corporat governance

8/8/2019 Corporat Governance

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Corporate Governance

It is a system by which companies are directed and controlled in the interest of shareholders

and other stakeholders. Governance should not be confused with management. Management

is concerned with running the business operations of a company but governance is about

giving a lead to the company and monitoring and controlling management decisions, so as to

ensure that the company achieves its intended purpose and aims.

Corporate governance has become one of the most commonly used phrases in the current

global business vocabulary. The notorious collapse of Enron in 2001, one of America’s

largest companies, has focussed international attention on company failures and the role that

strong corporate governance needs to play to prevent them.

Purpose: Monitor those parties within a company who control the resources owned by

investors.

Objective-Primary: Contribute to improved corporate performance and accountability in

creating long term shareholder value.

The main issues covered by corporate governance are:

The role and responsibilities of the BOD.

Composition and balance of board.

Reliability of financial reporting

Quality of external audit work and report

Directors remuneration and rewards.

Corporate Social responsibility and business ethics.

Approaches to CG

There are 2 main approaches to CG:

1. Rules based e.g Sarbanes Oxley Act in US

2. Principles based e.g Combined Code In UK

Other International Codes

The OECD has laid down 6 basic principles of Corporate Governance:

Protection of the shareholders rights.

Rights and equitable treatment of shareholders.

Role and responsibility of the board.

Role of stakeholders.

Disclosure and transparency.

Integrity and ethical behaviour.



Characteristics of Corporate Governance

Discipline/Integrity-Senior management to adhere to proper behaviour.

Transparency/Openness-Making information available to an outsider.

Independence-avoid dominance or potential conflicts of interest. E.g appointments

and auditors.

Accountability- account for actions taken

Responsibility-allows for corrective actions and for penalising mismanagement.

Fairness-the rights of various groups have to be acknowledged and respected.

Probity/Honesty-telling the truth and not misleading shareholders.

Reputation-keeping organisation reputation high.

Judgement-making decisions that enhance the prosperity of the organisation.

Social Responsibility-respond to social issues and high ethical standards.

1.1 A Impact of Corporate Governance Accountability

Strengthened economy and sustainable development

Attract investors

Boost goodwill of company

1.1 B Impact of Corporate Governance on role of the accountant

As provider of financial information: financial reporting is a crucial element

necessary for the corporate governance system to function effectively.

The need for a strong and effective accounts and internal audit dept: the directors of

the company are aware that its prime responsibility to prepare the financial

information in compliance with statutory and ethical obligations, and rely on auditors’

competence to review the financial statements.

1.1 C Impact of Corporate Governance on role of the auditor

The external auditor must review it for inconsistencies with other information within

the annual report.

If inconsistencies are found, they may impact the audit report,

o If the inconsistency is material and directors refuse to amend the error, the

auditor may qualify the report.

o Or the auditor may give an ‘emphasis of matter’ opinion to bring the user

attention to a particular issue

There are two basic models of board structure:

1. Unitary board- all directors participate in a single board comprising both executive

and non-executive directors in varying proportion.

2. Two tier board-CG is exercised through two boards. The upper board supervises the

executive board on behalf of stakeholders. This model is adopted in Germany,

Holland, and to an extent, France. In this model although the shareholders own the

company, they do not entirely dictate the governance mechanism. This is made up of:

i. Supervisory board- the board has workers representatives and shareholdersrepresentatives including banks’ representatives. The board has no executive function.



ii. Management board- A mgt board or executive board, composed of entirely of

managers, will be responsible for the running of the business.

The UK Combined Code

All listed companies in the UK must comply with Combined Code. It is a principles basedapproach of ‘comply or explain’ basis to CG. Listed companies must include a CG sta tement

in their annual report.

The main requirements of the Combined Code are:

Chairman and CEO not same person.

Role of Board.

Non executive directors-NEDs.

Audit Committee.

Remuneration Committee. Nomination Committee.

Establishment of a sound system of internal control and its annual review.

The review of the risk management system.

Chairman and CEO

Division of responsibilities.

Should be different person.

The board to appraise performance of chairperson.

Chairperson appraise performance of CEO.

Chairman preferably independent non executive.

Role of Board and its Role

Ultimately accountable and responsible for the performance of the company.

Must give strategic direction to the company and appoint CEO.

Retain full and effective control of the company and monitor management in

implementing strategies.

Ensure companies comply with all relevant laws and regulation and that it

communicate openly and promptly.

Define levels of materiality and delegation.

Identify key risks and key performance indicators.

