempted to mitigate this problem by granting additional tax credits

•         The American Jobs Creation Act of 2004 replaced the tax subsidies for exporting with new corporate tax benefits

•         Included a domestic production deduction- lowered the corporate tax rate by 3 percentage points on income from the domestic production activities of U.S. firms

•         And for 1 year the tax rate on dividend repatriations from low-tax countries was reduced to 5.25%

Legislation

Cross crediting

•         Firms use excess credits from income earned in high-tax countries to offset U.S. taxes due on income earned in low-tax countries

Active Financing Exception (aka Deferral)

•         Firms are not taxed by the U.S. on its overseas income until that income is remitted to the U.S. parent firm as dividends

Abuse of Transfer Pricing

Major Issues

•        U.S. Corporate Tax Rate

•        Active Financing (GE Example)

Corporate Tax Rates

Tax Loopholes

•         Companies have a huge incentive to pretend that their American operations pay too much or charge too little to their foreign operations for goods and services (for tax purposes only), thereby minimizing their U.S. taxable income.

•         Transfer prices shift income away from the U.S. and shift deductible expenses into the U.S.

•         Transferring ownership of long-lived, often intangible but highly profitable assets, like patents and software to overseas subsidiaries.

•         Aggressive lobbying for tax breaks.

General Electric

•         In 2010, GE reported profits of $14.2 billion, with $5.1 billion coming from operations in the U.S.

•         Tax bill for 2010 = 0; claimed a tax benefit of $3.2 billion.

•         Regulatory filings show that in the last 5 years, GE has accumulated $26 billion in American profits and received a net tax benefit from IRS of $4.1 billion, despite posting a loss in 2009 as a result of the financial crisis.

•         Fierce lobbying and “creative” accounting.

General Electric

Fierce Lobbying

•         In 2008, Congress threatened to let one of the most lucrative tax shelters expire.  GE’s tax team met with representative Charles Rangel of the Ways and Means Committee, who subsequently reversed his opposition to the tax break.   The following month, GE announced its foundation would award $30 million to New York City schools, including $11 million to schools in Rangel’s district.

•         In the past 10 years, GE has spent more that $200 million lobbying on Capitol Hill.

Creative Accounting

•         Consumer appliance division accounts for just 6% of GE’s revenue.

•         Industrial, commercial and medical equipment like power plant turbines and jet engines account for 50%.

•         Lobbying for changes in tax laws – depreciation schedules on jet engines to “green energy” credits for wind turbines.

•         Lending, through GE Capital, accounts for 30% - Active Financing.

Active Financing

•         Companies have long been allowed to defer taxes on income from overseas subsidiaries, but financial activities have traditionally been left out of this exemption because such activities are too easy to shift offshore.

•         Passed in 1997, active financing allows investment banks, brokerage firms, auto and farm equipment companies, and lenders like GE Capital to defer taxes on overseas profits, if those profits were derived by “actively financing” some activity or deal.

•         In other words, as long as a company claims that it intends to indefinitely invest profits outside of the U.S., they remain untaxed.

Active Financing

•         Proponents of active financing claim that the exemption helps “level the playing field” with foreign competitors by ensuring the U.S. corporations aren’t taxed twice.

•         Enhances competitiveness of U.S. corporations since many other countries have a much lower corporate tax rate and do not attempt to tax foreign income.

Active Financing

•         Opponents claim that the tax break creates an enormous tax shelter for companies who have lobbied it into law.

•         It encourages companies to create jobs overseas instead of in the United States.

•         The Joint Committee on Taxation estimates that the provision, which was extended for two years in 2010, will cost $9.61 billion in the two years to 2011. 

•        Other countries have broadened their tax base, which has allowed them to increase tax revenue as a share of GDP

•        Majority of other industrially advanced countries have revised and lowered their corporate tax rates

Proposal

Lower U.S corporate rates

•        White House Framework for Business Tax Reform:

•  Presented in Feb 2012.

•  Lowering the top income-tax rate for corporations from 35 percent to 28 percent .

Reactions

From multinational corporations:

•            Strong support although they point out that U.S. multinationals would still be paying higher taxes than their foreign rivals

From liberal groups (opposing view):

•            Need to eliminate corporate tax loopholes but without reducing the rates since there is a need for more revenue to address U.S long-term budget crisis. 

Benefits and Impact

•         Promote higher long-term economic growth.

•         Improve U.S. competitiveness.

•         Lead to higher wages and living standards.

•         Boost entrepreneurship, investment, and productivity.

•         Can attract foreign direct investment (FDI).

•         Lowers the tax burden on low-income taxpayers and seniors.

•         Lead to lower corporate debt and reduce the incentives for income shifting.

•         Reduce compliance costs.

Proposal

Do not extend active financing provision

•            The (FY) 2013 Budget propose extending the active financing exceptions

Reactions

Opposing View:

•             This exception helps "competitiveness" or "fairness“ for it allows US financial companies to compete on a level playing field with their foreign competitors when they go into overseas markets.

Proponents: 

•   As companies move abroad, they also move their manufacturing bases abroad to be closer to home as well as jobs.

•   Costs taxpayers US$5 billion a year.

Benefits and Impact

•  Its just another additional deficit to the U.S. budget.

•  Provides less of an incentive for multinational corporation to allocate their profits to foreign tax havens.

•  Addresses the issue of how companies shift income to other nations.