Non executive directors(NEDs)

NEDs are employed on a part time basis. They are not involved in the routine executive

management of the company. Their roles are:

Provide advice and direction to the company’s management in the development and

evaluation of its strategy.

Monitor the company’s legal and ethical performance. Represents the shareholders’ interests-no agency issue to reduce shareholders’ value.



Determine appropriate levels of remuneration for executives.

Remuneration Committee

It plays a key role in establishing remuneration arrangements. The committee will be staffed

by independent non executives directors, thus ensuring that executive directors do not settheir own remuneration levels. The committee determines the remuneration policy on behalf

of the board and the shareholder.

Nomination Committee

Responsible for recommending the appointments of new directors to the board.

Audit Committees

The board should establish an audit committee of at least three, or in the case of smaller

companies two members, who should all be independent non executives directors. At leastone member of the audit committee has recent and relevant financial experience.

1.2 A Functions or work done by audit Committee

Reviews the scope, results, cost effectiveness, independence and objectivity of

external audit and internal audit.

Review of internal controls procedures, accounting policies, management

information, the annual FS.

Ensure that the external auditors have performed an effective, efficient and

independent audit.

Deal with external auditors criticisms of management and ensure that the

recommendations of internal and external auditors have been implemented.

Review board papers.

Remind board of their rights, duties and responsibilities.

1.2 B Advantages

Improve the quality of financial reporting, by reviewing financial statements on behalf

of the board.

Create a climate of discipline and control which will reduce the opportunity for fraud.

Enable NEDs to contribute an independent judgement and play a positive role. Help the finance director- a forum where he can raise issues of concern.

Increase public confidence in the credibility and objectivity of financial statements.

1.2 C Disadvantages

Misunderstanding- fear that purpose is to catch management out and be a threat to

their authority or take some of their authority.

Too detailed- NEDs being overburdened with detail.

Cost- increase entity cost as the entity has to remunerate both executive and non

executive directors.



Powerful role of NEDs- as the audit committee will be made up mainly of NEDs, the

board may see this as a means of decreasing their power and possibly letting other

people run the company.

Coercive: risk that it may substitute or go beyond management responsibilities.

1.2 D Objectives

Increase public confidence regarding credibility and objectivity in reporting.

Assist directors in meeting their responsibilities regarding financial reporting

Strengthen the independence of audit function.

Improve communications between directors, auditors and management.

Board Committees

Main purpose: enable board of directors to delegate responsibilities for key areas. Thus

BOD can focus on strategy consist of: NEDs with expertise and skills in areas such asauditing.

Positives:

Give advisory opinion to BOD

Bring independence of thought and discussion and decisions.

Bring check and balance over executive powers.

Important:

They do not have decision making power( only BOD decide) Is complementary to BOD.( not supplementary or competing with board)

Report to BOD

Are watchdogs on behalf of shareholders. Look at interest of shareholders

Detailed focus on board matters

Internal Audit And Risk Management

The internal audit’s job may be to assist the board in risk management by: Providing objective assurance on the adequacy and effectiveness of the risk

management and internal control framework. Helping improve the processes by which risks are identified and managed. Helping strengthened and improve the risk management and internal control

framework. Provide advice on the design, implementation and operation of control systems,

identify opportunities to make control savings, and promote a risk and control culturewithin the organisation.

Act as facilitators, guiding managers and staff through a self assessments process,perhaps by leading workshops.



Question 1-June 2005You are a recently qualified Chartered Certified Accountant in charge of the internal auditdepartment of ZX, a rapidly expanding company. Turnover has increased by about 20% p.a.for the last five years, to the current level of $50 million. Net profits are also high, with anacceptable return being provided for the four shareholders. The internal audit department was

established last year to assist the board of directors in their control of the company and toprepare for a possible listing on the stock exchange. The Managing Director is keen to followthe principles of good corporate governance with respect to internal audit. However, he isalso aware that the other board members do not have complete knowledge of corporategovernance or detailed knowledge of International Auditing Standards.

Required:

Write a memo to the board of ZX that:

(a) Explains how the internal audit department can assist the board of directors in

fulfilling their obligations under the principles of good corporate governance. (10 marks)(b) Explains the advantages and disadvantages to ZX of an audit committee. (10 marks)

(20 marks)

(a) Memo

From: Chief Internal Auditor

To: Board of ZX

Subject: Role of Audit Committee

Date: June 2005

Board papers review- review to the board and papers produced by board to ensure

they are accurate, understandable, and relevant and present a balanced assessment of

company information and prospects.

Internal controls-as board need to maintain sound internal control system, internal

audit can assess the controls and its effectiveness and recommend improvement if

need be.

Good financial reporting(application of ISA and IAS) and disclosures- board need to

prepare FS according to required accounting framework. Internal audit is up to date

on the framework and hence can counsel board on this issue. It can also ensure that

the framework is being complied with appropriate disclosures in FS.

Ensure adherence to CG principles- internal audit must stress that CG is implemented.

Key element of CG is audit committee which among others establish a formal line of communication with external auditors. Audit committee also ensure that both internal

and external auditor work together to ensure that the internal control is strong.

Act as bridge between external auditor and BOD. There is a list of matters that the

external auditors must communicate to the board. Internal audit can follow up that

only appropriate information is furnished to the board by the external auditor.

Induction, training and briefing of new directors about CG and keep them updated all

the time.

Remind board members of their rights, responsibilities and duties in relation to GC

and the result of non compliance.

(b) refer to 1.2 B and 1.2 C



Question 2-June 2006You are the audit manager of Tela & Co, a medium sized firm of accountants. Your firm has

just been asked for assistance from Jumper & Co, a firm of accountants in an adjacentcountry. This country has just implemented the internationally recognised codes on corporategovernance and Jumper & Co has a number of clients where the codes are not being

followed. One example of this, from SGCC, a listed company, is shown below. As yourcountry already has appropriate corporate governance codes in place, Jumper & Co haveasked for your advice regarding the changes necessary in SGCC to achieve appropriatecompliance with corporate governance codes.Extract from financial statements regarding corporate governanceMr Sheppard is the Chief Executive Officer and board chairman of SGCC. He appoints andmaintains a board of five executive and two non-executive directors. While the board setsperformance targets for the senior managers in the company, no formal targets or review of board policies is carried out. Board salaries are therefore set and paid by Mr Sheppard basedon his assessment of all the board members, including himself, and not their actualperformance. Internal controls in the company are monitored by the senior accountant,

although detailed review is assumed to be carried out by the external auditors; SGCC doesnot have an internal audit department. Annual financial statements are produced, providingdetailed information on past performance.

Required:

Write a memo to Jumper & Co which:

(a) Explains why SGCC does not meet international codes of corporate governance

(b) Explains why not meeting the international codes may cause a problem for SGCC,

and

(c) Recommends any changes necessary to implement those codes in the company.

(20 marks)

(a)

Memo

From: A Manager, Tela & Co

To: Jumper & Co

Subject: Corporate Governance in the SGCC Company

Date: June 2006

Following your request on international codes of CG, please find hereunder my views and

recommendations on SGCC:CEO and Chairman

o The CEO and the chairman are the same person.o Good CG suggest that CEO and chairman of the board must be 2 different people.o Chairman controls the board whereas CEO runs the company.o It is suggested that a second person be appointed as chairman of the board.o Too much power is vested upon Mr Sheppard.



The board

o More executives than NEDs

o Good CG indicates that there must be a balance between executives and nonexecutives.

o Executives can dominate the board proceedings.

o It is suggested that there must be a majority of non executives. o Otherwise the board will have executive powers.

Appointments

o Too much power vested upon Mr Sheppard.o He can appoint any one he wishes to appoint as board member.o No care about the quality of director.o Suggested to set up a nomination cttee comprising of at least 3 NEDs.

Internal control and internal audit

o Internal control systems being reviewed properly. o Does not have an internal audit dept. o The ICS appears to be weak. o Good CG suggest that the control system to be monitored and internal audit dept be in

place. o Recommendation – set up and internal audit dept.

- Internal audit dept to report to an audit cttee.

Remuneration

o Board members’ pay is set by Mr Sheppard. o The remuneration structure is not transparent and Mr Sheppard sets his own pay.o Set remuneration without assessing suitable criteria.o Recommendations- set up of a remuneration cttee.

- Set remuneration levels for the board, taking into accountcurrent salary levels and the performance of board members.

- Remuneration should be linked to performance, to encourage ahigh standard of work.

Financial Statements

o FS provide information on past results of the company. o IFRSs state that when preparing Fs mgt should make an assessment of the company’s

ability to continue as a going concern. o FS should also contain information about the future development and some forecasted

financial figures to help investors to take decisions. o Advisable for SGCC to include information about future operations.

Risk Management

o No mention about risk management. o

Good CG suggest that risk mgt is effected by the BOD, mgt and all employees inaccordance with their defined roles within the organisation.



o Recommendations- board must communicate its risk mgt policies to mgt and allemployees.

- The board is responsible to the total process of risk mgt.

I hope this information is useful. Please contact me again if you require any further

assistance.

Sincerely,

XXX

corporat governance

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